Economics: Vegas Style!

The article, “Trading program sparked May ‘flash crash’” today (Oct 1, 2010) by Ben Rooney at confirms what I have feared for quite some time: there may be a good deal of ‘intelligence’ involved in the stock market, but very little wisdom.

The article outlines how a computer program was monitoring a certain type of stock, which reached a threshold, inducing the computer to start selling this stock. It was of a type and quantity, that the market reacted to the change, causing the computer to further react. This affected other stocks, and eventually caused the avalanche on May 6, where the Dow took the biggest drop on record in a single day (nearly 1000 points, or about $1 trillion).

It is an interesting article, which you should go read if you are interested, but for the point I am making, you don’t have to. One can easily see the problem here by just reading the article title. Why was a computer program trading stock in the first place? Well, it was playing the economic Craps game for wealthy ‘investors.’

To better understand what is going on with the markets today, I’m going to make up a little story to illustrate it.

Once upon a time, Mr. Smith had done well with his widget factory and had some extra cash stuffed away in his mattress. He noticed that his neighbor Mr. Black, had a great new macadamia nut cracker that he just knew would sell better if Mr. Black could produce them more efficiently. So, Mr. Smith made a deal with Mr. Black that if he gave him some money to build an actual factory and hire workers, he would, in return, get some of the profits of the company. This was good. It helped Mr. Black expand his business, and Mr. Smith made some extra money he wouldn’t have been making had he left the money in the mattress, though he also took some risk. However, Mr. Smith didn’t feel it was all that risky, as he knew Mr. Black and his capabilities, that the product was good, and that there were enough people who would want to buy the product.

One day, along came ‘the stock market’, computers, the Internet, stock analysis software, and a plethora of other ‘innovations.’ This was pretty cool, as now Mr. Smith didn’t need to find someone like Mr. Black. He didn’t need to know anything about the companies he was investing in. He simply had to look at some numbers and try to make good picks (or let the computer do it). He had to buy the right things at the right times and sell at the right times. If he did enough analysis, he could get pretty good at it all, and really make a lot of money.

One day, Mr. Black came over and rang Mr. Smith’s door-buzzer. Mr. Smith appeared on the video monitor to see who was there. Mr. Black asked why Mr. Smith had pulled all of his money out of Macadamia Co., when it had been doing just fine as a company. Mr. Smith climbed out of his hot tub, put on his bath robe, and started his trek to the door. He invited Mr. Black in and got his laptop so he could investigate. He hadn’t realized he did pull his money out of Macadamia Co. Then he found what had happened. He explained to Mr. Black that some peanut farm in Africa had been hit by some new type of peanut-eating fungus. Since peanuts and macadamia nuts are both seen generally in the ‘snack’ category, the software had decided it would be safest to sell off any of his stocks in the snack sector, which included anything to do with snack manufacturing, which apparently included Macadamia Co.

Mr. Smith and Mr. Black just sat there somewhat in shock as the reality of all of this sunk in. Unfortunately, very few others would come to such a realization, or if they did, would ever consider getting out of their hot-tubs to do anything about it.

The markets have become that depersonalized, not only in terms of relationships between people, but also in solid linkage between the actual value of a company and the investor. Making a good product, providing good jobs, building a strong community, and making a solid profit are no longer the real goals, nor can they be. The new goal must be to ever increase profits, eat up the competition, and make the numbers look good to those software packages; at any cost. If you know anything about economics, you’ll realize this can’t last. So, the powerful put up trade barriers, and companies outsource or move from place to place to continually reduce costs and up profits. Making a good product and a descent profit doesn’t matter if you’re not hitting the magic numbers.

The really sad thing, is that all these brains (including the SEC) can’t seem to see the real problem. They know what happened, but have no recommendation on how to stop it from happening again, short of just stopping the trading mechanisms to avoid avalanche. Hmm, but that isn’t the root of the problem, is it? The problem isn’t that it can avalanche, but the type of investing that lead to the avalanche in the first place.

OK, I have an idea, how about putting a minimum term on an investment, of say 1 year. If you sell before you’ve held a stock for 1 year, you get hit with a stiff penalty.

This might help ‘investors’ once again become real investors, rather than Market-Craps players. Maybe they would pay a bit more attention to the companies and their values, rather than ‘market trends’ and such. Then CEOs could start running companies more like companies again, rather than trying to hit unrealistic profit increases each quarter, by whatever (and I do mean WHATEVER) means necessary, no matter how destructive to the company long-term.

Folks, if the USA (and much of the rest of the capitalistic world) is going to make it, we’ve got to learn some lessons from recent events. We need to get back to BUSINESS and stop PLAYING GAMES!

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