Category Archives: Finance

I don’t think Twitter is dying

You can stop tweeting #RIPTwitter

Over this past week, Twitter has gotten weird. Reports flying that Musk fired literally everybody, that there’s no engineers managing the servers, that he demanded everyone work 80 hours or quit and most of them quit. Forgive me for not posting sources but most of this is ultimately unsourced info from social media anyway. Regardless, people on Twitter are tweeting up a storm about how this is The End of Twitter and how they’ll all move to Facebook or Instagram or Mastodon when Twitter inevitably goes down for good. I don’t think that’s going to happen, at least not for another year or more.

Twitter may lose some of userbase as its billionaire owner continues to go crazy, but I highly doubt it will be replaced all at once, or even in the next year, or so and for a few reasons:

  • 1.) Lack of alternatives

When MySpace lost the battle to Facebook, it was a true battle between two platforms that did mostly the same thing. Both were neck and neck in terms of usercount and both focused on very similar styles of content and posting. Twitter doesn’t have that problem, Facebook and Instagram are nothing like Twitter in terms of its microblogging content or its ability to spread content to every corner of the userbase by latching onto its trending topics. And Mastodon has a tiny fraction of the total usersbase, if it continues to grow every year and Twitter loses half its userbase every year, then in around 5 years they’ll be neck and neck like Myspace and Facebook were in 2008. Until I see a sustained long-term trend of that nature, I’m not ready to proclaim that This Is The Death Of Twitter.

  • 2.) Institutional Buy-In

Twitter gives institutions something that they really really want, the ability to spread their message easily to all its users at almost no cost. There’s a good reason that Justin Trudeau, his holiness The Pope, and the People’s Daily (most read newspaper in China) all have official active accounts on twitter. Most would never be caught dead on Reddit in an official capacity, and Facebook/Instagram/other sites don’t allow them to reach every user in the way that Twitter does. Even if everyone with a net worth under 1 million dollars left Twitter TODAY, the site would likely continue on the inertia from Institutions for quite some time, as they would find tweeting something and having it get picked up by other institutions (especially newspapers) would still be a great way to get their viewpoint out into the wider world. Institutions don’t change rapidly, and even if Twitter does die it could take years for many institutions to migrate off of it. And the key is that as long as those institutions remain on Twitter, Twitter will still have value to many different users. Users who like to troll politicians’ comments, or bloggers/journalists looking to keep up with what the institutions are putting out, these people will stay on Twitter as long as the institutions stay on Twitter. So even if you start posting your dog pictures solely to Instagram, I doubt the Washington Post newsroom will abandon Twitter any time soon.

  • 3.) The Court of Lord Musk

People like to see billionaires as unaccountable god-kings creating or destroying everything in their path. This is partly because that is the image most billionaires cultivate and partly because they are certainly held less accountable than those of us who work for a living. But Musk isn’t the sole proprietor of Twitter, or even the sole proprietor of Musk Enterprises. There are a legion of accountants, lawyers, and investors who check and double check his every move. It seems strange that a man flaunts both the SEC and slander laws is being checked and double checked, but the very fact that he has never been punished for what he’s done is a testament to the work of his lawyers, accountants, and investors. These intermediaries act as a moderating influence on Musk the auteur CEO and so will likely ensure that no matter what he does the bills will keep getting paid and the lights will stay on at Twitter Enterprises.

  • 4.) Ease of use

Twitter has already been integrated into just about everything imaginable. I only have a Twitter handle (@streamsofconsc) to tweet out my daily blog posts. But WordPress (and basically every other posting software) has made it super easy to link your Twitter handle to your blog and auto-post everything you do with no added work necessary. Mastodon isn’t integrated into this ecosystem and probably won’t be any time soon.

  • 5.) I’ve seen this game before with Musk

This is a bit personal, but I’ve predicted the downfall of Musk before myself. I was part of the Musk hate-culture in r/enoughmuskspam for a fair bit, and fell easily into the echo chamber which pushed a narrative where Musk was constantly on the edge of destruction. I eventually got out, but it made me realize how easily hatred and castigation get amplified in such an echo chamber. Twitter is currently a strong echo chamber declaring the death of the platform and the End of Musk, and since there’s no social benefit to going against the grain, the most hyperbolic and outrageous claims of destruction are shared and amplified. This reminds me all too much of the patterns I saw with the hate-culture surrounding previous Musk ventures, and it makes me skeptical about people’s claims for this one.

I don’t think Twitter will go down because Musk fired too many of the people doing server maintenance. I don’t think Twitter will be replaced by Mastodon within the next few years. I don’t think Musk will be charged with market manipulation or treason for how he’s purchases a major avenue of public speech and trashed it. And I don’t think the people who are declaring the death of Twitter today will ever look back and admit they were wrong (if they are indeed proven wrong) any more than the people who declared the death of Tesla back in 2018 or the peak-oilers of the early 2000s. I think most people will either forget entirely or will claim that they were “early, but not wrong,” eternally pushing back their predicted death-date as they get more and more wrong by the year.

