Due to its length this article is being published in two parts; Part_1 is available on this same site.
If you find it hard to compare the gambling in Las Vegas with the gambling on the New York Stock Exchange, consider the activities of each. In Las Vegas you enter a gambling casino, exchange dollars for tokens or chips and proceed to wager that certain events will occur according to your predictions. When you put money on a number at Roulette you are predicting (or at the very least hoping) that the marble will stop on your number. When you place bets in a card game you are predicting that your cards count higher than others' cards, in your game. When you put coin or tokens in a Slot machine you are predicting that the machine's parts will randomly align themselves in such a way that more money will be returned to you than you will put into the machine. All of these activities are called gambling because you are spending and receiving items of value, money; and because you may only do so legally if you cannot accurately predict the outcome of your wagers. For every winner there is a loser, if the house is the winner then the customer is the loser, and vice versa.
If you choose to place wagers on the New York Stock Exchange, you must also place money at risk and presumably be as ignorant, or at least as deluded, as other players. First you hire a broker and put money into an account, from which your broker can deduct funds when you wish to buy stocks, and into which your brokerage can put your winnings, should you be so lucky. You may contact your broker and tell him or her which stocks you would like to buy, and how much to pay. You now own a piece of some company, and your voice counts in managing your corporation, according to the percentage of ownership in your name. Your bet is that your workers and management team are going to out-produce the competition, make greater profits and return a larger dividend to you. If your corporation does do better you not only win with dividends, but your shares of stock are likely worth more than you paid. Other potential players will see the stronger position of your corporation and some of them will bid more money to buy into your game. If you should decide to sell your stock allowing someone else to take your place and risk, you will receive more money than you paid. This profit is called a capital gain.
If you guessed wrong and your corporation operated inefficiently and lost money, you would not get a dividend, and your stock might drop drastically in value, because more owners may want to sell than there are would-be owners waiting to buy. Sellers are forced to accept less and less for their stocks, potentially resulting in great losses for some. For every one who wins someone else has lost. The big difference in these two gambling industries is the length of time between wagers and the determination of profit or loss.
Brokerages that facilitate stock, bond and commodity trading, operate in a similar manner and purpose to companies that operate gambling casinos. Brokerages do not care if the markets go up or down, so long as trades are being made. The brokerages charge a fee for each trade; the more trades, the more income for brokerages. In gambling casinos the odds of winning slightly favor the casino owners when one bets against the casino; and the casinos charge players a fee for the use of their facilities when players gamble with each other. The casino owners' interest also lies in the volume of gambling; the greater the activity, the greater the income for the casinos.
Brokerage firms reap their wages and bonuses through fees from the number of stock, bond, or commodity transactions occurring. If the markets are sluggish, with relatively little trading going on, brokerages can buy and sell stocks and bonds with other brokers, kiting stock, bond and commodity values and thereby creating a mirage of investment activity. This practice is very old and is called, "Churning the market". This is principally done to provide them with cash flow and protect their stock, bond and commodity portfolios, since their net worth (and the value of their own stock) is tied to cash on hand and market value of their investments. This churning hurts on-going investment activity, because it prevents the markets from moving lower and allowing investors an opportunity to purchase stocks, bonds and commodities at a true market value.
In the United States there are three principal markets to buy and sell stock. The New York exchanges are the primary market, and the over the counter exchanges are the secondary market (NASDAQ). There is another exchange market for stocks and bonds that is referred to, as the "Third Market". The third market is a partial joining of these two markets to facilitate the selling of large blocks of stock. Which if they were offered through an exchange to individual investors would crash that stock's value, along with its paper equity, and could create large declines in the overall market if not panic and chaos.
The third market is composed of brokerages that will buy large offerings individually, or in concert with other buyers, at a set price and then resell it in small lots in the usual manner. Though the set price for these large sales is determined by prices set at auction in the exchanges, this stock is not being auctioned. It is being sold in a manner contrary to the rules of the exchanges, that all stock sales be offered in public via an auction to let buyers and sellers determine market price and value. The seller of a large block of stock is guaranteed, through the third market, to receive the highest possible price for such stocks or bonds, at the expense of unwary buyers in the regular auction markets. One person's loss is another person's gain in these markets. In the public exchange markets, if a large block of stock is offered at a price no buyer is willing to pay, it will then remain unsold or only a portion of it will sell. If it must be sold, then the price must drop until buyers agree that it has dropped to its proper value, according to supply and demand in a free market. The third market is just a creation of a controlled market to allow brokerage firms to protect the value of their own holdings and to prevent investors from profiting when other market-players' must sell.
The exchanges could have barred the sale of large blocks of stock, or limited the size and timing of all sales, but this would obviously not be a free market with prices determined by supply and demand. So they maintain the illusion of a free market by withholding knowledge and access to participate in sales, such as the third market, from the public. If the third market were a small market, as compared to the exchanges, little harm would be done to investors. But the third market is not small, it is very large and very controlled to maintain higher prices, requiring individual investors to pay more than a free market would require for many stocks and bonds.
