Punchinello’s Chronicles

February 3, 2011

What are Market Fundamentals?

Filed under: Word of the Day — Punchinello @ 3:01 am
Tags: , , , , ,

Whenever you ad an “-al” to a word, you’re hoping to make the word mean “in the nature of” or “characteristic of.” So we know what music means, right? It’s all that stuff you hear coming out of the radio. When we make it music-al, we hope to mean that something is “a whole lot like” music. It’s “in the nature of being like music.” See?

Alright, so what does fundament mean? It’s the bottom (literally, your butt) and the base. When something is fundament-al, it’s in the nature of being at the very bottom of something. Since we’re talking about concepts, logic and argument when we discuss economics, “fundamental” refers to the most basic premises, along with the very bottom of the cause-and-effect chain. What are the most basic components of a market?

Markets depend on business. That’s why we call it a market. Long ago, a market was a place where people went to sell things and others went to buy things. Many times the market was located within the walls of a city or a castle keep. The kings and lords who owned the towns or castles learned that they could charge a fee to walk through the gate. Sellers had to pay to have a stall or sell their stuff, and buyers had to pay a fee to get into the market.

We still have markets like that, just about everywhere. We also have online markets like eBay, Bonanzle, Craig’s List and so forth. And people often still have to pay a fee of some sort. But “The Market” we talk about in the economic news is a little more abstract. It’s the overall combination of all the ways in which people buy and sell anything in the world. We have oil markets, commodity markets, the job market and the housing market. But we also have the equities market, loans and mortgage markets, interest markets, and financial markets.

So what’s all this about fundamentals? How come they matter? What are they, and why do we even care?

The reason we should all care is because we’re being told that The Recession is Over! We’re being told that “the markets” all are looking up. We’re being told that manufacturing is picking up, jobs are being created, prices are holding steady, and people are buying houses. We’re being told that because The Dow is now over 12,000 for the first time in two years, Happy Days are Here Again! Just like in the 1920s.

How do you know if this is all true? Can you tell what’s what when everyone in the news business is telling you that things are getting better? Why do some people say we’re Recovering (from the Recession), and others say that we’re in the starting phase of the Great World Depression?

It comes down to these fundamentals.

One of the key fundamentals is that some THING has to be made, grown, created or otherwise put together in order for some ONE to buy that thing. Another key fundamental is that someone needs WORK to be completed in order for those things to be put on the market and sold.

A slightly more complicated fundamental is that some ONE knows something you don’t know, and YOU have to pay money in order to find out about it. For example, a doctor knows a lot about your body. You can’t see out of one eye, so you go to the doctor to find out why you can’t see, and whether anyone can do something to make it better. That’s a service, and is part of the service “industry” (market).

What do we make nowadays? What do YOU make? What do YOU know that people pay you money to learn?

Moving right along with that making and knowing stuff, there’s the idea that no single person can make everything or know everything. Well, except for me: I know everything and I’m, indeed, a legend in my own mind. But setting that aside for the moment (or until I’m crowned Emperor of the World), we often need some help. We have work to do, and we need help to get all that work accomplished.

A job is fundamentally work. You have something you need accomplished but you can’t do it yourself. So you pay money or trade something with someone else and they do the task. Maybe it’s something you don’t like, like mowing a lawn. Maybe it’s something you don’t know how to do, like fixing a broken pipe. Maybe you just need help because you don’t have the time to finish all the tasks, like when you need help making 10 dozen cookies in time for the bake sale.

One way or another, real things have to be made, real work has to be done, real tasks have to be accomplished, and real services have to be rendered. That’s the way things work in the real world.

But we don’t live in the real world, these days! No, we live in the statistical world of the Bureau of Labor Statistics, lovingly known as the BLS. These are the people in The Government who tell us what’s going on by looking at lots of numbers. Do those people do actual work?

Yes, they do. Most of us don’t know that much about statistics and numbers. We don’t have the time, energy, knowledge or resources to gather all the numbers involving work, jobs, manufacturing and so on. Actually; neither does the BLS. So they gather a “sample” of all those numbers, then take a guess at what the rest of the world is doing.

“The DOW is up on news that Egypt is exploding into revolution.” That’s the kind of idiotic headline you’ll read, then say to yourself, “Well, I guess the economy must be getting better. The DOW is up! That’s a good thing! My father told me so, and I believe whatever my father tells me to believe.”

Did you know that right now, the single biggest investors in the DOW are the Federal Reserve (Central Bank of America), and massive investment companies like Goldman Sachs? What about all those moms and dads, grandmas and grandpas? What about those little European retired soldiers, whose entire pensions are invested?