I may be wrong on this, and I’ll try to revisit this post in a year or so to either give my mea culpa or to declare how much smarter I am than everyone, but at this point I’d happily take the gamble that Twitter won’t be dying any time soon.

Flywheel investments, an anatomy of most crypto scams

FTX is in the news for both the enormity of its bankruptcy and the moral bankruptcy of its founder, Sam Bankman-Fried. Before even reading the news I knew in general how FTX went bankrupt, because it’s the same way every crypto ponzi scheme, sorry crypto “exchange” goes bankrupt. Here’s how it always happens.

Someone creates a whole bunch of magic beans, a billion in fact, then sells one of the beans to a sucker for a dollar. Their billion beans are now worth 1 billion dollars, because the most recent sale multiplied by the total number of items must be the fair value of them all, right? With net assets of 1 billion dollars, you can start doing some real financial malfeasance. You can take out big loans (using beans as collateral) or trade your beans for someone else’s beans, since you’re both playing a game where you pretend these beans have value. This gives you cashflow (although most of your “cash” is just other people’s beans) and the ability to pretend you’re running a business.

Once you’re trading beans, you tell suckers (retail investors) that your business is profitable and they should invest. Not by buying stocks in your company on the stock market, that’s a mug’s game. Stocks actually have value and are regulated by the government, no we’re in the business of beans. You tell people that to invest in your beans they just have to hand you over some of their dollars and in exchange you’ll give them beans. You tell them that the beans are interest payments on the dollars they’ve deposited with you, and since you’re still claiming the beans have value these suckers can then trade the beans amongst themselves. You then take those dollars they deposited and gamble them away on over-leveraged stock and crypto bets, all while pretending you’re the Wolf of Wall Street.

As long as people keep giving you dollars in exchange for beans, the scheme is solvent. The beans cost you nothing and you can print as many as you like. If a few people want to exchange their beans for dollars again, well that’s OK too because you’ve still got a big pot of dollars that you haven’t lost yet, so you can give them back their dollars and take back your beans to maintain the illusion of solvency. Your beans are your main asset remember, they’re what you are selling to raise money, they’re what is underwriting all your loans, so people need to believe that the beans have value and the best way to maintain that lie is to always be willing to buy back beans at the current market price.

It seems like the magic of a flywheel, once you spin it up it keeps going and going forever. As more and more people see your company as being profitable, more and more will want to buy your beans to “invest” in you. And when they invest, you give them all the beans they could ever ask for. As long as you keep buying back beans, fear of missing out (FOMO) will drive many investors to throw more and more money at you, driving up the price of your beans and making your company seem like a can’t lose bet. But nothing lasts forever, entropy will eventually slow down a flywheel and risky bets will eventually end a crypto exchange. There’s always some trigger, whether it be too many bad bets, a collapse in the price of bitcoin (which is probably one of your main “assets” after your magic beans) or you or an employee just steals everything and runs. But eventually people will start to catch on that you’re probably insolvent, and they’ll want their money back.

The reason FTX was insolvent is the same reason every crypto “exchange” is insolvent, there is absolutely no profit to be made in doing what they claim to do which is hold people’s money and always be willing to give it back. There is zero profit in doing this, banks write loans using depositor’s funds because that’s the only way to make a profit, and for the same reason exchanges gamble with depositor’s money because that’s the only way they make a profit. But banks are highly regulated to prevent insolvency and stupid bets, whereas crypto exchanges just aren’t. So eventually all exchanges make stupid bets and go insolvent, while most banks don’t.

So insolvency, it’s just a fancy word meaning people want their money back and you don’t have it. You gambled it all away and now all you have are magic beans, magic beans which only have value because you’ve been claiming you’d always buy them back at the market price. So the price of your beans collapse once people learn what’s up and that you no longer have the money to support your beans. Everyone tries to get their money out but you’re broke and can’t give it to them, then the people you took loans from realize you can’t pay them back either. As long as the numbers were going up, people kept buying beans from you and you could use more and more deposits to pay back your loans and keep up the fascade, now you can’t so you’ve got no choice but to default on those loans. And those loans and other obligations were underwritten with beans, which are now worthless as you won’t buy them back from anybody.

This above scenario is more or less how every crypto collapse has operated, plus or minus a few cases of an insider just taking all the money and leaving. They always issue their own coin because it’s an easy way to create the illusion of assets, they always take deposits and gamble them because it’s the only way to make money, and their balance sheet is always nothing but crypto so when the price of crypto goes down, they collapse under the weight of their own coins. Sam Bankman-Fried isn’t the first crypto scammer (although he does have the most appropriate name for one), he’s just the biggest one so far.

