Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Month: August 2011 (Page 1 of 2)

Q&A:s The Monetary System & Fractional Banking

criticism fractional banking monetary systemA look into the arguments against our current monetary system, and the criticism surrounding fractional reserve banking with fiat money.

There are thousands of opinions and experts that claims that our monetary system, a fractional reserve banking system backed by fiat money, is doomed to fail. The idea got even more popularized by the criticized but also praised documentary Zeitgeist. There is also a lot of critical, often gold-related, websites such as www.gold-eagle.com and lewrockwell.com who make these claims.

Here follows a summation of some arguments used to criticize our current monetary system:

Our monetary system is totally based on fiat (faith) money without any real value or promise. What many people, especially from the younger generation, do not know is that there was a time where people could exchange their money for gold. Today they are guaranteed to exchange their money for exactly nothing in the end.

All things will at some time in history return to its intrinsic value. That means that paper money will at some point be worth only the paper it is written on.

Debt grows exponentially, while the economies’ of states grows like s-shaped curves. That must lead to a debt that will sooner or later being too big to being paid back. All economies depending on this monetary system will therefore eventually crash.

Although the claims above seem very logical, a few arguments arise that are not so often answered by the people who are making those claims:

  1. You are not forced to take credit. So you are never forced to pay any exponentially growing interest to some evil bank. How bad can it be to let people freely do business with their own chosen terms?

  2. Most creditors are likely to be included in our economies. The economies that we are told will be destroyed be the exponentially growing interest in the long-run. So the only thing that can really happen to our economy is that money goes from the people making bad business to the people who are doing smart business. Kind of like how the system has worked since the beginning of time.

  3. Even if we had a gold standard we could and would still have exponentially growing debt. If you lend someone ten ounces of gold you would still want to have eleven ounces back. So that argument is not specifically related to our current monetary system, but to all free economy systems.

  4. If the fractional banking system of today is so bad, how come most countries, that are economically and politically stable, have had their monetary system intact since War World II?

  5.  The fact that debt is growing exponentially may sound alarming, but exponentially only means that it grows by a certain factor every year. If debt increases by 2% every year it is growing exponentially, but it is growing at a fairly low rate. It will take 35 years for that debt to double. The growth of debt is met by economic output, such as services, natural resources and production of goods which is constantly being added to the economy. So an exponentially growing debt will be met as long as people work. Increasing debt also means inflation or that the value of money/debt decreases. With an increasing population and economic growth there should be no problem with an increasing amount of money or debt as long as it increasing in harmony with other economic outputs such as houses, cars, or plates with food. In the long-run there will be a problem to produce an ever-increasing stream of those products, but that is an ecological problem and not a problem of the monetary system.

Please feel free to come with other questions or if you are one of those questioning the current monetary system try to answer one or more of the questions above.

Negative Interest Rate in Swiss Franc… Again

Switzerland is now charging interest (or call it a tax if you want) if you want to lend the country your money! That is right, for every franc you want to lend them they will give you less back.

No matter how crazy this might sound, this is actually for the second time period in history that Switzerland charge investors to give them money. The first period where Switzerland had negative interest rate was in the 1970’s and that initially lead to a decline of 27% before the appreciation continued. Switzerland sure seem like a country who knows how to take care of its currency. Maybe something other countries could learn from.

Today you have to pay 0,82 Swiss Franc for a U.S. Dollar. The facts above indicates that the market sentiment is a bit stretched to say the least, and if the pattern from the 1970’s repeats, then there seem to be a good risk/reward to buy U.S Dollar with Swiss Franc. 0,7765 is where I put the stop loss for this idea, which is 5,3% below current value.

US Dollar Swiss Franc USD CHF

Beware! Be sure to understand money management and the risk of trading before attempting any trades. For instance, in the example above, if you only want to risk 1% of your trading capital you need to invest a fifth of your capital. There will be a risk and money management article coming up in later posts.

Bernanke Speaking at Jackson Hole

FED director Mr Bernanke is now starting his speech in the Jackson Hole FED-bank conference.

bernanke jackson hole stock market

The market participants are now waiting for news about the economy. Last year a big rally started in the stock market that lasted until this summer.

This time people do not seem that optimistic about the things Bernanke has left to offer. A Quantitative Easing number 3 is what many hopes for to help inject money into the markets. But even if that comes that is no guarantee for a raising stock market.