Consider a stock market very different from the market that has developed; a new market, where brokers facilitate buying and selling but own no stock themselves. A market where short selling is illegal, and where speculation is suppressed by not permitting a purchased stock to be resold in less than 30 days without a significant penalty tax paid to the federal government. Similarly for bonds, the sale of a bond would be final, until redeemed at maturity, or a penalty greater than its lifetime yield would be assessed. And in the commodity markets only those who produce commodities could sell contracts up to the amount they can produce, and only those companies that process and consume those commodities could buy contracts, up to the amount they have a track record of consuming.
Markets with these restrictions would require different corporate structures. Workers and communities would be the largest and most stable investors in the companies they worked for or the communities they are located in. The raising of capital and investment in production would follow the path of vested interest. Which would require most corporations to be publicly owned and operated, for the benefit of consumption without debt.
Market investments like stocks, bonds and commodities are considered to be barometers, gauging the health of our economy. Market watchers are always trying to forecast future economic activity based on current activity and market trends. Trends and market activity, however, are no better barometers to predict the future than reading tea leaves. Economic activity is much more a barometer of what the markets should do than the other way around. This money circulating in these markets has no direct bearing on general economic activity associated with the production and consumption of goods and services.
Because most stock trades are between one investor and another or one speculator and another, wherein the company that issued the stock is in no way involved, the stock market could go out of business without having a catastrophic economic impact on society in general. Certainly all of the people employed in operating the stock market would be devastated, and the general misunderstanding of how these markets operate would cause psychological panic amongst other industries and the public in general, which could lead to a complete economic collapse. But such a collapse would be as unnecessary as having our whole economy collapse if Las Vegas were put out of business by a major earthquake. Certainly the workers and owners of all of the casinos and related businesses would be financially distressed and have to seek other opportunities. But the rest of society would not need to go into a panic. We deal with catastrophic weather and geological events affecting our lives and economy every year, and we take them in stride. Problems in gambling industries should never be perceived as causing negative economic impacts. A panic in the stock market could only spread to our productive economy if people are ignorant of what the stock market represents and how it operates; but then if people knew how these markets functioned they probably would avoid them altogether.
The stock market is very much a balloon market, because it contains so much air (presumed equity). For example, consider a small stock market with just ten companies. Each company has sold 10,000 shares to the public, and each company's stock is currently listed at $10.00 per share. Since stocks usually sell in lots of one hundred shares, each lot is worth $1,000.00. Each company's total shares are worth $100,000.00; making the total value of all ten companies stocks to be $1,000,000.00. If one trader comes into this market and offers $11.00 per share to purchase one hundred shares of Company-A stock, then he or she has paid a total of $1,100.00, but has only increased the real equity of that one lot of one hundred shares by $100.00. The market, however, reports that all 10,000 shares of that company's stock are up and valued at $11.00 per share. One hundred dollars has created $10,000.00 in presumed equity, for this one company's ten thousand shares of stock. All of that increased value is a fraud, because the original $100.00 in additional value went to the seller, and is in no way further associated with Stock-A. Now consider that if the seller of stock in Company-A takes the $1,100.00 and invests it in one hundred shares of Company-B, another $10,000.00 in air is created. Continue this from B to C, C to D, etc. until the seller of Company-J's stock winds up with the $1,100.00 and is out of the market. All ten companies' stock has gone up ten percent and the $100.00 in additional equity has exited the market. One hundred dollars has created $100,000.00 in paper equity in just ten trades and is out of this market, as is all money invested in stocks, it is always outside the market, the seller has the money, but no stock. Obviously, the real stock markets are much larger, with millions upon millions of stock trades daily. This unreal and presumed equity can certainly be taken out of the market in a similar manner, since so much of what is reported as equity gains is only air.
All stock purchases are transacted by bringing money from outside the market to trade with those who own stocks and would be willing to leave the market, becoming non-owners, if they are paid their price. The sellers exit the market, even if only temporarily, with the money that was never in the market. Trading your current surplus labor for stocks will only net you a gain if in the future someone else is willing to trade you more surplus labor for the right to own your stocks. Your money is not in the stock, bond, or commodity markets; it is in the pocket of the person that sold you stocks, bonds, or commodities. Both today and in the future, the un-inflated value of stocks is the fire-sale value of equity in buildings and equipment and resources that are not collateral for loans and bonds. Everything else is a mirage, appearing as inflated equity created by too much surplus wealth being exchanged (gambled) for control of corporations and their future profits. This "air" in the market is why price changes can be so volatile; small changes up or down on small amounts of a company's stock are leveraged to effect all of its stock by and because of investor ignorance.
Let me digress a moment to another discussion of money, in the realm of buying and selling as done in the stock market. All money available to purchase any asset is pocket money, in the context of liquidity. It is not invested in stocks and bonds, or real estate, or gems and precious metals, or stamps and rare coins. Money simply moves from one pocket to another (from one bank account to another), in trade for assets or consumption of goods. Those who purchase stocks and bonds, or real estate, etc., take money out of their pockets to effect a purchase, while those who sell stocks and bonds, or real estate, etc., put money into their pockets to effect a sale of those goods. The key to the future value of any commodity, or stock, or piece of land bears directly on the amount (and trade value) of pocket money available at any given future time. These markets are devoid of any value other than future demand to own stocks, bonds, commodities and real estate; and that demand will depend on the mount of pocket money available for investment or speculation. The money is always outside the markets because it only moves from one pocket to another, wherein the last pocket always belongs to someone who is NOT IN THE MARKET.
