National (Slippery) Treasure, Part 2

In Part 1 on this topic, I gave a brief overview of why the stock market is a wonderful democratizer of wealth. In this post I will contrast stocks with cryptocurrencies.

At the outset I should state that inasmuch as cryptocurrencies continue to exist, I can respect someone incorporating them into a diversified portfolio. I can also respect someone knowingly engaging in speculation (i.e. essentially gambling on the price going up), as long as they are honest with themselves about what they are doing. I can also respect that for people who live in countries with volatile economies or oppresive governments, it might make sense to use cryptocurrencies for specific purposes. However, I am very concerned about the way that cryptocurrencies are being marketed to average people and for their potential deleterious effects on the nation's financial system.

Stocks and cryptocurrencies are similar in that both are traded and subject to the forces of supply and demand, and both can be quite volitile. But when you dig deeper there are important differences. With stocks there is an actual economic engine (i.e. a company that sells products and/or services) behind that supply and demand. As the company generates wealth over time, it shares that wealth with its shareholders. Especially when we think of large companies represented in the S&P 500, you don't have to get in early in order to benefit. You can invest in a company that was founded before you were born and still have a reasonable expectation that you will be rewarded over time.

Cryptocurrencies, in contrast, do not have an economic engine and therefore do not generate wealth. They are an empty vessel that simply reflect the price that people are willing to pay for them [1]. Certainly there are people who have become rich by buying and selling cryptocurrencies, but it is important to understand that this reflects a transfer of wealth rather than creation of wealth. And those who become the most rich are usually those who got in early.

This fundamental difference leads to different incentive structures. Imagine that you own stock in a company that makes good products and generates reliable profit, but for some reason has not come to the attention of other investors or isn't a popular investment and so the stock price is low [2]. This is fantastic for you because the low price enables you to purchase additional shares knowing that even if the stock price never takes off due to increased demand, you are getting a great deal on the dividends paid by the company [3]. You don't need additional investors in order to reap rewards. In fact, a long-term investor would probably prefer that the company's stock remain overlooked by additional investors [4].

Contrast the above with cryptocurrencies. In order for your money to grow in cryptocurrencies you REQUIRE additional investors to buy at a higher price. And those investors will REQUIRE additional investors to buy at a higher price, because there are no underlying dividends or interest payments to drive the value. Suppose, like the stock example above, you purchase a cyrptocurrency that is generally overlooked by others and continues to be overlooked. This is a terrible scenario because the value of your investment is tied exclusively to the trading price. So as long as the investment remains undiscovered, your money is dead in the water.

Looked at from this perspective, it is no wonder that people who own Bitcoin and other cryptocurrencies want other people to use them. That's the only way their money grows [5,6]. This dynamic is the key to understanding why cryptocurrency enthusiasts have switched from selling the idea that cyrptocurrencies are free from government manipulation to cheering on government "strategic reserves" and other taxpayer-funded methods of propping up cryptocurrency value.

The steady drumbeat over cryptocurrencies as the way of the future needs to be viewed extremely skeptically in light of the financial incentives of the drummers (not to mention its failure to find a solid use outside of rampant speculation, fraud, money laundering, organized crime, etc). Moreover, the idea that Bitcoin or any cryptocurrency is the key for underprivledged people to get ahead requires magical thinking (bolstered by unrepresentative anectdotes) and should be seen for the crass exploitation that it is. Most worrying to me, however, is the potential financial disaster that awaits us if cryptocurrencies continue to become intertwined with our financial system. Just like the junk mortgage-backed securities that brought on the great financial crisis of 2008, cyrptocurrencies could bring on disaster even to people who don't own any, while at the same time necessitating taxpayer-funded bailouts to those who pushed these slippery treasures onto our society in the first place.

For a skeptical look at cryptocurrencies, I recommend the writings of Stephen Diehl and Molly White.

Notes:
1. There are definitely areas of the stock market--usually small companies--where the same dynamic is at play because the fundamental business is weak or outright fraudulent. It is harder for large companies to disguise a poor economic engine, though it does happen sometimes. And obviously, circumstances can change such that a solid business becomes weak due to shifts in competition or consumer demand.
2. This is an unlikely scenario for a public company of any substantial size because thousands of stock analysts armed with computers are constantly looking for good deals.
3. Not all companies pay dividends. Those that do not tend to fall into one of three camps: they are unprofitable and can't afford to return capital to investors, they are re-investing profits into the business and aren't ready to return capital back to the shareholders, or they return the capital in the form of stock buybacks instead. From an accounting perspective, dividends and stock buybacks are mathematically equivalent.
4. Sharp-eyed readers will remember that in my last post I recommended that everyone own stocks. The difference, again, is the economic engine behind them. Although the stock market doesn't need your participation in order succeed (apart from enough people to keep trading liquid), in a democratic system of government I think it is good for voters to have a direct financial incentive to uphold government that enacts wise economic policies. Also, holding a diversified stock portfolio as part of long-term savings is generic personal-finance best practice.
5. It is not the only way to make money in cryptocurrencies, however. Another way is to own a company that provides some kind of service to owners/traders of cyrptocurrencies for a fee--just like you can get rich off of gambling without actually gambling by owning a casino.
6. My central critique of cryptocurrencies could also be applied to gold, and in fact I'm not a big fan of gold (putting me in company with Warren Buffett). However, at least gold has a long history, use cases outside of pure financialization, and can't be created or destroyed on a whim (no Fed rants, please).