The positive side, I think, is that so many are negative now and not many believe in a strong stock market. That is the only, but very important, tell that we might enjoy some strength in the market.

But beware of volatility. Always take smaller trade sizes during times of high volatility. More about trade sizing in later posts.

S&P 500 is at this time down 1,3% to 1144.

POST-MEETING UPDATE 16:48 CET

No specific information about quantitative easing was given as most had expected.  But Bernanke said that the U.S. Federal Reserve will do what is necessary to support the economic recovery. — Suprise suprise!

The recovery in the U.S. economy remains modest. The recovery is slower than the Fed had hoped for, but the Fed continues to expect better growth in the second half of 2011. — I think you should change the world “expect” for “hope for”. What they or any expert expect is rarely what happens.

While noted a significant growth in the global economy and America’s banking sector is generally in much better shape now, says Bernanke, and I believe him, but it is not now I am worried about. It is tomorrow or next year. Warren Buffet also seems to believe in the American banking system. Google Buffet + BAC for more info about his latest investment.

The Federal Reserve has a number of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. — They might have the holy grail but they have not used it yet and do not want to tell us about it.

Their next meeting is in one month.

S&P 500 is at this time down 0,7% to 1152.

Our Economies Last Safety Barrier is Reached

Our Economies Last Safety Barrier is Reached and Things look Pretty Gloomy from here.last barrier of the economy

The economical crises we see and read about these days started with consumers that got broke and could not repay their banks. Which in turn lead to banks going bankrupt. Many banks got saved by the state, but now lately even states are going or are getting close to bankrupt.

Consumers ? Companies ? Countries ? What is next?

Who is left to save the last barrier of the economy?

When companies got bad the states invested in them making them go from publicly owned companies to owned by the state.

So what will happen when states get bankrupt? I guess one reasonable way to go is to sell companies owned by the state to the public. The management or managerial system have obviously not done a good job so it is time to let a new management in.

Another way we could go, that have also happened in the pass, is for the states to use force to confiscate people’s assets such as land and natural resources. That is a socialistic or totalitarian approach that I do not think will work in this new age of information technology.

In the long-run, I believe, pure Darwinism* will show that capitalism, an efficient system based on mans free will, are going to prevail over socialism, an inefficient system based on force and musts.

* The survival of the fittest. In this case the survival of the fittest economic system.

Creating Something out of Nothing – The Story of our Monetary System

Today our guest blogger, Carl Norberg, gives his view on the current monetary system and why this system has always been doomed to fail.

What is the common denominator for the financial, ecological and social crisis? All these crises are now accelerating caused by a dysfunctional monetary system, or more popularly expressed, the financial system.

The basis for why it continually becomes more difficult to deal with these crises lies in the very foundation of our financial system, the way money is created and derives its value. In order to create sustainable capitalism an unconditionally sustainable monetary system is needed. This is because the intrinsic logic behind a monetary system controls all other economic decisions.

It controls if there is a short-term and unsustainable economic growth that benefit but a few individuals or a long-term sustainable economic growth that benefits the whole society.

Bush & Greenspan - Experts on Economy

One Expert Giving a medal to another Expert

The monetary process is difficult to understand for many, even for experts (see picture). The process of how banks create money is so irrational that it almost is repulsive for our way to reason.

Seemingly though, it appears as if we borrow something very valuable from the banks (money) and we are therefore more than willing to pledge something valuable in return, we even pledge to give a part of our future earnings and our possessions (assets) in the case of if we do not pay. But in reality, the relationship is just the opposite. We get something from the bank which is basically completely worthless (figures in an account or coloured paper) and it is we as borrowers who have to cover or fill these worthless digits with any value, namely the promise of performance. Money is thus created in a completely different way than most people think.

The bank has only received power from the state to create money through credit lending. Therefore, today’s money is called “debt money” or “Fiat money”. The Bible says that God created light out of nothing but the power of his words. He said: “Fiat lux” (Let there be light). Fiat money is also created from “nothing”, but their value is created through a social construction, where we cover up the “nothing” with a debt recognition and a performance promise.

