Panic at the Stock Exchange
The Coronavirus is scary, therefore, you must act irrationally
Like all articles on The New Haberdasher, this story is presented to you for free. If you like what I do, consider supporting my work with a small monetary contribution at my Patreon and thank you.
I should preface this little article by saying that I am a political theorist, and not an economist. I really don’t know how the Dow Jones Industrial Average is even figured out, though, if it is an index, I think I could make a relatively educated guess.
That’s not important, to me, or to you or really to anyone except those who make a fortune buying and selling stocks, and those who have been tricked by these investors into sinking their retirement funds into companies listed in the Stock Market. In this time of crisis involving a strange virus which seems to be spreading around the world like an expertly played game of Plague Inc. on easy mode, let me say, to the first group, the investors, you will be fine. We all know that you leverage and hedge and have portfolios designed to offset all losses with profitable stocks elsewhere. You can ride it out and still make money, because you are trained to bet against success of the economy for your own personal benefit.
This is what short sales are about. I am well aware that there are a good many investors who have made millions of dollars selling this market short already, and I do not doubt that you will continue to do this as the crisis deepens. As long as you pay your taxes at about two thirds the rate of your working class countrymen and women have to because of preferential capital gains tax rates, everything will be totally fine, and you can continue to do what it is you do best, which is serve yourselves.
Nor will working people be affected, until the vultures described above have finished picking the bones of the economy clean and other vultures come in to part out then sell off the companies you work for. Most workers do not have the expendable money to play around in the market on any level, and pensions for working people are just a distant memory.
The people I need to address are those who have pensions in the stock markets. Most of you folks are in the middle class and were told that your pensions and retirement savings accounts were safe in the stock market. Those pensions will be wiped out, friends. I am sorry: this is a matter of fact. As long as markets are acting the way they are, and it continues hemorrhaging as it is, you will continue to watch your hard earned retirement savings and hopes for a happy future as a retiree go down the drain.
This is grim, I understand. And let’s be clear: it is happening TO you. Not because of anything you did. You just happened to make the mistake of believing people who said that betting in the great casino known as the stock market was a winning bet. I understand: the prospect of 7% gains on your investments was much more attractive than the prospect of 1–2% gains in safer treasury bonds or half a percent at the bank, or the prospect of not having any retirement savings at all. A cynical person would say you got greedy: just like all those old people who got ripped off by Bernie Madoff, you thought you were betting on a sure thing and ignored the fact that it was too good to be true.
I understand. It stings. But I also know that someone sold you that bill of goods: someone who for some reason prefers your money in the private sector where, perhaps they can get at it, rather than in a public pension system which is so safe that panicky investors are fleeing to bonds rather than keeping their own money in the Stock Market driving interest rates to new lows, and actually threatening banks who lend at interest. That should tell you something: Perhaps there is something to public pensions, even if they are lower yield than the stock market — if the investors don’t even trust the market.
But perhaps I, as a theorist, can help you all understand why it is happening to you. And it is happening TO you. This is what capitalism does to people: It tricks you into thinking that you control it, but its real purpose is to take money from you and transfer it up to people “not you.” After all, that promised 7% yield has to come from somewhere. It doesn’t just magically appear: For every winner, there is at least one loser, and for someone to make a billion dollars a year in investments, how many people have to lose their life’s savings? Well: you are not the ones making the billions, though a lot of people “not you” are. So which side of that equation do you think you exist on?
Capitalism is not your friend. It never was. It does not exist to serve you, but to serve people who are not you, who are much richer than you, starting with the idle investment class directly above you. It doesn’t care when you will retire, or if you will. It doesn’t care if you have food on your table or if you starve to death tonight, or aren’t able to get medical treatment for the infection that is about to kill you. It only exists to take money out of your pocket and put it in the pockets of people who are not you. Who they are really don’t matter in the long run: the only thing that should matter to you is that you are not them and the system is set up so that you will never be them.
You cannot control that: this outcome is part of the very structure of our economy, and as long as we keep this structure, you will not change the fact that this happens to you and people like you, over and over again. While you cannot change the system without abolishing it, you CAN decide what you want to do in response to this crisis.