The End of Growth part 3: Peak Oil

I’m still going through The End of Growth by Richard Heinberg. His central thesis is that in 2011 the world economy completely changed and we can expect no real economic growth happening after that year. He furthermore discusses Peak Oil and how it’s the key to understanding the end of growth. Here’s his first prognostication on oil:

The US had been the world’s primary oil producer, but by 1971 its oil production peaked and began to decline

This was a very defensible position in 2011. Not so today when we’ve seen US oil production skyrocket once again and far outstrip the highs of 1971. Even in the absolute depths of the Coronavirus pandemic, when oil prices briefly dipped below zero dollars and producers had to pay to get excess oil shipped out, oil production was higher than the “peak” of 1971.

An aside: how can oil prices dip below zero but oil wells still afford to pump? Well the coronavirus pandemic was temporary, we all knew it was temporary, and oil wells kept pumping in expectation of the good times just around the corner. Those good times have indeed come to pass, and the price of oil has rocketed back up again along with new production to feed this demand. The price was below zero, but that doesn’t mean you could get oil for “free,” it was only below zero if you showed up to an oil well with the proper equipment and container vehicles to ship oil off the property.

Anyway, Richard Heinberg goes on to sketch out the Peak Oil scenario that he believed in 2011 was an inevitable future. I don’t want to just quote his book verbatim but I’ll summarize it here:

  • Around the year 2010 oil production inevitably stagnates, leading to oil prices skyrocketing. This causes an economic crash
  • The economic crash leads to economic contraction, meaning oil demand slackens and oil prices fall
  • Oil prices falling means demand can pick back up
  • …but then oil prices also go up, leading to yet another economic crash
  • We repeat theses steps ad infinitum, each boom/bust cycle happening quicker and quicker and causing more and more social chaos
  • No force is able to stop this cycle, price volatility precludes oil investment which means supply remains constricted

He goes on further to state that this scenario isn’t actually a prediction of the future, it’s a description of the past

  • This Peak Oil cataclysm began in 2008, led in part to the Financial Crisis, and continues to the present time (2011 when Heinberg wrote his book)

This is all very interesting, especially the key feature of his theory that new supply will never be be able to be produced in quantities that will keep up with demand. He claims that rising and falling prices will ensure that there is too much volatility to make the investment sound, and that in part is his theory for why this cycle can’t be escaped with oil. It’s an elegant theory, but it’s a theory that’s been proven false since he wrote it, oil supply did increase and volatility wasn’t an impassible barrier for new production.

Even without the benefit of hindsight it would be unreasonable to believe his theory in the first place as it assumes no one has any sort of agency during this crisis, everyone can only watch helplessly as the price of oil rockets up and down. Let’s discuss the story of Joseph in the bible for a second: The Pharaoh foresaw that 7 years of good harvests would be followed by 7 years of famine and asked Joseph what he could do to prevent calamity. Joseph explained to him the simple principle of storage and rationing: store food during the good times and hand it out during the bad. Instead of a boom/bust cycle leading to massive death and destruction, Egypt under the Pharaoh and Joseph had a smoothed-out supply allowing them to weather the storm and continue living and farming. I bring this up not as a bible lesson but to explain that we have known for thousands of years how to prevent the exact cycle described by Heinberg’s theory from occurring. If we can predict something like this then we can prevent it using even the simplest of economic activities such as storing and rationing.

The United States even has an entire system dedicated storing and rationing oil: the Strategic Petroleum Reserve. When prices are low, the US buys oil and fills the reserve, which keeps the price high and encourages producers to keep producing and investing. When prices are high (such as 2022), we empty the reserve, selling the oil and alleviating the worst effects of the shortage. And the US government isn’t the only one engaged in this, from OPEC to Exxon-Mobile, nearly every oil-producing entity has or pays for a way to store oil during the glut and sell it during the dearth, to mothball unneeded production but then turn it back on when prices spike. The Peak oil cycle never happened, Heinberg theorized that oil supply would stay relatively constant as the volatility precluded investment but instead the volatility was mostly smoothed out by both market and government forces and investment (and production) have continued to rise.

As I said, the cycle sketched out by Heinberg isn’t just theoretically unsound it was disproven by history. He suspected that low oil prices would allow economic growth, leading to high oil prices and another crash. But while oil prices did dip not long after his book came out, they dipped because of sky-high supply from the US and OPEC not contracted demand due to an economic crash. Let me state that again: falling demand did not cause oil prices to crash, rising supply did, which runs completely contrary to Heinberg’s Peak Oil theory. Oil investment has continued and oil production has increased, the US currently produces around 12 million barrels of oil a day, more than any time in the 1970s and more than double as much as was produced when Heinberg’s book was published. I wonder what he would think about that.

The end of growth?