Debt Money was out of this first called “Protestant” money, since they got their legitimacy through the formation of central banks in Protestant countries such as Sweden (1668) and England (1688). There is thus a religious background to today’s non-rational monetary system. The confession and the trade of guilt was a Catholic mission. Within Protestantism the trade of debt or guilt became an internalized settlement between the individual and God. The creation of money through debt recognition therefore appears like a “natural” psychological step for a guilty Protestant. Today’s money is basically based on a secular faith, nothing else. It only exists because we believe in an illusionistic, but internalized guilt. [Editors note: In Sanskrit, Hebrew, Aramaic, ‘‘debt,’’ ‘‘guilt,’’ and ‘‘sin’’ are actually the same word.]

The right to create money has previously always been confined to a state’s sovereignty. Today that right belongs to the private banks.

The ability to create money “out of nothing” is the modern industrialized world’s foundation. It really is an impressive illusionary masterpiece that requires some respect. Since we would not have the society of today and it would also have been impossible to understand it without recognizing the essence of this illusion.

All financial business that describes economy is thus based on paying back a debt, since all earned money is initially borrowed money that must be paid back. But as everyone knows, there is also an interest on debt. And since money is created through credit, this means that the compounding debt of society is continually growing as we must borrow more money to repay our debts plus interest. This means that we have indebted ourselves even more, with even more interest requirements and so on.

This is a classic vicious circle. Those who have read a bit about systems theory knows that any system that has a positive feedback is doomed to collapse. Therefore, it is a mathematical inevitability that our monetary system must sooner or later break down. The existing monetary system allows that debt grows exponentially over the years, so that is doubling at an even pace, i.e.: 2, 4, 8, 16, 32, 64. Sooner or later the system ends up in a debt crisis where states, organizations and individuals no longer have the power or will to borrow more to make more money. Money needed to create even more growth in order to pay the interest of our exponentially growing debt.

The dysfunctional monetary system of today has a wide range of adverse side effects during its final stage (before the collapse) that get more apparent and emerge as we all now are becoming aware of. The interest makes a few accumulate more bills of debt (money) while the rest are becoming increasingly indebted. Some have to go bankrupt so that others can pay their interest.

Excessive growth of debt must be met with an equally excessive economic growth, when the liabilities are covered by a performance requirement. We must therefore work more and consume more — at any given price.

Growth is hence all of the economists and politicians’ stubborn mantra. Only through growth can we even try to catch up with the exponential growth in the interest expense of our debt.

Logically our debt grows even more when we try to meet its interest requirements. So we struggle in vain no matter what we are doing. The system must, mathematically, end in a collapse as our burden of debt grows to infinity. Meanwhile, the pressure to perform increases on people, nature and our social systems. Nature’s resources will, like people, get more out of balance. The exponential need for growth do not respect the natural need for recovery.

Societies are forced to save on the lookout for opportunities to cope with the increasing burden of debt. That is what we are seeing in many countries now where states are forced to save. While at the same time citizens are expected to consume so to increase growth so that an impossible debt can be paid back. This is an equation that does not add up.

In other words, there is a self-destructive mechanism built into our monetary exchange system. A society without a functioning exchange system is a society without a functioning division of labour and is in an acute existential crisis. Our current monetary system therefore imposes a serious threat to our nations. We must realize that the monetary system now must be changed. Only a financial system with an exchange of value will build a sustainable monetary ground, and gives us the opportunity to build a sustainable economy and therefore a sustainable and just society in the future.

—Carl Norberg

Please feel free to comment if you agree or disagree.

The Rise of the Machines

computer guided tradingLast week we could read from the supposed to be knowledgeable people that short-selling (see article) is to be blamed for falling stock market. Yesterday it was the computers turn to be blamed.

According to some financial “professionals” it was the computer guided trading that is to be blamed for many of the big declines in the market, such as the one we saw yesterday when stocks fell 5-6% across markets. I wonder how the authorities think that their ban of short-selling turned out?

From time to time you will hear other equally ridiculous claims such as it is the fault of the:

  • Institutions
  • Daytraders
  • Short-sellers
  • Scared Investors
  • Analysts
  • Investors taking wrong decisions

I guess markets still have a long way to fall when we hear these ridiculous claims trying to explain why the stock market declines.