No, they don’t exist. Not any more. Well, they actually exist as people, but no, their money isn’t involved.

And what about all those taxes you’re paying (if you’re working)? Aren’t all those tax dollars going to fund the stimulus, bail-outs, and entitlements? Uh…no, they’re not. The United States takes in around $2.16 trillion dollars in tax money. We have an on-the-books deficit of $14 trillion dollars. We spend around $45-billion a month just to cover the minimum monthly payment on all our debts.

When you factor in the military, basic government services and basic public functions, that $2.16 trillion dollars pretty much disappears by the end of January. YOUR tax money is gone before it arrives in Washington. YOU aren’t funding a damn thing, when it comes to all this other spending (like Social Security, Medicare, Pensions, Medicaid, and so on).

But…you heard on the radio that YOU, The Taxpayer will be paying all this money for GM, the public unions, and so forth, right? Nah…don’t worry about it. None of that money actually exists.

Fundamentally, in order to have real money we have to have real products, real services, and real work. In order to have real work, we fundamentally have to have real people with too little time or too little knowledge. Do we have that? How much real stuff are we actually making?

Another fundamental is the concept of value. Let’s say that I have a 15-inch tire for a 1995 Ford van. I come to you and ask if you’d like to buy it. I tell you it’s a terrific deal, and I’ll sell it to you for $50.

Your first question might be, “Why the hell would I want an old tire? I drive a Toyota compact car!” Another question might be, “Why should I pay you $50 for a stupid tire?”

In other words, my tire has no value to you whatsoever. Ah, but what about intrinsic value? Isn’t there something about the very nature of the tire that makes it valuable? Well sure, the rubber. IF you want to melt it down, IF you have a way to recycle that melted rubber, and IF you produce something out of that rubber. Otherwise, it has no value.

Something is valuable ONLY if someone else wants to buy or possess that something. A “thing” is only worth what someone will pay for that thing. Are you willing to pay $250,000 for a house tomorrow afternoon? How about $800,000?

We hear all sorts of statistics about houses and how much they’re worth — how valuable they are. It seems not that many people think a house is all that valuable, right at the moment. Particularly those people who don’t have any money! If nobody is paying to buy houses, then they become less and less valuable.

What about malls and strip malls? How about downtown office buildings? What about all that commercial real estate property? Isn’t that still valuable? How many stores have closed in your neighborhood? Is anyone running to fill those empty stores with real stuff?

Talking with someone who believes that the overall economy is bad and getting worse, we say they’re a “bear.” Someone who believes the economy is getting better and will be back to normal soon, we say they’re a “bull.” Are you bullish or bearish? On what basis? On what foundation? What fundamentally do you see about the economy to support your feeling?

For thousands of years, people have used gold and silver as real money. We can look at the price of a piece of gold or silver in terms of paper money and determine the fundamental value of paper money. The more paper money it costs to buy a piece of gold or silver, the less that paper money is worth. The higher the price of gold or silver, the less value paper money holds in The Markets.

Did you know that people are removing their money from mutual funds and stock portfolios by billions of dollars? They’ve been removing that money, pulling it out of the financial equity markets for more than 30 weeks. Week after week, people are taking their money and going home. And yet, The DOW closed at over 12,000 points today. Is that good?

How can this average of Very Important Company Stocks be going up, when so much of the fundamental economy is going down or holding steady at very low levels? One way would be to remove from this average any company that isn’t doing very well. Another way would be for someone with an infinite supply of money to buy as much of those stocks as possible every day, regardless of whether or not they make a profit.

What about the Consumer Price Index (CPI)? This is an average of what a “basket of goods” costs on the open market. How can that CPI remain steady, indicating according to statistical analysis that prices aren’t getting higher? One way might be to remove things like oil, gasoline, energy and food. Another might be to change what’s in that “basket of goods” from steak to hamburger, and eventually to cat food.

And how about those manufacturing numbers? General Motors (GM) failed last year, and had to be purchased by the government. They say that The Taxpayers came up with that money, but in fact it was just more paper money created by the Federal Reserve. WE, the Taxpayers don’t HAVE any money!

GM supposedly is doing Just Great! They “sold” more cars than last year, and Happy Days are Here Again! We’ll just ignore the fundamentals. Indeed, GM “sold” half a million cars to their dealers, who put them into their inventory. By golly, Manufacturing Inventory numbers are up too! Therefore, says the BLS, the economy is improving!