There are a few points that we can glean from theory, specifically liberal economic theory, which can help us gain some perspective.
Liberal economic theory holds that markets are composed of individuals. The market as such does not actually exist in any real sense. It is instead a relationship between buyers and sellers. These two groups negotiate between one another. If buyer wants something and seller has something, this is a market. The negotiation takes place in this marketplace for the transfer of the good or service from the seller to the buyer in trade for something that the seller wants, usually money, and both are ideally satisfied with the outcome.
Fine. Repeated iterations of this interaction, over and over across all economic activity produces an economic system, which is governed, ideally self-governed, by the characteristics of the interactions themselves. This is the “invisible hand” that you may have heard about so much. The Invisible Hand of the market ensures that for every demand, there is a way to satisfy that demand, and for every good or service, there is an ideal equilibrium price that can be set, at the exact intersection of a supply and demand curve.
As we can see, in this extremely simplistic, but very useful common pedagogical tool, Supply is line “S”, Demand is lines D1 and D2. The Vertical axis P is “Price”, and the horizontal axis Q is “Quantity”. This particular chart shows ΔD, or some change in demand: put into English, as demand increases from D1 to D2, and supply remains constant but more of it is being sold (from Q1 to Q2), the equilibrium price (should) increase from P1 to P2, unless there is some distortion in the market which alters the equilibrium price — something like government subsidies, artificial shortages to protect prices, or price setting among members of a cartel for example.
But why is this supposed to work like this? Well, the idea is that both buyer and seller in the market place have their own interests, and know perfectly those interests. A buyer will approach a seller with an interest of acquiring the most for the least amount possible— this is the economic sense of the word “rationality”. The seller will have a similar interest though flipped: they shall seek to provide the least amount for the most money possible. The equilibrium price is therefore somewhere in the middle.
The more competition that exists in the market, the greater the supply, and theoretically, the lower the price each seller can ask for a single unit of the good. From a buyer’s perspective therefore, the true price is somewhere between the point where there is not enough supply in the market that a desired good maybe obtained, and the point where everything must be free because it exists in such abundance.
From the seller’s perspective, if there is only a limited supply, and each unit of that good is in higher demand, the seller can force the buyers to bid higher for the good. (It may be in the interests of the producer to CREATE demand to soak up supply, but that is more advanced than I want to get into right now.) At some point some buyers will drop out, and at some higher point all buyers will drop out. The true price of a good is somewhere between where a seller cannot earn enough money on the thing to produce it, and the point where nobody can afford to buy the thing.
This is how liberal economics, and therefore capitalism, which is liberalism applied to wealth accumulation and profit maximization, SHOULD work, in an ideal sense. And it is a fact that this forms the cornerstone of all liberal economic thought, which is, unfortunately hegemonic in the western world.
Liberalism as an economic theory is amoral: its only ethic is finding the natural and self adjusting equilibrium price point between demand and supply. In the process, the system itself does not care whether people starve, and it does not care for value or worth, except in so much that poor quality decreases a demand for a good or service.
Liberalism further assumes rationality, in both the buyer and seller, and it also assumes perfect knowledge among both buyer and seller: they have to know what the equilibrium price is, over the whole system before they know where the price they encounter is too high or low. If all those assumptions are met, you have a functioning liberal economic system, where buyers only ever pay what a good or service is actually worth, and everyone’s life can be better for it.
Fine. But let’s talk for a moment about market distortions.
The most obvious distortions are governments intervening in the activity of the market. There are some important reasons why governments would want to intervene in the market. In liberalism, there is room for government intervention, espeically to protect contract rights and property, but also to guard against monopoly, which is both the ultimate market distortion as it eliminates competition, and therefore cancels the effects of the Invisible Hand, and the ultimate goal of all capitalists, so long as they are the sole survivor of outcompeting their rivals.
