Terror on Wall Street, a Financial Metafiction Novel (11 page)

     “What about a full collapse of the economy?”

     “That, Mr. Rodriguez, may call for some emergency measures.  We’ll talk about that in the next class.”
 

CHAPTER THIRTY ONE

FOR LOVE OF MONEY

“Class, we’ve talked about the best ways of investing in a volatile market, but we haven’t touched on the subject of our money supply.  Does anyone here understand how the international monetary system works?  Ms. Baxter?”

     “It’s all about the dollar.  The dollar is the world’s reserve currency.”

     “That’s right, Ms. Baxter.  The dollar is the world’s reserve currency and, currently, there is no other currency ready to take its place if it fails.”

     “The dollar’s not going to fail.”

     “How can you say that with such confidence, Mr. Thompson?”

     “Because the United States is the largest nation of consumers.  The world needs our buying power.  If the dollar failed, they wouldn’t be able to sell us anything, and their markets would fail.”

     “What if I told you, Mr. Thompson, that back in 1978, before all of you were born, the dollar nearly failed as the world’s reserve currency.”

     Everyone in the class looked up from their notes at Harry.

   “That’s right.  The dollar almost failed.  Inflation was over 50 percent and the U.S. Government had to issue treasury bonds in Swiss Francs.  The International Monetary Fund came to the rescue, issuing special drawing rights, or SDR’s (which are, essentially, world currency) until confidence in the dollar returned.”

     “So if confidence is lost in the dollar, investors will sell dollars and that will cause their value to drop?”

     “Exactly, Ms. Baxter.  Economics 101.  The dollar is subject to a market like everything else that’s bought and sold.  Supply and demand.”

     “Why are we not seeing inflation now, since the Government put trillions more dollars into the money supply to bail out the banks in 2008?”

     “A very good question, Mr. Rodriguez.  The Federal Reserve has increased the supply of dollars over 400 percent since 2008 and we’re not seeing any signs of inflation.  If you accept my premise that we’re in a depression, we would have seen massive deflation were it not for the inflationary actions of the Fed. 

     “But it’s also my opinion that inflation is coming, and, also, that these dollars have not been put to work because the economy is structurally damaged.  The Federal Reserve will keep issuing new money until it reaches its inflation target of 2.5%, but that fails to take human nature into account.  Perhaps Mr. Pendleton can explain why that’s such an important factor.”

     Ike looked up from his iPhone.  “Excuse me?”

     “Of course, if you’d rather stay on your phone, you know where the exit is.”

     Carlos laughed.  Ike looked up from his phone, startled, and saw that everyone was staring at him.

     “Should we wait until you finish that darling cat video or WhatsApp message?”

     “No, no, professor: it’s okay.  I can answer that.  Once we start to see inflation, people will panic and expect that it will go higher.  That will lead to even higher inflation.”

     “That’s correct, Mr. Pendleton.  The Fed thinks inflation is its friend.  If it keeps inflation high, the U.S. debt will stay at a low level, and it can reduce that debt and, at the same time, collect more in taxes.  But it is courting an unsound fiscal policy.  If inflation runs away, the dollar will lose its value against gold, and Russia and China, whose central banks have been stockpiling gold, will be there to offer the world a new reserve currency.

     “Let’s look at the point where we are in terms of history – recent history.  From the start of this century, we should have been in a natural state of deflation.  The United States is the largest consumer nation in the world and we have enjoyed the purchase of cheap goods from China, made with cheap labor.”

     “Then why didn’t that put us in a deflationary spiral?  Why did prices go up instead of down?”

     “The Fed, Mr. Rodriguez.  It lowered interest rates, which curbed deflation alright; but it made borrowed money too cheap, which created the housing bubble.”

     “Then, when that bubble burst, the housing market collapsed.”

     “Correct, Mr. Pendleton, and that turned the spiral back into deflation; this time because of the devaluation of $1 trillion in mortgage loans and trillions more in derivatives based on those loans.”