Ultimately, it’s up to you, me, and each of us as individuals, whether or not we care to learn about the underlying fundamental facts of today’s markets and economy. Half the population seems to believe that “facts” are whatever someone says they are. The other half holds that facts are statements in a language, which match an observation in reality. That second half also holds that reality is real, regardless of whether or not human beings exist to perceive reality.

Half the population holds that reality is a figment of our imagination. Many of those people work in the Bureau of Labor Statistics. Many more of them work for the important news services around us. To them, since reality is whatever anyone wants to say it is (or feels that it is), then facts are simply interpretations of feelings. If it feels true, then it is true, according to modern deconstructionists.

So what do YOU think? Is reality just something to ponder when you’re having a beer after dinner? Or is reality the fundamental platform in and on which we all exist? Do you feel that the economy gets better or worse all on its own? Do you think the economy is only a result of underlying fundamental events?

Sadly enough, it soon won’t matter which way you think or feel. Reality always has a way of being real, and no amount of pretending can change that. I feel this is really, really true, y’know? I mean, like, I read it on the Internet, so, like, it sorta has to be true, right? Or…whut-EVERRR!


November 27, 2009

What’s a Credit Default Swap – CDS

Filed under: Word of the Day — Punchinello @ 6:08 pm
Tags: , , , ,

I never really understood much about the world of finance. There are all these strange words, secret acronyms and phrases that sound like priestly incantations. It’s mostly because I’m now at the bottom of the economy that I’m curious about how all this happened, why it happened, and what will happen to the rest of the people in the workaday world. So I figured I’d use some of my free time to learn about economics and finance. One of the terms flying around everywhere is the credit-default swap, also known as the CDS.

At first I thought it was like an insurance policy. Think about when you were a kid and wanted to buy a car with a loan. You probably had to get a co-signer; someone with good and trustworthy credit, like your parents. That co-signer would vouch for you, and stand in to cover the loan if you couldn’t make the payments. Both you and the co-signer actually had a stake in the loan for the car. You, of course, wanted the car. The co-signer was placing their credibility on the line, along with their trust in your loan payment actions.

I’d thought that a CDS was a way to get something like credit-card payment insurance if you lost your job. You pay the insurance company maybe $10/month while you go out and use your credit cards. If you get sick or lose your job, then you can make a claim on the insurance and they’ll keep your payments up to date for some period of time.

Nope. It turns out that credit default swaps are legal gambling. It’s why we have the term “casino economy” floating around.

Imagine two guys on the school playground; one with a red shirt and the other a blue shirt. They’ve decided to get into a fight.

Like many situations, red-shirt and blue-shirt are pissed at each other and begin this fight. And of course people start to gather around. There’s a lot of yelling and cheering, and a crowd starts to form. Depending on where you’re from, there’s always one guy who decides to start taking bets on who will win the fight. He’s the bookie, betting agent, and also the bank.

Our bookie starts taking bets from the kids around the crowd. Ten bucks says red-shirt will win, so a kid hands the bookie $10 and gets a notation in a book. Now think about it. If red-shirt “wins” that means he’s continuing on with life. But that means blue-shirt has lost.

Now suppose that red-shirt and blue-shirt are in business. If one or the other “loses,” that could mean anything. Maybe red-shirt can’t pay a loan, or perhaps their stock goes down. It could mean they postpone a dividend or it could mean they go bankrupt. Whatever the terms of the deal, that’s the “trigger.”

So let’s offer “fight-default swaps” in the playground. I’ll “swap” you $10 for a piece of paper that says I’m “in the game.” I’ve place a bet. We’re swapping some money for a “note” otherwise known as a “security.” That note gives me the right to collect my money if I win, or lose my money if you win.

We could even make this complicated and offer “derivatives.” I give the bookie $10 to bet on the fight. In return, I get a piece of paper that says I’m “in the game.” Then I sell my piece of paper to my younger brother for $9. That way, I get at least 90% of my money. If the guy I bet on loses, my brother loses. If the bet pays off, my brother makes $1 on the deal.

And, of course, my brother could then sell another derivative to our younger sister. And so on down the line.

The ENTIRE output of the planet Earth works out to be $54-trillion. That’s the gross-domestic product (GDP) of Planet Earth. The “estimated” (i.e. wild-ass guess) of the total derivatives market is anywhere from $200-trillion to $400-trillion!

Ten bucks says that red-shirt will win the fight. Five bucks says that red-shirt may win the fight, but will end up in the hospital. On the other hand, blue-shirt is hyooooge! One dollar says that blue-shirt will lose the fight, since it’s “obvious” he’s going to beat the crap out of the other guy. Someone else doesn’t agree and says that twenty bucks says blue-shirt will lose.