There are other political, and therefore, moral reasons a government should intervene in the market. Especially in democracies, Governments provide public goods, because the citizens demand these things. But knowing that the government is required to meet the will of the voter, the capitalist gains a huge advantage. If we know that a government is going to need a new road, because the voters ordered the government to build a road, and we are a road company, guess which way the price to the government for that road goes relative to its equilibrium price. You would be correct if you guessed that it goes up.
This is why it costs me 15 dollars for an excellent hammer in a hardware store, if that, while it would apparently cost the US government 10,000 dollars for a toilet seat on an airplane. It’s not because the government is wasteful or incompetent as Conservatives claim, but because the Government is forced to buy the toilet seat by the voters, where I am not.
But the most common distortion, and certainly most pernicious, is a failure in the opening assumptions. Suppose you didn’t have complete information? Suppose that your “rational self-interest” is not so rational (think spending thousands of dollars on a diamond ring, which, except for looking pretty on the hand of your intended and its ability to cut glass, is absolutely useless.) Imagine if those assumptions do not exist to begin with. Would you still expect the system based on those assumptions to operate the way it would if those assumptions held?
We never have complete information. The time I would have to invest in simply discovering the exact demand and supply for every single economic decision I make in a day is just mindbending. If I had to do that, I would literally never have any time for anything else. But should I trust the supplier to tell me what the equilibrium price should be? Why should they tell me that information honestly? Their interest is in making as much money as possible from me, at the least possible loss of supply. So where am I supposed to find this actual equilibrium price?
What I do instead is I substitute my preference for complete information. I think “how much do I want this?” My preference and the actual equilibrium price have as little to do with one another as apples and internal combustion engines. But this is what I rely on, which leads to the second false assumption about the market — that I will make rational decisions in the market.
I know that cigarettes will kill me eventually, if I smoke enough of them. And yet, if I am a smoker, I am driven by cravings to shell out 10 dollars a pack for cigarettes. If I am this addict, can I say that I am acting rationally? Or is my craving doing the decision making for me? If I was not addicted to nicotine, would I pay 10 dollars for a pack of cigarettes, which I literally plan to smoke and exhale into the atmosphere? In my case, perhaps, but I enjoy smoking and treat a cigarette as a luxury, only to be indulged in occasionally. That thinking is also not rational.
We have never had complete information, and I don’t think we always make rational choices for ourselves, but at any rate, individual rationality often leads to collective irrationality. An economic theory like liberalism absolutely requires BOTH for its correct operation, and without even one, the system itself goes nuts, and does strange and unpredictable things, things which have real world consequences for people
So, let’s go back to this coronavirus thing. Over the last week, our market has lost something like 3.1 trillion dollars in value. Why? Was there some change in the fundamental structure of the economy? Was there a sudden drop in demand for a static supply, which would suggest that the value of those commodities should lose their value?
Or was it the mere threat of the unknown, literally, which sent jittery investors panicking and running for the hills or “safe” bonds and gold? We know the answer to these rhetorical questions: The drop in the stock market is entirely panic driven, and therefore, it is not being driven by reason.
In fact, I will say: at no point was the stock market ever driven by reason. It has always been speculation based. You can see this most obviously by the effect that the futures market has on opening stock prices. At all hours of the day, futures are bought and sold, where investors bet on what they think the stock is going to do in the future, at some future, hence the name. That futures’ market dictates the opening price each day. It’s almost as if, after a while, the bet on the future becomes a self-fulfilled prophesy.
This speculative action is not at all rational: these investors are not buying and selling something actually, based on any actual price of that thing which does not actually exist. They are merely buying and selling long and short based on what they think a stock is going to do. We need rationality in the market for it to function properly. And we do not have it, especially when our market is driven largely by this speculation, on one hand, and knee jerk reaction on the other.
We also need complete information, and we do not have that either. The health officials around the world know very little about this virus: they know its a virus, and they know where it appears after it appears there. They also know it kills some people. But they have no idea how many people are carrying it. They do not know how it transmits from one person to another. They do not know how many people it will kill. They do not know whether or if this outbreak will get more serious than it already is.
And our government is not helping at all by throwing all sorts of wild misinformation at the problem and subjecting what little information there is to political concerns. Our president is blaming the media, and Democrats, and China and everyone else for causing the stock market to tank, which he feels must make him look politically bad, calling it a “hoax”.