While investment in the stock market is considered to be a capital investment in our productive economy, it very seldom is. If you are able to purchase new stock directly from a corporation that will use that money to expand their productive capacity, then you are investing capital in our economy. But when a stock is sold the second, third and so on... times, the new owner is not investing in that corporation. The vast majority of stock trades are done between one investor-speculator and another, trading places between would-be owners and those who would rather not be owners. As far as our productive economy is concerned, these dollars serve no useful purpose. They create no jobs, build no factories, nor do they feed or shelter anyone, except stockbrokers and speculators. The taxes paid on gains are offset by the deductions taken on losses. Brokers and the people that keep these markets going are all on capital welfare. They facilitate these gamblers in transferring money and stocks, and charge a fee to do so. But unless they are helping a corporation issue new stock, they are just recording the economically irrelevant bets of their customers. Stockbrokers and Bookmakers (that manage bets on horses, or sporting events, or whatever) are the same animals in twin professions.
Many baby-boomers are being encouraged to invest in personal savings accounts like IRA's to benefit their uncertain retirement. And many of these IRA's are invested in the stock market, bringing additional dollars to the New York style gambling industry. This money is simply inflating stock prices and giving the illusion of equity growth. Remember, money put into an IRA or 401K, to buy stocks and bonds, is going into the pockets of the sellers. To reap your reward as a seller when you need retirement money, you are betting there will be more buyers in the future willing to pay more to own your stocks and bonds than was the case when you purchased. Such reasoning is how pyramid schemes operate. The boomers are buying into a pyramid scheme that is shrinking at its base (without exception, all pyramid schemes fail); the following generation will be too small in population and earning capacity to bid up prices and produce a profit for the boomers to retire on. The generations following the Boomers are going to have their income taxed heavily to pay the Social Security and Medicare for the Boomers and thereby will not have the pocket money to buy into IRA's and 401K's; causing those markets to fall catastrophically in value and bankrupt many Boomers.
Consider also that most 401K plans are not invested in industrial stocks and bonds; rather they are only speculating on the profitability of a mutual fund company, i.e., the stock you own and will need to sell at a higher price to have retirement income is your investment firm's stock, and no other. Since your fund managers must buy and sell stocks and bonds, etc. to make a profit, similar to all other mutual funds, you can only come out a winner if other 401K speculators come out losers. The Boomers will either suffer losses that will destroy the value of their retirement investments, or they may be forced to keep their capital tied up in owning stocks and bonds and only receive relatively small dividends, without ever being able to recover and spend their invested capital.
The game of win or lose goes like this. If investor-A buys some stock costing one hundred dollars per share and it rises in value to one hundred ten dollars per share, at which time investor-A sells to investor-B; investor-A has made ten dollars per share profit. If this stock continues to rise to one hundred twenty dollars per share and investor-B sells to investor-C, then investor-B has also made ten dollars per share profit. If this stock falls back to one hundred dollars per share and investor-C sells this stock, then investor-C has suffered a loss exactly equal to the previous gains. Similarly, if this stock had dropped for investor-A & -B but rises for investor-C, the initial losses would equal the final gain. For every gain their will ultimately be an equivalent loss, and for every loss their will be an equivalent gain, the books are always balanced. Brokerage fees, taxes and inflation operate to guarantee that in the long run, less money leaves these markets as investor profits than comes into them as gambling wagers. Over time those who profit from these markets do so only by losses incurred by others. Periodic panics and crashes in these markets balance the books by creating the losses that equal the year over year gains for the years between such panics and crashes.
The featuring by the news media, over the years, of catastrophic losses by certain international banks, or certain brokerage firms, or individual investors, shows the general ignorance of how these gambles work. If we heard news of a poker game wherein three players lost $50,000 each, but a fourth player won $150,000, we would not dwell on the losers and the tragic consequences of their losses, without mentioning the winner. More likely, we would focus on the winner and attempt to associate ourselves with such winners, and generally ignore the losers. In the financial markets losses may be tragic to one person or corporation, but on the principle that gains equal losses, both are irrelevant to the market and to the economy. If governments, market directors or investor-speculators alter their market strategies based on someone's losses, they are forgetting someone else's gains, implying that they do not understand these markets and ought not to be in them. Reporting gains and losses in any of the markets is a camouflage of fraud to keep unwary investors in the game. These markets are a zero net sum, so gains and losses are irrelevant for society overall. But since these con-games require continuous inflow of surplus wealth to support brokers and investment bankers, there is an industry of reporting and describing activity in these markets that operates on a foundation of collusion of ignorance and obfuscation of facts. In this ever-changing world investing is nearly dead, so happy speculating.
© June 2009
Craig D. Hanks
This article is taken from a chapter of my book SOCIAL BENCHMARKS. Other excerpts can be viewed at http://beyondfarenough.blogspot.com/