Warren Buffet Wants Increased Taxes

Warren Buffet is calling for higher taxes for the really wealthy to pay off the US deficit. 

warren buffet on higher taxesBillionaire Warren Buffet wrote the opinion editorial in today’s New York Times and calls for higher taxes for everyone earning more than 1 million a year, and even higher taxes for the few thousands of people who earn more than 10 million a year.

He says he has been talking with his mega-rich friends and that they have the same opinion. Well, I am not surprised. Many of these billionaires are contributing a lot to charity, and Buffet is one of the biggest in the world. It is not hard to understand that they want to contribute even more now when they see that the country that brought them their fortunes are nearing a collapse.

Buffet also says that:

“While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks.”

This editorial got me thinking. Coming from the highest taxed country in the world — Sweden — I am against high taxes, but when a country is in great debt and that country need income to repay its financiers, you need a plan.

So why not let the people who have the best ability to pay and, most likely, have been the ones that benefited most from the economic growth help paying a bigger part of the bill.

I am against taxes, but when a country has a big deficit it means the taxes have been too low! Reduce government spending and lower taxes will follow.

Platinum and Silver vs. Gold

Balancing your portfolio for stability by adding platinum and silver to your investments of precious metals.

Both platinum and silver have a lot of industrial use. Much more so than gold and thus they are more sensitive to the growth of the economy. According to Adrian Ash, head of research at BullionVault.com, industrial use accounted for 11% of total gold demand, but accounted for more than 60% of silver demand worldwide. The whole article can be read on marketwatch.com.

But even if you buy gold as an insurance (read my previous article) you might also add a part of platinum and silver, both which have been lagging gold for the last weeks.

Platinum has almost always been a much more expensive metal than gold, but today it is priced at parity with gold.

Silver had a few extremely strong years and has even been outperforming gold the last years.

gold platinum silver

80% Gold, 10% Silver, 10% Platinum, seems like a reasonable balanced mix of precious metal if are aiming at portfolio stability, rather than risk-taking. So if you want a portfolio total of 20% precious metals you buy a 16% gold, 2% silver, and 2% platinum.

Benefits of adding platinum and silver:

  • Might be better for a long-term investment since it contains metals that are more sensitive to a growing economy. So if gold is underperforming other investments, silver might do better in times of higher economic growth.
  • There is less chance that you buy at the wrong time, since these three commodities vary a lot both from other financial instruments and from each other.
  • The more expensive gold gets the more chance of other precious metals to compete to take a share of its place to store value and for its industrial use.

Drawbacks of adding platinum and silver:

  • Silver has much higher volatility than gold,
  • Silver has a higher correlation (higher beta) to the stock market, which is negative when trying to balance your portfolio to get less risk.
  • Gold has historically been the number one asset to own in the worst financial crises.

Good luck with your investments and trading!
Johan Lindén

Regulating Short-Selling is Ridiculous

As always when the stock market is running bad there is this discussion among authorities to forbid short-selling* of stocks. This time is no different as I could read yesterday that several authorities are talking about banning short-selling of stocks.

So, it must be good for the market if we forbid short-selling right? No, wrong.

  1. There is no evidence whatsoever that it will be better for the financial markets. Show me proof and I will surrender!
  2. Why keep up prices if market participants want them lower? Prices will always end up where they belong sooner or later. The sooner a stock shows its real value, the better for an effective stock market.
  3. Restricting the market makes the market less liquid and effective, which leads to lower prices. Not really what the authorities had in mind I guess.
  4. There are ways to get around this ban by using futures and options. So as usual, the ones that lose are the average Joes who do not have access to those instruments while the sharks prosper as usual. Or maybe we should forbid those instruments too? Why not forbid the whole stock market to avoid turbulence?

The most important point though, is why there is only talk about trying to lower the downward swings. If the market have not gone so high to begin with it would not have gone so deep now. Why ban short-selling? If we instead had ban people from over-investing and buying on the margin we might not have gotten these swings.

Check out the chart below for how the market did the last time we did when banning short-selling in 2008.

short-selling ban 2008

Edit: 28th of September. Adding a video from Bloomberg below.

*For those who do not know what short-selling is, it is when you are speculating in a falling price and sell something you do not have. So instead of owning 100 shares of XYZ, you are owing 100 of XYZ, meaning you have a total of minus 100 shares of that stock in your account and thus prosper when the stock is going down and you later buy it back cheaper.

