In the latter stages of the run-up to last year’s financial meltdown, the market was filled with synthetic contrivances engineered by Wall Street wunderkinds who were unthinkingly grinding out anything that could be sold at a profit, regardless of its investment value. It didn’t seem to matter if there was any real value inherent in these artificial securities as long as they could be sold.
Family photo circa 1890, great uncle Frank far right
One of the underlying assumptions ingrained in most modern-day economic activity is that you can always find someone to buy what you want to liquidate - what some refer to as “the greater fool theory.” Thus we buy houses with no down payments taking on huge mortgages in the belief that the property will appreciate and we can sell it at a profit, or “flip” it using today’s jargon. As I have asserted many times previously, this is not investing; it is speculating, pure and simple. In more recent years the stock market has also become thick with speculators churning stocks, buying options, or betting on upturns or downturns – all very casino-like. These are the kind of financial transactions that would make my great uncle Frank, a conservative banker, turn in his grave. In his day, there were clear distinctions between investing and speculating. One was for dependable income or growth, “serious money” such as retirement, saving to buy a home, college tuition for the kids, etc. The other was almost sport, like Monopoly money using only a small portion of one’s cash to take some chances and gamble a bit. It was actually fun if you could afford it.
Merchants or business owners would keep their operating reserves in safe investments and only speculate with their own personal surplus cash. Credit was rarely used and never relied upon.
But then the quick-buck mindset, along with a shift from savings/reserve-thinking to credit-thinking, permeated the culture and people got impatient and greedy. Rapid gratification became the goal. As long as we could sell something we did it. It didn’t need to have intrinsic value as long as there was someone who’d buy it and pay more than we did.
In the more recent days on Wall Street, purchase value was based on anticipated resale price. It didn’t matter what it was really worth. There's an old story about two sardine futures traders who trade inventories of canned sardines back and forth in the pits for 20 years. One day one of the traders forgets his lunch and decides to open a can of the sardines to eat. He spits out the first bite, "This is terrible," he yells. The other trader says, "Of course it's terrible, you idiot, these are trading sardines, not eating sardines."
This “greater fool economy” in which we have been living for several generations may have been revealed for what it is now that the system has blown up so publically. But I’m not so sure. Yes, perhaps many flaws in the old system may have been revealed in the past year, but will lasting lessons be learned? Will we reinvent a system that is based on true value, restrained from the silliness we previously allowed? Or will we simply polish up the old system, touch up the paint and send it out again without any meaningful structural changes or contextual shifts in underlying assumptions?
If anyone knows the answer to these questions I haven’t heard or read of them as yet. I’d like to think someone is looking at the larger, longer-term future of our economic system, the one system upon which we arguably rely more than any other. This could be wishful thinking in a vacuum of information. Have no worry though, the system will let us know soon enough. If it is only superficially patched up, it will fold again, even more disastrously next time, and our children’s children will inherit that mess.
All I can do or advise others to do is to be aware of our past participation in the dysfunctional system, how we enabled all this to happen, and make sure we engage it differently in the future. We have little influence over what others do but we can adjust our own behavior so our roles and reliances are more responsible, thus resigning our membership in the Greater Fool Economy.
For more about John, his writings and his work, see his website.
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