I’m doing that thing again where I read old books just to dunk on the authors. This time it’s “The End of Growth” by Richard Heinberg. Written in 2011, here’s how it starts:

The central assertion of this book is both simple and startling: Economic growth as we know it is over and done with

Heinberg goes on to say that although countries may still experience a few quarters or even a whole year of growth,

the general trend-line of the economy (measured in terms of production and consuption of real goods) will be level or downward rather than upward from now on

Not only that, but Heinberg goes further in decreeing that this is true for the entire world, not just any one nation. Any national growth in one nation (which will necessarily be very small, as stated above) will be balanced out by a reduction in the size of the other economies of the world. Heinberg confidently asserts:

the global economy is playing a zero-sum game, with an ever-shrinking pot to be divided among the winners

This is, to put it bluntly, laughable. It was crockery in 2011 and it’s only been proven more ridiculous as time has gone on. It goes back to my post from before about how everyone is always fighting the last war, in 2011 with growth still anemic this seemed like a defensible conclusion but today, not so much. And more broadly, history has proven this thesis to be wrong startlingly quickly: the Federal Reserve has a handy-dandy chart of US GDP in constant dollars (ie dollars accounting for inflation) and we can use it to see that in 2011 the GDP was about 17 trillion dollars, and by 2019 (the most recent year on the chart) it had climbed to 20.5 trillion; a growth of 20% over just 8 years. And it’s not like this is fake growth either, you can see it in the cars we drive and the gadgets we use: lane assist, rear-facing cameras for backing up, electric vehicles, hell even smartphones and tablets. These are all new and useful things that we didn’t have as much of in 2011. Just 31% of Americans owned a smart phone in 2011, today that number is nearly 90%. Just a quick look around us should dispense with this idea that growth has ended, even the consumption of oil, electricity, and natural gas have gone up. Real growth in our economy has occurred.

So the trend-line for America has most decidedly not been flat, but what about the rest of the world? Have we merely stolen growth from everyone else? Hardly. Look at China and India, two countries accounting for around 1/3 of the world’s population, their economic growth has continued to outpace America since even before 2011. They’re growing faster than us, using even more oil, electricity, and natural gas, and buying even more smartphones and electric cars than we are. They are definitely growing in a very real economic sense. And what about the rest of the world? Europe hasn’t grown quickly, but they are by now means trending downward, and neither are Africa, South America, or the rest of Asia and North America. Every part of the world’s economy has seen real growth in the past decade, with real increasing in living standards being the norm not the exception.

And this isn’t an illusion. Mr Heinberg seems strongly intent on portraying any semblance of “growth” as nothing more than an illusion created by debt, yet the fact that I’m typing this out on a laptop that’s computationally stronger than my 2011 desktop seems to put paid to that idea. Heck, I’m in science, 10 years ago Cryo-EM was barely able to do any of the stuff we take for granted today, now we can image and define the structure of thousands of proteins relatively easily. Is this just an illusion? Is our ever-expanding catalogue of verified antibodies for scientific experiments an illusion? What about the fact that just 2 years ago we invented and deployed an entirely new type of vaccine for a disease no one had ever heard of before? That literally happened, and it isn’t an illusion. Technology has continued to rapidly progress since 2011 and shows no signs of stopping, Mr Heinberg’s thesis on growth seems utterly ridiculous. And even our base inputs continue to go up, the amount of oil pumped and burned continues to go up year after year, alongside the amount of electricity the world is using. I’d love to hear Heinberg’s explanation for how world energy consumption keeps increasing year after year despite our growth having ended.

So why did Mr Heinberg think that growth was ending? Well I’ll have to keep reading, but I think that like I said he was simply fighting the last war. The Financial Crisis was a real shock to a lot of people, and the lethargic pace at which the world’s economy recovered from it made people think that it was a new normal. But it wasn’t. Secretly I also wonder if Mr Heinberg is of the heterodox economic school which believes that steady-state or even de-growth is preferable to economic growth. When one looks at all the resources humanity is using one instinctively feels they must eventually all run out. But Malthus predicted we’d outstrip our food supply centuries ago and despite him and many others believing this to be true, year after year people are eating more and living longer than they ever did, along with enjoying more and more of the amenities of modern life. I don’t know what Mr Heinberg was thinking when he wrote this book, but on the first page I can already say lol, lmao even.

Let’s see how he defends his thesis.

Don’t put all your money into bonds

In fact, don’t put all your money into any single investment. I’m not anti-bonds, I’m pro-diversification.

As the Fed has continued to hike interest rates, I’ve been encountering a lot of chatter about buying bonds, and while I agree with some of it I’ve also seen talk saying that anyone with money in stocks is a moron and that everyone should sell everything they own and put it all into long-term government bonds. The benefits of government bonds are clear: they are a risk-free way to protect and sometimes grow your money. A bond is just a loan to the government and the government (whether the Federal government of America or the AA+ rated governments of Europe and the rest of the world) is not going to go bankrupt. Governments like Germany, America, and Japan will always pay their debts so purchasing a government bond is guaranteed to return your money to you at the end of the day. But just because they don’t have risk doesn’t mean they don’t have cost.