But this lack of rationality in market decisions and this absence of almost any information let alone complete information is what is driving the markets down today. Problems like this week’s drops in the market are usually offset by a modulating and correcting business cycle, where there would be periods of ups (booms) and downs (busts): Exuberant demand caused by the arrival of a new product of service leads to over production, over supply and collapse of prices for a commodity, followed by layoffs and depression.
I have a friend who was talking to me about why people would vote for Trump over Sanders. He kept telling me that under Trump, his 401K was doing great, because Trump’s policies were designed specifically to boost stock prices and corporate profits. He did not use those words specifically: He said something more like pro-business policies. But if/when Bernie was elected President, that would be all over and investors would respond. As if they were suddenly sick of making bank vaults full of money and using the economy as their personal money press on January 21st, 2021. So people who had pensions in the stock market were afraid of the so-called “socialist” Sanders, and would support Trump just to keep the good times going.
But the thing is: The business cycle is a fundamental component in liberal capitalism. If it functioned the way its theory said it did, we wouldn’t have a business cycle. But it doesn’t so we do.
The Business cycle, this boom-bust cycle should be viewed as endemic in a malfunctioning liberal economic system.
Our Government has done all it could to lengthen the “boom” part and forestall the “bust” part. In fact, the Trump Administration itself, you could argue, has overheated the economy, and forced it into stratospheric territory by its unmitigated pro-big business policies, deregulation, and meeting and exceeding policy demands made by corporations. But while liberal economic theory may be malfunctioning, the theory of gravity is still perfectly applicable: Those things which go up, must come down.
And when something is as artificially juiced as our economy has been, first through fiscal policy under Obama and then under business-fetishism of Trump, the economy has been going up. But when that economy runs out of gas, it will crash. That’s going to happen. My friend said that Bernie Sanders was going to take the fuel out of the economy. But it turns out that it doesn’t even require the election of a Democrat to the office of President.
It just requires a microbe, a bunch of misinformation and some good old fashioned collective panic. That panic breeds more panic and more stupidity among investors and Americans who have become convinced that the Dow is the economy. And meanwhile, massive corporations, like 3M are making a killing off of the panic, selling useless surgical facemasks which aren’t about to stop a virus from getting into your system.
In conclusion, the system looks like it is falling apart now, because it was broken to begin with. It has been made worse by the intervention of a pro-capitalist government, and the irrational panic of both investors and the general public. It is based on faulty opening assumptions. So it is no wonder that it doesn’t act the way we think it should: the error is in our own thinking.
And there really is nothing you can do about it. The problems with our economy were there before you were born, and they will be there long after you are gone, unless something is done about it. But if you are unwilling to change the economic system to something which doesn’t require the impossible, and doesn’t hinge all on faulty assumptions to begin with about human nature, then this will continue to happen.
As the Stoics say: There is no way to control the outcome, only your actions in the meanwhile. They also say there is nothing so harmful to us as our reactions to things. You can choose to panic or not. You can buy a face mask or not. You can seal your entire house with duct tape and plastic wrap like the idiots did after 9/11 when there was supposedly anthrax in EVERYTHING, and they ended up suffocating themselves in their own houses. Or you can continue to live your life, and deal with problems as you encounter them. You cannot change the ultimate outcome: We all die of something. We can only decide how we live in the meanwhile.
Let this then be of some solace then. Bernie Sanders can not destroy your 401K and impoverish you in the last years of your life. But you sure can, by keeping your money in the casino known as the stock market. Knowing that the business cycle is an inherent part of the liberal economy we have in this nation, you should also understand that your money is not safe there. If you also understand that there are some people who are at this very moment profiting from the panic and uncertainty in the market, you will understand WHY it is not safe there. You can take it out or keep it there. One or the other would be the wise choice, but not both.
I wish you wisdom and calm levelheadedness in this time of panic.
Like all articles on The New Haberdasher, this story is presented to you for free. If you like what I do, consider supporting my work with a small monetary contribution at my Patreon and thank you.
