Thursday, October 18, 2012

stocks & bonds?

The market was up the other day because retail sales were up.   Last week it was down because of Euro worries.   Note that "because."  I have to admit that I have never quite understood the whole idea of stock markets.  Why should they go up and down like that?  How does the "because" fit in?

I look at starling flocks in the sky: sometimes they're here, sometimes they're there, the mass darkens and fades in response to mysterious messages, and the people who buy and sell stocks must be like that too.  Everyone's going here.  Let's go here!   No, everyone's going there.   Let's go there!  And starlings do it without six-figure bonuses.

The way I always understood it, and I'm being purposively naive here, the point of the stock market is to bring people with money to spare together with people who need money to do useful, or at least profitable, stuff.  In this imaginary world the stock market as a whole would reflect the current business climate and the stock price of any firm would reflect what the market thought about its prospects.  If this were actually the case, we would expect stock markets to be rather like other markets--supermarkets, for example, which bring people with money to spare together with groceries--that is, calm and efficient places operated by clerks, with fairly stable prices.

Obviously, the stock market is not like that.  The stock indexes and individual stocks go up and down, not only daily, but micro-secondly, and we read in the commentaries on these movements that they were "caused" by fluctuations in data, news about employment, housing starts, deliberations on the Euro, or some such, always after the fact.  These must be  explanatory fictions, since the fate of an actual existing firm cannot (except in the special cases, as, say, when a drug company's new drug fails or when one firm purchases another) be tied to the fate of some transient variable.

The number of variables that could possibly affect the real fate of firms must be so large as to be incalculable, and therefore these fluctuations must be in the same class as the roll of dice or the flight of my starlings.  It has been pointed out many times, by distinguished economists, that success on Wall Street is a random walk, and that it's really impossible for any stock market management to consistently beat the indexes.   We would expect, therefore, that the handling of stocks, like the handling of tomatoes, would be a clerkly function, and paid accordingly.

This, to put it mildly, is not what we see.  Colossal amounts of money are made in finance, and I don't think anyone really understands where it comes from.   What is the ultimate source of this Amazon of riches?   I used to think I knew what made money happen.  There's value added, for example.  Dirt gets turned into food and fiber.  Capital helps in this process by funding machines that make it more efficient, the society gets wealthier and everyone prospers.   There's innovation.  Everyone agrees that innovation should be richly rewarded: an industry springs into being where none was before.  There are various kinds of services that save time, from retail to airlines, and time is money.  (There are numerous actual investors in all this, people who study companies and buy and hold chunks of them, in the old fashioned way, and most people would agree that this is part of capitalism, and that the people who were smart enough to back Apple and Intel should get their share.)  But how did it happen that what should have been a mere ancillary service, greasing the transfer of money from savers to businesses, developed instead into the hypertrophied organism we now observe in New York and other financial centers?  Where do the billions actually arise and how does it flow in such volumes into the pockets of these guys?  Is it theft?  Is it looting?  What's the source? One is baffled and not a little annoyed; because one has a sneaking suspicion that some of those bucks should have ended up in my pocket, and yours.

And it's not as if these individuals are being rewarded for taking risks with their own money, to which some premium might conceivably be attached.  Heaven forbid!  Basically, or so it seems to me, they're being rewarded for going to Vegas with other people's money and putting a chip on red.  As long as red comes up, they're financial geniuses, the toast of Wall Street.  When black appears, they give way to the next genius, who has discovered the virtues of black.  They leave the scene with their hundreds of millions, a just reward, we think, because not everyone can place a chip on red with such flair.

Also, if the market is, indeed, a random walk, then anyone who consistently makes money through financial manipulations in the market, year after year, must be not a genius, but a cheat.  He knows, because someone told him, that red will come up on the next turn.  Yet no matter how many financiers are indicted and jailed, the whole thing goes on and on, and, as we've seen, in infects the real economy too.  It always has and it always will, until it's stopped.

It'd be real interesting to see someone come up with a general solution to the problem of financialization, although I don't expect the current batch of politicians to do it.  It's an Easter Island-level problem for us.  We've always built giant statues, ever bigger one, and we always will, until the society collapses.

 I should say that I have a simple financial plan.   When I first started to make serious money from my writing and realized that it could not last and that I had to put some of it away, and not into a place in Tuscany, I asked the guy who did my taxes what I should do.  My ignorance of markets was complete; never bought a stock in my life, missed many opportunities for billionairehood, I guess, but there it is.  He said, "Vanguard index funds, 60 per cent stock and 40 per cent bonds, stick a fifth of your gross in there, forget about it and you'll be fine."   So I did and I am fine.  I never made a lot of money, but I never lost a lot of money either, even in the crashes, since I started this plan.   I have more than enough to support my fairly modest life-style, even if I never sell another sentence.   This is how ignorant I am of financial affairs.  


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