 

Trading vs. Poker

Having been a full-time poker player for a few years before I started my recent venture in finance, I have found many similarities between the two occupations.

trading poker

When I read the book Poker Wizards, a book interviewing some of the best poker players of all time, I found it very interesting to see how the poker professionals reasoned and how it was related to the financial markets.

Let us look at what Daniel Negreanu, one of the most acclaimed and well-known poker players of all time, has to say about the traits of successful poker player:

  1. The one quality that I think is definitely the most important in being a successful player is having good people skills.
  2. The second most important quality is an aggressive personality.
  3. Third is discipline.
  4. The last quality is having a fundamental knowledge of the game, which is the easiest part.

I could not have agreed more about this list of qualities that makes a successful player. The interesting part though, is that the same thing goes for the players in the stock market or other financial markets. So let us look at these four qualities one by one when it comes to being a successful trader.

People Skills

Most definitely one of the most important qualities! A good poker player knows that when the table is tight and people hold onto their money he should be more involved and putting his money in the pot more often. But if many players are involved most of the time, then he plays fewer hands.

The same thing goes for the stock market. When everyone talks about how good it is to invest in stocks and you hear stock tips just by visiting your local coffee shop, you better stay out. But when people loathe the thought of owning stocks, that is a good time to own stocks.
stock market psychology behavioral economic

Another way of seeing why you need good people skill is to understand what drives the stock prices. In the long-run it is the earnings of a company that leads the way for stock prices, but in the long-run we might have gotten broke already.

In the short-run it is the hope and fear of people who decides where the stock prices moves. This is what we call market psychology or behavioral economics. Instead of fundamental analysis of the company itself, many successful traders try to measure and use people’s behaviour when analysing the outcome of a trade.

An Aggressive Personality

I prefer to call it an unafraid personality. If you assessed the risk of your strategy you must be willing to follow through your plan and not change it just because you are currently losing. When people panic they often take the wrong decision.

Discipline

Even if you have the best trading plan in the world and make money 95% av the time, you might lose all those winnings in the last 5% of your trades if you trade inconsistently. You must also have discipline and routines to look over your trading on a regular basis to optimize results, but also take care of your well-being to not lose focus due to stress and other factors.

Another very important aspect that many people fail to follow is the discipline of game selection. Both poker players and traders alike love their game so much so they often join a game where they do not have an edge instead of waiting for the right opportunity. To sit out and not take a position is many times the right decision. Or to put it another way, to not get involved in losing games makes you a winner in the long-run.

Fundamental Knowledge of the Game

It is easy to get a fundamental knowledge of poker. Anyone can get it by reading a few good poker books. In the stock market this is much harder since there is not much scientific evidence about doing the right investment. Are value companies better than growth companies? Is it better to buy a stock with a low P/E? Many people have an opinion but if you ask them for some statistical evidence they think you are a donkey not taking their word for granted.

It is a big leak for a trader or investor who is using his common sense to take decisions instead of finding a scientific measurable edge. But just as in poker, those bad traders might win in the short-run and complain about being unlucky in the long-run. Do not become one of those people!

Differences between Trading  and Poker

Finally I would like to point out two differences between trading and poker. In poker, many go with their gut-feeling when taking hard decisions. They might see something in their opponent, a tell, that looks suspicious, and take actions according to that. That is fine! People have had millions of years to evolve skills in reading other people’s subtle expressions. But traders usually do best in avoiding that gut-feeling that usually comes from fear or greed instead of the body language of their opponent.

The similarity, however, is that you should try switching of your emotional senses in both poker and trading to avoid taking emotionally driven decisions. So much money has been lost in both poker tables and in the stock market for those emotionally driven decision. But your own emotions are one of the toughest challenges to master no matter if you are a trader or poker player.

My last point regarding the dissimilarities between poker and trading is that trading and the financial markets is much tougher to master than poker. It is much harder to find an edge in trading than in poker. If you have two aces and get your money in before the flop, you are making a good investment. That is a fact. In trading you rarely find those facts.

I want to finish of with a quote:

“Poker is like sex. Everyone thinks they are the best, but most people don’t know what they are doing.” -Dutch Boyd

I hope you enjoyed this article. Feel free to comment!

Related posts:
Ten Characteristics of Successful Traders
Quotes of Market Wizards

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