---

Continue reading...

How to Not Be the Bad Guy in a Future Museum

I was recently at a museum that had displays dedicated to the civil rights movement of the 1960s. You've probably seen similar displays, with pictures or videos of black people being beaten, arrested, or sprayed with fire hoses. Such displays also give voice to politicians of the time who vowed not to allow black students to go to school with white children, and so on. Even while maintaining a sense of charity that it was a different time and that people are shaped by their prevailing culture, it's hard not to wonder what the hell was wrong with people, including many who considered themselves devout Christians, who fought so hard to maintain Jim Crow laws and that thought that cruelty toward black people was acceptable [1].

I would like to suggest that the probability that you will end up being the bad guy in a museum for having supported Stephen Miller's return to power via the Trump administration is much, much higher than the probablility that you will be the bad guy for having opposed him. Sure, you may not personally be featured in a museum display, but several decades in the future you will walk through a museum where the sins of Stephen Miller and Donald Trump and the effects of their cruelty will be on full display and you will either have to break out your supply of excuses to explain, if only to yourself, why you helped them into power, or you can be grateful that you saw them for what they were--even though you may wonder if in retrospect you could have done more to try to stop them.

The reason I can predict this is that intentional and performative cruelty usually marks the bad guy, while opposing cruelty rarely makes you the bad guy [2]. By their fruits, you shall know them.

Inasmuch as Trump, Miller, and gang are already in power, there's not much that we can directly do about it now. But what we can do is quit supporting any politician that supports them. We can vote for Republicans that oppose them in primary races, and if they don't win we can quit making excuses for why we can't vote for a Democrat in a general election. And in the future we can avoid voting for politicians who advocate for cruelty as part of their campaign. It's one thing to be surprised when an otherwise acceptable politician turns cruel. But if they campaign on cruelty, saying that you didn't think they really meant it is a weak excuse and won't save you from the future museum.

By the way, it's in your best interest beyond your sense of self-respect in a museum. Normalized cruelty will eventually make its way to you and your loved ones.

Notes:
1. Not that it's entirely a problem of the past, of course.
2. And if it does, then maybe it's worth being the bad guy.

---

Continue reading...

National (Slippery) Treasure, Part 1

You may have never heard of Jack Bogle, but he arguably did more for the financial well-being of society than any other individual since the New Deal of the 1930s. His major contribution was to pioneer the concept and implementation of a low-cost index fund, thereby making a diversified stock portfolio accessible to the average person. If you have any kind of retirement account, some of your money is almost certainly invested in a stock index fund.

Although they can be volatile and ruinous if not managed wisely, stocks are an elegant democratizer of wealth. The basic concept is quite simple. Stock ownership gives you a small piece of ownership in a company. The company hires workers and builds infrastructure to offer goods or services for sale. Customers who value those goods and services purchase them. If everything goes well, the company takes in more money from customers than it uses to pay its own bills and eventually returns some of that excess money to its owners--the shareholders. Stock prices fluctuate constantly as buyers and sellers estimate what that future financial return is worth. Sometimes prices become disconnected from financial reality, but in an efficient market (i.e. where accurate information flows rapidly) reality eventually reasserts itself.

Different companies have varying success at being profitable over time, which is why it is important to own a large selection of stocks and thereby reduce the risk that company failures will wipe out your investment. (That's what Jack Bogle made easy, through index funds.) And since the stock market is such a potent method of wealth generation, and since wealth so easily corrupts people, the government plays an important role to maintain the health of the system by enforcing rules designed to keep things as honest and safe as reasonably possible. Many of these rules were born from the Great Depression as part of the New Deal.

One of the beautiful aspects of stock ownership is that the wealth creation that occurs is repeatable. I don't mean that everyone gets the same return, since risk and reward will vary by company and over time. Rather, anyone who consistently invests in a diversified stock portfolio over the long term is likely (but not guaranteed) to be rewarded with (variable) growth in their wealth. You don't have to get in at the right time or be lucky enough to have picked the right stock to benefit. The companies behind the stocks are economic engines that keep churning and generating wealth. Therefore, our children and grandchildren can expect to generate wealth through stock investment just as we have. The companies and industries might change, but as long as conditions remain fertile for companies to grow, we can expect stock ownership to continue to deliver wealth over the long term.

While there may be valid criticisms to be made in how the stock market operates and is regulated, when you take in the big picture it is a marvelous system that embodies and facilitates capitalism (i.e. individual judgments about how capital should be allocated), and I am a beliver that virtually everyone should have some level of investment in stocks. Doing so gives you a piece of ownership in the national and international economy and makes you a beneficiary of the success of companies you otherwise have no financial ties to [1].

In a forthcoming post I will contrast stocks with cyrptocurrencies and explain why I think we should be skeptical of cyrptocurrencies in spite of the hype around them.

Notes:
1. The stock market, as most people interact with it, is a secondary market where stock owners buy and sell stock. Purchasing stock in this market does not directly provide any funding to the company behind the stock. Different people will have different views on the ethics of this matter, but it's important to understand that owning stock in, say, a beer company simply means that you are entitled to benefit from the company's profits and to vote in coproprate elections. You aren't providing the company any additional working capital, and selling the stock doesn't financially punish the company.

---

Continue reading...