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Tuesday, March 15, 2011

Q & A: Markets & Finance

I'm often asked questions about the stock market and finance by people who are curious about it but their knowledge is focused on other areas and pursuits.  I'm not asked so much about what to buy or where to invest because that's something I simply will not do.  Instead, I'm often asked about the psychology and temperament of markets, traders and investors and why the post 2008 market is so different.   I will try to answer some of the questions I get often asked as concisely and understandable as possible.

So let's start with one I am asked often...

Q:  Why are traders and investors such deeply arrogant people?

A:  Many traders are sociopaths. This means they lack human empathy.  For instance most people look at what's going on in Japan and feel deeply saddened and pained by all that's occurred.  Most investors feel basically nothing and see the whole situation as one big investing opportunity.  There's no reflection of the world outside of themselves or how their decisions affect or hurt others.  But beyond that, think of it this way-  you'd feel pretty smug and superior too if playing a ultra competitive, high stakes game that was always rigged for you to always win.

Q:  What do you mean?

A:  Imagine you are playing football or soccer vs. an opponent.  And when your opponent was in the lead, everyone but you is happy.   And if your opponent ever fell behind and was losing,  the referee would directly involve himself to ensure your opponent regained the lead.  The game being manipulated openly by the referee to ensure your opponent wins.  The 'referee' in the game of finance and markets is Federal Reserve Chair Ben Bernanke.

Q:  So he makes sure the investor is always on the winning side by rigging it?

A:  Pretty much yes. Everything in global finance is catered to the investor because he/she is the one who steps in and buys nations' debts via bond purchases and auctions. For instance, whenever any policy decisions are considered by the Fed, they are intentionally leaked so investors can digest it and always be in the best position to benefit. The investor can never take a haircut or loss of any kind.

The stock market, like the US economy itself is not 'breathing' on its own.  Its like a patient needing machines to be kept alive.  One 'machine' is the Fed.   If/when the markets drop too far, Bernanke steps in and injects hundreds of billions of dollars into the system i.e. the markets.   It gives a nice sugar-high, then when the markets taper, he will give another.  This is 'Quantitative Easing' 1 & 2 thus far.

Q:  So what's wrong with that?  I don't want to see the Dow at 7500...

A:  Well, why not? You don't really benefit either way unless you're actively involved and trading.  And if the Dow accurately reflected the US economy as it Truly stands, it would be exactly that -- 7500.   But that aside, here's whats' wrong with the cash injections.

First, it means those who invest.. the Professional investor, not speaking of 'mom & pop' investor putting in a few thousand dollars, Never Ever takes a loss.  Because at first sign of continued market drop, free money is kicked in to ensure their portfolio grows.  It's called rigging, stacking the deck, cheating..   Second.  This 'free' money is really added debt which eventually will have to be repaid by you, your children, grandchildren and so on.  And the more $$ printed, the more the dollar is devalued (costs more dollars today to buy something you could have bought yesterday)  Third, the Fed has spent over $1.5 Trillion to pump the markets to help banks, corporations and traders/investors-  this $ did not create jobs or trickle down to the bottom 98%.

And remember, the US really has no manufacturing base any more.  So two largest sectors of which to collect tax revenue is the finance and service sectors.  This is why over the last couple decades, the Fed has found it additionally important that the markets at least appear 'strong'.   Some perspective-- On November 21, 1995, the Dow closed above the 5,000 level (5,023.55) for the first time in history.  It took about 200 years to get to 5,000 yet it only took 12 more years to almost Triple that number, reaching its record zenith of 14,164 on October 9, 2007.   All due to market rigging which was legal because it was the Federal Reserve doing it.

Q:  So the average American saw pretty much no benefit in QE?

A:  Virtually none.  Obviously people have 401k and other indirect investments in the market, but in terms of a direct benefit, no.

Q:  You make it seem like Bernanke is more powerful than Obama?