Do you see how ALL these bets going on have NOTHING to do with being in a fight yourself, or the people making the bets being in the fight? They’re ALL just standing around in the crowd, watching. They have no stake whatsoever in the fight itself! If they win or lose a bet, they only win or lose money. They don’t get punched in the face!

A credit-default swap does NOT require any direct stake in the business, company or event under consideration. The bookie handling the various bets is NOT required to keep ANY of the actual money being placed for bets! None! The bookie can do whatever with the money. When the fight’s over and people want to collect their money, they just “assume” the bookie has the money.

Finally, there are no regulations whatsoever as to the process of making these bets. There are no rules, no regulations, no laws, no nothing. Anyone can start taking bets on anything.

A typical CDS bookie is a bank of some sort. They’re involved with this or that “fund,” and they look around for various things on which to place bets. It’s like any Las Vegas casino offering bets on boxing matches, horse races, soccer games or whatever. It also offers a solution to addicted gamblers. If a “legitimate” casino won’t offer odds on something weird, you can sure as hell find someone to offer odds.

You could go to Las Vegas and hear that because a lot of rain is falling in California, someone is betting $100 that 10 houses in a particular county will wash off a cliff. If you’re an addicted gambler, you’ll find someone willing to take that bet and offer odds.

So too, there is SOMEone, somewhere who’s willing to take a bet that ANY event at all, anywhere in the world is likely or unlikely to happen. And many times, the “someone” is a big bank, like Bank of America, JP Morgan, Citibank, Bank of England, or you name your favorite “too-big-to-fail” bank.

Think about our bookie in the school playground. Lots of people are handing over money, betting on blue-shirt or red-shirt. Soon, our bookie (a bank) has $1,000 in his or her pocket. Looking around, he or she sees ANOTHER fight about to break out, this time between black-shirt and yellow-shirt, somewhere else on the playground.

Our bookie truly believes that yellow-shirt is absolutely going to win that particular fight. So he or she wanders over to the other fight and finds yet another bookie taking bets. This time, our bookie (the bank) decides to bet $1,000 that yellow-shirt will win. Someone else in the crowd bets $1,000 that black-shirt will win.

What happens if the first fight comes to an end and blue-shirt loses?

Given the odds, the bookie is suddenly obligated to pay back a significant amount of money to all the kids who were placing bets in that first fight. But…unfortunately, the second fight is still going on! He or she has the $1,000 “invested” in that second fight.

A liquidity problem!

If the bookie doesn’t pay off the bets on the blue-shirt red-shirt fight, then either he or she will go bankrupt, or will get his or her kneecaps broken! Ah…but the beauty of it all is that there are NO laws that require the bookie to do squat! They just declare bankruptcy, and “someone else” (the FDIC) will pay off the bets! How sweet is THAT!

So the FDIC decides to take over the bookie’s business. Their first order of business is to sell the entire thing. To whom? Well, isn’t it lucky that the Federal Reserve has created “qualitative easement,” or QE for short. The Fed, using taxpayer money, will buy up the bookie’s business. Why?

We could let the bookie get his or her ass kicked, but they’re also the student-body president! It simply wouldn’t look good! So although the FDIC “should” put the bookie (bank) out of business, instead, they let the Federal Reserve “give” the money to cover the bets. The Fed now “owns” the bookie’s business, and hands over the $1,000 so the bookie can cover the bets.

Oddly enough, although the US Federal Reserve is now that supposed owner-of-record for the bookie’s betting business, they “actually” don’t own the business. They only have an IOU that they’ll maybe own the business. In “fact,” they let the bookie keep the business (the bank), and keep placing more bets.

The “influx of liquidity” to the “market” means that every time the bookie decides to bet on yet another fight, no matter WHAT happens, the Federal Reserve will pay off the bets! It’s like the Fed is a co-signer with unlimited money!

Credit-default can mean anything. It doesn’t actually have to mean that a company defaults on its loan payments. It doesn’t have to go broke, go into bankruptcy, become “insolvent” (has more debts than assets). In fact, a bet for or against the company can be “triggered” by anything at all. And anyone can play the game, anyone can place bets.

Better yet, the bookie taking the bets (the bank) is guaranteed to have the money to pay off those bets! That means that the bank can make more and more bets, on weirder and riskier “fights” anywhere with NO LOSS!

Nice work if you can get it!

You and I, average folks out in the world struggling to survive; we’re in “the fight.” It’s the fight to survive, to put food on the table, to pay the phone bill. We’re trying to start a business, find a job, sell something online, or whatever else it takes to keep a roof over our head.