Everything in economics has an opportunity cost and this applies especially to bonds. There’s no guarantee that the investment you made was the best way you could have invested your money, even if you made a bit of money through it in the long run. Let me explain some of the opportunity costs you are facing when you buy bonds.

If you buy bonds today, you lock in a fixed interest rate for the length of the bond (let’s ignore I-bonds for now). That means you will receive a fixed amount of money for the length of the bond, plus you will be given back the initial amount you paid at the bond’s maturity. So if you buy a 10,000$ bond, and hold it to maturity, you will have made 10,000$ + 4% interest, it sounds like a great deal. But what other opportunities did you have with your money? Well in December the Fed will have another meeting, and it’s possible that they will once again raise interest rates. If that happens, you could buy a bond with around 4.75% interest instead of around 4%, so one of the opportunity costs you have is that if you just waited another month you could have bought a higher yield 10,000$ bond and made more money.

That’s not the only opportunity cost though, what if you suddenly have to make a big purchase? You could sell that 10,000$ 4% bond you purchased, it’s still worth somewhere close to 10,000$ if you bought it recently, but if you sell it after the Fed has raised interest rates you will find the price you can get for it is much lower than what you may have expected. That’s because your bond is paying a lower interest rate than what people can get buying new bonds, why spend 10,000$ to buy a 4% bond when you can spend 10,000$ to buy a 4.75% bond. So if you buy a lot of bonds then have to sell them after an interest rate hike, you’ll have lost out compared to if you had bought after the interest rate hike or if you had not bought at all.

Another scenario is that the Fed doesn’t hike interest rates but the markets recover. Say the inflation report comes out and shows inflation slowing substantially, in that case the Fed would have less reason to raise rates and the markets would have more reason to rally as people expect better times ahead. You’ve still got your 4% bond but markets on average rise 7% each year, so in an average year the stock market can be expected to give greater returns than buying a bond. In this case you haven’t lost any money but you’ve incurred an opportunity cost by buying bonds instead of stocks, you could have had greater returns buying stocks.

I’m not saying don’t buy bonds, bonds can be a good way to mitigate risk and ensure consistent returns. But I am seeing some people act like current trends will last forever, that the market will stay down forever and thus bonds are the only way to get any kind of return. I’m just saying that every action has an opportunity cost, and while buying bonds are low risk they are still a bet that interest rates won’t go much higher and the market won’t gain too much. Otherwise, you might have been better off putting your money elsewhere.

People are always fighting the last war

We live in a time of high inflation and rock bottom unemployment, but I remember less than a decade ago reading the prognosticators of economics talk about how low inflation and high unemployment (or underemployment) were the inevitable future of our economy. It was said with as much certainty as could be mustered that the Financial Crisis had fundamentally changed the nature of our economic reality, no more could we expect governments to bail us out (they all had too much debt), instead we were going to keep suffering for a long while for the profligate lending of the banks. Of course that wasn’t true, and neither is it true that inflation and low employment are a certainty for the rest of time.

What’s crazy to me is that both predictions were made with the same data. Our population is aging, globalization inevitably moves certain jobs overseas and forces American workers and companies to compete with those in foreign nations. Our government has high debt, real wage growth is anemic or negative, and the job of fixing all this has landed solely on the head of the Federal Reserve since the rest of the government can’t or won’t do so. This describes 2012 as much as 2022, and yet this evidence is used just as confidently by the takemongers of 2012 who predicted an eternal low-growth as the takemongers of 2022 predicting eternal inflation. It reminds me of all the sci-fi books and movies from the 70s and 80s predicting a far future of the 21st or 22nd century in which the Soviet Union still existed, people routinely project their current reality onto the future without any further thought. If pressed they’ll then use any evidence at all to defend their predictions, even if the same evidence could be used for an entirely different conclusion.

The 2010s were a period of low growth, low inflation, and high unemployment/underemployment. The 2020s have so far been a period of higher growth, high inflation, and very low unemployment. Both decades have challenges, and many of the challenges are the same. But I see no reason to believe that the trends of today will last forever.

Are passive ETFs creating market inefficiencies?

Yesterday I wrote about how the YOLO memesters might be creating market inefficiencies, today I thought I’d look at the other side of the coin with the more mature, more upscale passive ETFs.

For those who don’t know, a passive ETF is just a pile of money that you can buy into like a stock. When you hold a stock of $VTI for example, you own a tiny percentage of that big pile of money. The money in turn isn’t just a bunch of cash, it’s invested into the stock market according to the ETF’s prospectus, from which the ETF is not allowed to deviate from by law. $VTI’s prospectus says for example that it will seek to track the performance of the whole US stock market by investing in a representative sample of companies in that market. In this way, $VTI isn’t making a decision on the worth or value of any individual stock, it is merely buying every stock and assuming the market will do the hard work. Since the value of the total US stock market grows at an average rate of between 5% and 10% every year (with some down years like 2022), this means that $VTI is expected to grow at that pace as well and an investor in $VTI can make 5% to 10% returns without any of the stress or hassle of picking their own stocks. The only things $VTI asks for in return is a tiny amount of money in the form of it’s expense ratio, just 3¢ for every 100$ of investor’s money is taken for expenses, which seems to be a reasonable deal for everyone involved.