A: When it comes to global finance, he is.  Many often refer to a US President as 'leader of the free world'.  The chair of the Federal Reserve is the 'leader of the free economic world'.  Because the dollar is a reserve currency and can print as much of it as it wants, the Fed has the means to not only assist markets domestically but globally.  After 2008's crash, the Fed gave money to the European Central Bank (ECB), the International Monetary Fund (IMF), banks in England, Scotland, Spain, Portugal, Japan, South Korea, etc, private businesses like McDonalds, Harley Davidson, etc and whoever else needed a cash injection to prevent outright global collapse.   The global community looks to the Fed Chair for leadership, particularly in crisis. And this is why European and Asian markets usually copycat US markets.. Wall St goes up on a particular day, then Everyone goes up.

When Bernanke 'sneezes', the world banks say "Bless you"

~ Federal Reserve building

Q:  How is a Fed Chair appointed?

A:  Appointments are overlapped so that nomination or renomination is never the same year as a Presidential election.  So if a Presidential election is 2008, 2012, etc,  a Fed Chair's confirmation is in 2010, 2014 etc...  There's no set term limits.

Q: Onto a different topic-- right now I get no rate of return on my savings and money market accounts at the bank.  Is this somehow tied in to the stock market or is this separate?

A:  It is all tied in.   The Fed is keeping interest rates at abnormal lows to stimulate borrowing (indebtedness).  This means savers are taking a beating, getting less than 1% return.  But it serves a dual purpose to the Fed- they want people in the market, so like cattle or sheep to a pen, the Fed is trying to steer you from save havens to riskier ventures.

Q:  But I don't understand.. why does the Fed want indebtedness?

A:  That is how the economy is run- everyone in debt to one another.  Everyone working to repay one another.  Wealth is created through the repayment of interest on debt.  Without it, the economy wouldn't function.  If everyone paid all bills on time and repaid all debts, the world economy would collapse.

Q:  I heard of something called 'Fractional Reserve' once and referring to banking and loans.  What exactly is that?

A:  There used to be a time when a bank could not lend $100 unless it actually possessed $100 to lend out.   And to acquire the money necessary to lend out, it had to pay enormous savings rates- sometimes as high as 9% to ensure it had those funds.   The banks were barely profiting and by the Panic of 1873, banks lost so much money from this fiscal policy, that the law was changed that for a bank to lend out $100, it only needed to hold $10.  This would allow banks opportunity to expand their profits on the lending side by having more $$ available to lend, and also on the saving side by dramatically lowering interest to pay out to savers since physical possession of a savers' money decreased in importance.

Q:  It sure seems the banks make a killing today, especially if they pay about 1% in savings yet lend to others at much higher rates, yes?

A:  Exactly.   Here's a very simple math example.  You have $1000 in a bank.   At 1%, your yearly interest is $10.  You made $10 off your $1000.   Now the bank takes that $1000 and can lend up to $10,000.  If it charges a super-low 5% interest on a loan, it will collect in simple math, $500 interest of $10,000.  After paying you $10, the bank still made $490 off your money based on just $1000 saved.

~ Circa 1911  $10 bill

Q:  I want to get back to the stock market.  I know you don't give financial advice as to where to invest but I am so confused- everyone is pushing gold and silver, or this stock or that currency.  I don't know where to invest...

A:  Some brief comments on that-  First, no one gives unbiased advice.  If someone is pushing a stock or sector of stocks for your portfolio, or a commodity, often that person is Heavily invested and your involvement will help to drive up His/Her portfolio. Actually in the case of Goldman Sachs, they would give investors advice to invest a specific way, then they would go the opposite way, profitting off the downfall of the person or entity they were advising.

 A lot of people are fearful about the future and the value of fiat (paper) currency so they're running to gold and silver.  I will not say that's good or bad.  But just remember on a practical level, gold in itself doesn't fill the belly or put gas in the car, so if your local supermarket or gas station won't take gold coins, then how 'valuable' is it?  Lastly, if you Must invest, don't do it now... there's great volatility in the markets, domestically and abroad.  Japan lost 10% of the totality of its stock exchange, the Nikkei,(over 1000pts dropped) just yesterday.  Sit on your money and be patient- if you Must invest, wait until things settle.

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