     “Which halted construction, increased unemployment, and forced a sell-off of assets.”

     “I believe that we are in the midst of another stock market bubble and another housing bubble at this point in time.”

     “Isn’t that good for the economy?”

     “No, but it
is
good for brokers and bankers.  That’s where the greed factor comes in. 

CHAPTER THIRTY TWO

FINANCIAL FIRST AID

Harry came in early to class.  He sorted out his index cards and wrote on the board
Financial First Aid Kit.
Dean Anderson popped his head in.

     “You got a minute?”

     “Yeah, Walter.  Come on in.”

     Anderson was the head of the School of Economics.  He was about Harry’s age, but hadn’t taught any classes since going into administration.

     “Could you stop by my office after class?  I’ve got some things to discuss with you.”

     “Sure, Walter.  I’ll see you – when I’ve got no class.”  Harry grinned, but Walter didn’t catch the reference to Rodney Dangerfield’s
Back to School. 
Snookie and Carlos walked in and took their places.

     “Okay, see you then.”  Dean Anderson left, and gradually the seats began to fill in the lecture hall.

     Harry called the class to order.

     “Class, for a diehard passive investor like me, today’s lesson is perhaps the most difficult I have ever had to give.  Remember that we were talking last time about a possible collapse of the dollar?  I hate to talk like a survivalist, but does anyone have any idea how you would survive if that happened?”

     “I do, professor.”

     “Very well, Ms. Baxter.”

     “When the dollar drops in value, gold goes up.  So it makes logical sense that gold would be used in place of the dollar.”

     Harry wrote on the board:
1. Gold.

    
“How about it, class.  Does anyone think that merchants will stop taking dollars and require gold as payment?”

     “It would most likely be higher prices in dollars.”

     “Yes, Mr. Pendleton, but probably just in the initial stages.”

     Harry wrote down:
2.  Cash.

     “Well, you’re both right.  Because our money is digital, any problems in the system would mean that, at least temporarily, cash is king.  The investor should keep a six month supply of cash on hand for a rainy day, so to speak.”

     “A stormy day.”

     “Yes, Mr. Pendleton.  More like a hurricane.  Any other investments you can think of that could weather such a storm?  Mr. Rodriguez?”

     “Real estate.”

     Harry wrote down:
3.  Real estate.

     “Why real estate, Mr. Rodriguez?”

     “It’s the oldest form of investment.  And traditional collateral for modern forms of investment.”

     “The real estate market fluctuates, as does the market for gold, but it is considered to be a hard asset.  Anything else?”

     Harry looked around the room.  Nobody was raising their hands.  He wrote on the board
: 4
. 
Fine art
.

     “Fine art is also a hard asset.  If the dollar crashes, you can be sure to find a market for it in whatever money turns out to be the next world reserve currency."

***

Harry fidgeted in his seat in front of Dean Anderson’s desk.  He felt like a boy who had been called into the principal’s office.

     “What’s on your mind, Walter?”

     Walter Anderson looked at him with a frown over the straight edge of his bifocals.  He sighed.

     “Harry, you know that I think you’ve been the greatest addition to the faculty that this department has ever seen.”

     “Thank you, Walter.  But I’m sure you didn’t call me in just to boost my ego.”

     “No.  Actually, we’ve had some student complaints.”

     Harry looked up at Walter in surprise.

     “Complaints?”

     “Relax, Harry.  Not from your whiz kids.  From some of your undergraduate students.”

     “I’ve always told you that forcing art majors to take economics does not compute.”

    “It’s not that, Harry.  They say you haven’t been sticking to the material in the text.  That you seem, well, distant and aloof.  Like you can’t concentrate.”

     “Walter, I should tell you that I’ve been diagnosed with beginning Alzheimer’s Disease.”

     “Alzheimer’s?” 

     Anderson sunk back in his seat, took off his glasses, and started to nibble on them.