$VTI and other ETFs like it are easy, low-risk investment vehicles, so it’s no wonder they have exploded in popularity. Not only that, but studies have demonstrated that passively managed ETFs almost always outperform their actively managed peers. But is this “$VTI and chill” mindset of investors creating market inefficiencies of its own? Remember that passive ETFs invest in the whole market, regardless of if an underlying stock is any good or not. Not all ETFs are as broad as $VTI of course, some seek to track a certain market segment or a certain type of stock, but all passive ETFs share a commitment to obeying their prospectus and investing in valid companies without precondition. This means that they cannot participate in price discovery which is seen by some as the primary purpose of markets, including stock markets. If company A is growing, profitable, and well run, then it should be rewarded with having a higher value than it’s competitor, company B which is shrinking, unprofitable, and poorly run. We would expect that the stock market would perform price discovery on these two companies, investors would buy stock in the A and sell the stock in company B, raising and lowering their stock prices in turn. This then rewards company A for its success, and lets it use its high stock price as a tool to further expand the company, hopefully rewarding investors in the process and creating a virtuous cycle of success breeding success.

But passive ETFs don’t participate in price discovery, they don’t sell bad companies and buy good ones. Passive ETFs buy a representative sample of companies according to their prospectus, and they keep their expense ratios as low as possible in part by not doing the kind of deep dive on their investments that you would expect from an active investor. If company A and B are both worth 5% of the total stock in a passive ETF’s market, then it will hold 5% of its total value in both A and B. And if every investor in the market was a passive ETF, then there would be no way for the price of A and B to move relative to each other, because there would be no sell pressure on one relative to the other. Indeed some have claimed that the rise of passive ETFs is making the market less efficient, and tipping the scales towards large companies that will get bought up by the most popular ETFs simply because they are large and thus make up such a large portion of the market. If this is the case, then the erudite bogleheads are doing as much damage as the memesters.

Are stocks-as-memes creating market inefficiencies?

Stocks have long been the investment vehicle of choice for people with small amounts of excess cash.  Bonds are confusing, bank interest doesn’t pay much, and property requires high amounts of cash that most people don’t have.  But stocks are easy to understand, potentially give jackpots, and require such a small amount of upfront investment that almost anyone can afford them.  In ages past stocks were still usually bought through a specialized broker, and while the shoe shine boys in New York giving out stock tips may have been seen as a signal of a price crash, most people not living in major cities didn’t have access to a broker who could help them buy.  The brokers were therefore a barrier to entry that prohibited a lot of people from owning stocks who otherwise might have.  These days buying a stock can be as easy as installing the app, so quite literally anyone can own one at the push of a button.  This has democratized the market, but may have led to some unexpected consequences.

It seems that these days, stocks have become more than an investment opportunity.  Some stocks can be a badge of honor, a feeling of belonging, or a source of self-actualization.  You may invest in nuclear power because you want to help fight climate change, you may invest in Manchester United because you love the club, you may invest in GameStop because you believe you’re destroying the short sellers and want to be part of something greater.  None of these feelings have anything to do with the stock’s financial value.  They aren’t a dividend, they aren’t growth, they are a feeling you have when you own the stock and those feelings are often irrational.  In some ways these feelings call into question our understanding of stocks and investors generally.  

Now let’s be clear, there has always been emotions in the stock market.  Some people have always bought a company simply because they “liked” it with no better reason why, and “panics” can be just that: mindless rushes to cash out based on fear without thought.  But when a stock’s price is almost entirely based on feeling rather than actual value, to some extend it forces us to re-evaluate the market as a whole.  Last year, GameStop’s stock rose exponentially for no good reason whatsoever, and while some have considered it nothing more than a bubble, the price remains irrationally elevated even today.  There is no way a stock with no growth, no earnings, and no path to profit should be trading so high, and yet it is. If you took a company that was identical to GameStop in every way, but called it something different, it would  have but a small fraction of GameStop’s market cap.  That’s because GameStop isn’t just a company, GameStop truly is a meme. It seems insane, but there truly is a group of people for whom ownership of GME stock is bringing them no financial value whatsoever, but who continue to hold it out of emotional value.  You wouldn’t think such a group would be big enough to move the market, but last year showed them to be plenty large, and I believe there are still enough of them hanging around, holding the stock, and even buying more to ensure continued upward pressure on the stock’s price. 

