NYT: Sloshing

Left to their own devices, and couches, humans instinctively resist change. Kings and C.E.O.s like it at the top. Workers don’t volunteer to give up their jobs in the name of progress. Profits and productivity may create wealth, but how it gets into the right hands is another matter. Money doesn’t flow — that sounds so planned. It sloshes. There’s a difference. As scary as it sounds, it’s the chaos of markets that keeps us well fed and out of trouble.

You work, you get money. Congratulations. After covering bare essentials like food, shelter and a high-definition plasma TV, you save the rest. You can shove it in your mattress, but central bankers like our Federal Reserve, who haven’t the foggiest clue how much money is needed to run our economy, print more money every year. They target 2 percent inflation, which is another way of saying that they overprint dollars by 2 percent, diluting your worth. How rude. A 2-percent haircut by your very own government. Annoying, but it’s been going on forever. The Roman Emperors debased their coins from 4.5 grams of pure silver to less than a 10th of a gram over a few centuries. Deal with it. Stored wealth is an oxymoron - Weimar, Germany and Argentina are more modern diluting disasters. Don’t get mad, get even.

Liza Minelli insisted that money makes the world go around (along with that whole “life is a cabaret” nonsense), but it’s really the opposite: money goes around the world looking for profits — peeking in skyscrapers, factories, alleys, even gutters. Money sloshes around the globe seeking its highest returns, on a risk adjusted basis.

Money’s been sloshing around since creation (what’ll you give me for a rib?) in the form of gold and paper and now the online dollars and euros and yen of today that can make it from New York to Caracas in the blink of an eye.

You may not put your money to work, but someone else certainly will. Floors the size of football fields at brokerage firms and hedge funds are filled with traders and computer monitors blinking rapidly, sending money scurrying to the four corners looking for productive wealth-creating profits.

Chemicals in Copenhagen, a refinery in Russia and shoes in Shanghai all will attract capital if they can generate returns. No borders, no politics, no personalities; the only governor on funding is risk. Something may be rotten in Denmark, Putin may nationalize all energy companies, and maybe China’s baby teeth haven’t yet fallen out. Money may still slosh to these places, but it will fund only the very, very highest-return businesses. It’s why very little investment money ends up in Africa — the risks of poor infrastructure, undereducated workforces, corruption and a history of nationalization are so high that money just sloshes somewhere else. Lowering the risks is the only solution, or else money will stay away and not bother telling you why.

So here’s the dilemma for the United States. We all want money to stay local, to hire our workers and to invest in our own ideas and great companies. The trick is to have the best-looking prospects for profits along with the lowest risks. That’s what the stock market is for.

While money is a unit of work, a stock is nothing more than the sum of all future profits of a company (discounted back to the present for you persnickety sticklers). To raise money, you sell a share of those profits. You could convince your Uncle Ira to pony up some dough to help expand your ink company in Indiana or India. That counts as sloshing, sure. But how much of the company does he get, and how will he ever get his money back out? Not so obvious. Markets do this, for big enough companies anyway.

A stock exchange is nothing more than a busy room (or servers in Prague) that swaps shares around so that they end up in the right hands at the right price. The market values companies by valuing those future profits.

Markets put banks to shame — helping raise money in exchange for a share of the profits, rather than lending against some piece of collateral. Because it’s not only a company’s prospects that drives this action — the market changes its mind by the minute, worrying about economic growth, global stability, competition, technological change, politicians and every other worry you can imagine.

The stock market is the sum of what every investor in the world thinks. It doesn’t just listen to companies, it scours around for any information it can get to predict the future of profits — who is making them, how much, how good management is, and on and on. It’s daytime soap opera writ large. That’s why when Ben S. Bernanke, the Federal Reserve chairman, belches, markets erupt. The stock market allocates capital to companies that have what it believes are great prospects and starves those it no longer believes in.

There was once a great minicomputer company with Digital in its name. It was the leader in its field and had huge profit margins, was hiring people like crazy and in 1987 even hired the QE2 for a $20 million sales event in Boston. But over time, its stock kept going down. Wall Street analysts kept pounding the table, telling their clients to buy more shares. “The stock is cheap,” they repeated, “and profits are great.” The future was so bright they had to wear shades. There was no plausible explanation on why the stock was going down even though the outlook was so good.

What happened next was a decade-long decline, a drip, drip, drip of cutbacks and layoffs and plant closings and division sales as profits eroded. The C.E.O. was rightfully sacked. Minicomputers were slowly being displaced by workstations from Sun Microsystems and personal computers like Compaq’s, powered by Intel processors. In 1998, the once-pipsqueak PC maker Compaq used its highflying stock and cash to buy this company out, putting it out of its misery.

So it turned out the future wasn’t bright: The company was wearing blinders instead of shades. The stock market not only figured this out, but stopped the company from becoming an even bigger disaster. As money sloshed away and the stock declined, the market starved it of capital for growth, because better prospects were elsewhere.

No government bureaucrat had to raid that computer company’s offices and tell it to quit hiring and throwing lavish parties. The stock market did this. In Japan, where the stock market was rigged in the 1980s by cross ownership, and brokerage firms kept stock prices artificially high, operating losses at many Japanese companies were hidden under an accountant’s rug. The party went on and on until in 1991 it collapsed under its own weight, and Japan tread water through 15 years of turmoil and little growth.

We are lucky that Enron was not located in Tokyo, where it might have been deemed too big to fail. Good money might have been pumped in after bad to help Ken Lay-san stay afloat. Chrysler’s 1980 government bailout meant the stock market couldn’t do its job of starving a company that in retrospect should have been, as my veterinarian would say, put to sleep. GM and Ford would be in better shape today. Ditto airlines. Politics get in the way. What a shame.

O.K., enough of that. Want to find stocks that go up, that money will slosh towards? Me too! Here’s what works for me: Figure out what everyone else believes and then why they are wrong. Works every time.

http://kessler.blogs.nytimes.com/2007/04/04/sloshing/

Comments

[Joe Agliozzo]

I am a fan of your writing, have purchased several of your books, and have this blog in my RSS feed, but I must tell you that I think it's pretty weak to post excerpts of your posts that are behind the Times subscription wall. Either post content here that people can read, or don't post to your blog at all. It feels kind of like semi-scummy "teaser" marketing, and you're better than that.

[frank]

Joe
See the exchange below the previous posting.
Then lighten up. Buona Pasqua!

[Stan Carlyon]

Andy,
Have purchased 3 of your books (from Australia where the cost is greater) and enjoyed them all, however I agree with Joe.
Stan Carlyon

[Mark P]

Andy:

Inflation? I believe the numbers are skewed to limit COLA adjustments for Social Security and Public Pensions. And they are still broke and won't meet their obligations.

However, the inflation hawks never mention the areas where prices are actually not rising as a percentage of household income. You're not hearing about anyone wanting to calculate home prices into the CPI anymore? As much as the FED is a neutral entity, it's still a political appointment. Love your commentary. Keep up the good work.

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