     “Yes, but there’s a new treatment I’ve been approved for that’s supposed to reverse the disease, and I can promise you that it won’t affect my work.  I’m dealing with it.”

     “That’s good, Harry; but, if it’s all the same to you, I’d rather take over your undergrad classes until you can report some progress.  You can keep your whiz kids class.  I know you’ve promised something important to the government and I don’t want to let you down.”

     “Thank you, Walter.”

     “I’m sorry, Harry.”

     Harry left Anderson’s office wounded in ego and in spirit.  It was as close to hopelessness as he had ever been.

CHAPTER THIRTY THREE

A WINNING OR LOSING PROPOSITION

Harry’s teaching style never incorporated a podium.  He didn’t want there to be a barrier between him and his students.  However, it seemed his new flash card system would not work without it, so he had a lectern installed in the classroom.  He stood in back of it awkwardly and referred to the first index card sitting in front of him. 
This will take some getting used to.

     “What if I told you that not only can you not beat the market, but most stocks actually lose money.  Would you believe me?”

     “I think the statistics show that about 75% of stocks in the U.S. market have historically generated a loss.”

     “Based on their performance over the last 40 years or so, that is correct, Mr. Pendleton.  Now, if that is the case, why wouldn’t investors just stick with the 25% super stocks that are generating all the growth?”

     “Because nobody knows what they will be.  If you try to compose a portfolio of carefully selected stocks, you could easily wind up with none of the best performing stocks in the market.  Missing out on even a handful of these super stocks can mean failure.”

     “So if you compose your portfolio by looking for the gems, you’re going to go through a lot of turds.”

     “That’s a colloquial way of saying it, Mr. Thompson, but yes.  Some investors and fund managers do happen to pick the winners from time to time, but their success is short lived.    And even if you were able to accumulate a concentrated portfolio of super stocks, after a while you'd find that most of your net worth is tied up in a handful of holdings.  According to Trim Tabs, there is a trillion dollars sitting in money market funds making next to nothing. Soon investors will see stock prices to go up and the public will buy high and sell low during the next downturn.”

     “Which is why I’m saying that neuroeconomics is so important.”

     “It is, Mr. Pendleton; but even though psychological factors may cause the market to deviate substantially from its intrinsic value in the short run, stock values are still ultimately determined by economic fundamentals. The focus of every long-term investor should be the growth of purchasing power – monetary wealth adjusted for the effect of inflation. The safest long-term investment for the preservation of purchasing power clearly has been a diversified portfolio of equities.

     “There is a fundamental relationship between risk and reward. Stocks that have higher risk will produce higher rewards, or returns, as we call them. The instant a stock shows a potential for increased profits due to a new product, an increase in demand for its products, or more favorable economic conditions, the stock market reacts by increasing the value placed on the security. Today each and any change in a company’s future fortunes is translated into a movement in the company’s stock price. These changes occur at random. That is, they have not been incorporated into the stock’s price up to now. This simply means that in today’s market, all securities and their prices reflect what is known about the security and the business it competes in. We call this the efficient market hypothesis, or EMH.

     “EMH is the subject of intense debate among academics and professionals alike. If, indeed, security prices fully reflect all the available information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill. Thus, risk and risk alone determines the degree to which returns will be above or below average and thus decides the value of any stock relative to the market.

     “I have invented an equation for this called Harry’s Equation.  It goes like this: More volatility=Higher standard deviation=Higher risk=Higher return. Now, what does this all mean to the individual? Please listen carefully—the following will save you a lot of money sometime in your future.

     “There are no bargains in the market. There is no such thing as a bargain stock. No individual security is better than any other on a risk adjusted basis, and the market is very efficient at pricing securities on that basis. Further, no one can tell you if the market is underpriced or overpriced at any point in time. Anyone who tells you he has a plan or scheme to find individual securities that will outperform the market for that segment of the market is either ignorant or lying.”