If a market is anything, it is a mechanism of price discovery. The stock market should be a mechanism to discover the correct price of companies, and our research assumes that this in turn allows profitable and growing companies to prosper while unprofitable and shrinking companies fail. We know market actors can be irrational, but the average of all market actors, the “wisdom of the crowds” so to speak should have some logical underpinning if the market is to find the correct price of these companies. Stocks becoming a form of self-expression more than an investment vehicle could introduce inefficiencies to this market, and I’ll still trying to come to grips with what the consequences could be. We might imagine a future in which board members will seek out a CEO based not on the value they can add to the company but by whether or not they, like Ryan Cohen, have a ready-made base of support among the memesters. But I don’t have the economic or statistical background to understand how much this would change things, maybe CEO’s have always been picked for dumb reasons. What do you think?

Markets tend towards completeness: the story of Ric Flair and terrorism

There’s a funny story about Ric Flair: Flair was at the height of his career making millions of dollars every year, but he knew that the good times would someday end and that he had to invest his money for retirement. He decided that he would invest in a business he knew well, and what could be a better business than a gym. Wrestling is a body business, and during his world travels as a wrestler Flair had been to all sorts of gyms to keep his physique in top shape for his matches. He knew what he liked and knew what a gym needed, so he put his money into building a high-end luxury gym in the Bahamas, then he starting dropping the name of his new gym in his promos so his legions of fans would want to buy memberships there. It was all coming together, but tragedy struck when in its very first year of operation a hurricane hit the Bahamas and wiped out Flair’s gym. Flair was distraught, but his friend tried to comfort him saying “surely you haven’t lost everything, didn’t you have insurance?” Flair shot back “what do I look like, an idiot! Why would I ever pay for insurance!”

It’s a story I like because it speaks to the mindset of many professionals, most of whom can be experts in their own field but just don’t understand how finances work. It’s easy to throw your hands up and see financial markets as a tool by evil rich people to take our money, but it’s important to know that everything in finances is just a bet or a hedge usually made in good faith. When you insure your property, you’re reducing your downside risk by ensuring you get a payout if the property gets destroyed, but in turn you reduce your upside return because you’re forced to pay for the insurance for as long as you hold the policy. The insurance company meanwhile is increasing their downside risk because they have to pay you money if your property gets destroyed, but in turn they increase their upside return by forcing you to pay them money for the policy. The insurance policy can also be seen as a kind of bet: the person paying for insurance is betting that the value of the payout will be more than the amount they pay towards the policy, aka a hurricane is more likely to hit the property. The issuer of the insurance is betting the opposite, that the payout will be less than the amount paid towards insurance. It’s funny to realize, but buying hurricane insurance is sort of like a placing bet that your property will get hit by a hurricane.

But what if the insurance company wants to reduce its own risk? There are various tools and instruments an insurance company can use to hedge its risk, in the same way a gym owner can use insurance to hedge the risk to a gym, and they all work in much the same way: one party bets than an action will happen, one party bets that it won’t, and the money goes to whoever is correct. A whole bunch of insurance policies can be securitized into catastrophe bonds for example. Let’s say Ric Flair builds a second gym and this time he insures it, in that case the insurance company can sell catastrophe bonds based on his policy. Now let’s say I buy 100$ worth of catastrophe bonds based on Flair’s insurance policy: the bond has a lifetime of 3 years, so if after 3 years no hurricane has destroyed Flair’s gym then I am entitled to my 100$ back plus some extra money known as the “coupon.” If on the other hand a hurricane does destroy Flair’s gym, then I lose my 100$ investment because the insurance company takes it to pay back Ric Flair. By buying this catastrophe bond, I am participating in a bet in which I think a hurricane won’t destroy Flair’s gym, and I make money if my bet is correct.

Now remember that a catastrophe bond is a security, it’s like any other bond that I can sell on the open market. If I need money, I can sell my bond to someone else for a fair value, but the amount I can sell it for will change as it gains or loses value based on outside forces. Say for example that scientists publish a report saying that the upcoming hurricane season will be the most destructive in history, suddenly it looks more likely that Ric Flair’s gym will get destroyed, meaning my bond won’t pay back the money, meaning the price of my bond will go down because people think it’s a less good investment. The opposite could occur too, if the Bahamas institute some national policy which mitigates hurricane risks for all residents, then it becomes less likely that Flair’s gym will be destroyed and thus more likely that my bond will pay back the money, so the price of my bond will go up. And because the price of bonds can go up or down, you can go short or long on them essentially betting on their price movement which is in part determined by the underlying risk.

Now let’s add another twist: hurricanes aren’t the only thing you can insure against, what about terrorism?

Let’s paint a scenario in which Ric Flair insures his gym against terrorism instead of hurricanes. The insurance company securitizes his policy into a bond which someone buys, I then take a short position against that bond. My short position means I’m betting the price of the bond will go down, and why would it go down? It could go down in part because people think terrorism is more likely to happen and destroy Flair’s gym, and in the aftermath of large terrorism attacks many catastrophe bonds’ prices do go down as the markets become fearful of follow-up or copycat attacks. By shorting a catastrophe bond on Ric Flair’s terrorism insurance, I make money whenever terrorism happens.