Imagine thousands and thousands of faceless strangers, gathered around in easy chairs, munching popcorn and watching each of us (you and me). They’re laughing and joking, placing bets on our daily events. “Hey…I’ll bet that guy loses his job next week and gets thrown out on the street!”

“Ten thousand bucks says you’re wrong!”

That’s the financial markets today. That’s the so-called stock exchange, commodities markets, foreign exchange markets and so forth. That’s the “playground.” If you have the money and know-how, you too can get into the game! Bet on your neighbor losing his house! Bet on your town going broke. Or, conversely, bet on your neighbor buying a second house and selling it again for less than he thought he’d make.

It doesn’t matter. Whomever “defaults” in a credit default swap, they lose. The default is the “trigger.” Whatever the trigger is set up to be, that’s simply the bet being made. “I’ll bet that Home Depot only sells 1% more than they did last year on the day after Thanksgiving!”

You don’t have to own stock in Home Depot. You don’t have to shop there. You don’t even need to know what “Home Depot” means! All you have to do is take the bet or make the bet. If Home Depot sells 1.00001% more than they did last year at this time, then you win. If their number are down by 0.00001%, you lose.

It’s amazing, isn’t it! And you didn’t even know anyone was that interested in your life, did you!

September 11, 2009

Nonexistent Investors Gain Confidence

Filed under: Moron Speak — Punchinello @ 12:50 am
Tags: , , ,

The financial headlines and top-of-the-hour news today all speak about the wondrous rally on Wall Street. A week ago, the DOW closed at around 9200. Today, it closed at around 9600, the largest comeback over the year so far. And we’re told the reason is “investors” must be gaining confidence. “They” hear that unemployment numbers (for the week) were less than expected. The recession is over, the world is in great shape, and so “we” (investors), the little guys, are driving this rally.

Toro poo-poo!

There are very few individual investors doing much of anything nowadays. In fact, most of those individual investors have had their head handed to them, along with their butt and whatever other parts of their anatomy. People have had their entire pension funds and retirement portfolios wiped out. Foreclosures are at a record high, banks are failing left and right, and only the high-end Wall Street investment banks are making money.

The truth is that modern investment is often handled by computers. Massive software programs, which give rise to the term “program trading,” examine all sorts of minutiae. Those applications can make instantaneous trades, moving vast sums of money back and forth without really involving human beings much at all. The software can take advantage of price changes taking place over minutes or hours, all automatically.

It’s like automatic bidding on eBay, which in my opinion, helped wipe out the whole concept. You see an item and decide you’re willing to pay $19 for that item. So you set your computer to automatically bid in increments of say, 50-cents. Someone else has set their computer to go to $19.50.

In less than 10 seconds, the two computers bid, up the bid, re-bid, and zoom through the entire set of permutations. What’s the difference if you and another person take 10 minutes to make the same bids, or 10 seconds? Well, suppose that ten seconds takes place at the very last minute of the auction? A human being wouldn’t be able to respond in time, but a computer can do it all in those few seconds. You might as well have flat-rate pricing, which is what eventually happened.

Same with price fluctuations over a single trading day. Some set events drives speculation on a stock that raises the price 50-cents per share. Institutional traders, handling billions of dollars in pension funds, government funds, corporate funds or whatever make a trade for 100,000 shares. That’s a sale producing $50,000 right there.

Then consider that General Motors was performing so badly, the company was removed from the overall index. So how many other failing companies have been removed? I could prove to you that I’m a wealthy person, simply by reporting only what I’ve gained over the past 40 years and never reporting what I’ve lost. Or what I might lose.

Yet every day we hear idiots in 30-second sound bytes telling us that because the DOW has moved up 100 points, therefore the entire set of historic events taking place…doesn’t exist. There’s no collapse in the US dollar, nobody’s worried about the price of gold, housing and employment are immediately fixed, and life is perfect!

Until tomorrow, or the next day when the DOW suddenly drops 100 points. Then the world “suddenly” is concerned about whatever nonsense the AP Wire suggests.

If you really and truly believe that when the stock market these days goes up or down, it’s “investors” making those decisions, then you’re in for a massive and rude awakening. Wall Street has become the world’s largest gambling casino, and it’s entirely fixed. You, the individual, haven’t got the slightest chance of making any real money in that casino. It’s very similar to Las Vegas or Atlantic City. Yes, you could possibly make a bit of money, but the odds of walking out with a major win are very, very small.

Wall Street gained for the fourth straight day, as investors gained confidence over signs that the recession is coming to an end. Yah, right. Anyone interested in buying a bridge I happen to have?

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