This exact situation has been seen by some as a monstrous moral hazard because since I get paid when terrorism happens I have a financial incentive to support policies that make terrorism more likely. What those policies are I won’t speculate, but some have painted grim pictures in which hedge funds could secretly move money to support terrorists in order to scare the market and make bank on their investments. In the aftermath of the Financial Crash this even led some to propose banning securitized insurance altogether, because not only was it speculative and dangerous just like the credit-default-swaps that were blamed for the crisis, but it also came with an in-built hazard in that people were incentivized to ensure terrible events happened. I feel like this is a misunderstanding of financial markets: these markets tend towards completeness. What that means is that every angle of a financial transaction tends to have space for someone to make a bet, because if there’s no monetary incentive for the price to move in every possible way then there’s less of a mechanism for price discovery. If you can securitize a loan then you can securitize an insurance policy, and if you can short a stock you can short a bond, these are just ways for companies to hedge their risk and for the market to discover the correct price of something. And note that the person shorting a catastrophe bond isn’t the only one with a financial incentive for terrorism: Ric Flair himself would have a financial incentive since he gets an insurance payout if his gym gets destroyed by terrorism. We’ve had laws to investigate and prevent this kind of thing for hundreds of years with arson and other forms of insurance and if we think people are breaking those laws then we should investigate and prosecute them, not ban an entire financial market.

“No one wants to work”

Inflation is up, unemployment is down.  This year there have been tons of stories about shortages and supply chains, and invariably a call has arisen from business owners: they’d like to hire more people but no one wants to work.  

When I see stories on local restaurants and businesses closing, inevitably I see an owner blaming their failures on no one wanting to work.  They had a good and profitable business going on, then after the pandemic suddenly no one wanted to work anymore.  This meant they couldn’t hire employees and so couldn’t do anything at all to make money and thus were forced to close down.  This is a dumb argument for many reason’s but to just pick one: labor has a market just like any other service. There is a supply and a demand for labor.  If you are demanding labor while the supply is constricted, the price you pay for labor will go up, and if you refuse to pay that price then you will go without, just as if I refuse to pay more for a Pepsi I can’t get one.  The price you pay for labor is the wage or salary so if you can’t get people to work for you then you need to increase the wage or salary you are offering.  No one is going to work for less than the market rate and so if you can’t afford the market rate of labor then I’m sorry but you’re going to go out of business just as if you couldn’t afford the market rate of rent or supplies or anything else a business needs.  People want to work, but no one wants to work for you if you’re not willing to pay them.

This “no one wants to work” nonsense got spread around a lot as the price of labor increased and many businesses found themselves unprofitable.  It was easier for owners to blame the moral failing of society than to admit that they weren’t good enough to turn a profit in a high wage environment.  But while this nonsense was rightly criticized by many, it reminded me of a similar economic trope that I don’t see get much criticism.

I’ve been reading “The Rise and Fall of Nations” by Ruchir Sharma.  What stood out to me was his discussion of immigration where he used a very popular left-of-center talking point that “immigrants do the jobs natives don’t want to do.”  He justified this with several anecdotes, but to me this smacks of the same false narrative as “people don’t want to work”.  It’s not that natives don’t want to do those jobs, it’s that those jobs are unwilling to pay a higher cost for labor and so usually receive special carve outs and exceptions allowing them to pay less.  This in turn makes the jobs unattractive to natives who have other options, and when the job creators whine to the government saying “no one wants to work!” the government responds with selected programs to allow the importation of cheaper workers.

Just look at agriculture in America.  In Massachusetts the minimum wage is $14.25, but it’s just $8.00 for farm workers!  Farm workers are also except from overtime pay and some OSHA requirements alongside the NLRA and many state laws.  The law has excepted farm workers from a majority of the protections and benefits afforded to other workers, so why would anyone work on a farm?  Why work on a Massachusetts farm for $8.00 an hour with no overtime, no safety, and no protection when you could make $14.25 an hour working for Walmart.  So instead these jobs go to immigrants, especially immigrants on special visas which only allow them to work on farms!  There’s no fear of your workers leaving for a better job if your government forbids them from doing so!  So let’s be honest, are these jobs that natives don’t want to do?  Or are they jobs that natives refuse to do because they have low pay, low benefits, low safety, and there are plenty of better options available.  

Farm employers say that it has to be this way: they can’t raise wages or they’d go out of business, or prices would rise, or America’s food economy would be destroyed by cheap imports.  This is the same excuse the “no one wants to work” crowd gives for refusing to raise wages, and is strikes me as the same 19th century nonsense that people used to use to argue against the minimum wage and every single worker’s rights law for generations.  Which is why it’s so infuriating that many left-of-center voices believe in the “jobs natives don’t want to do” narrative, even while they rightly point out that “no one wants to work” is a false narrative.  If farm jobs were as good as Walmart jobs we’d see far more Americans take them.