Beware: This response to 2399 is way OT!
Good Raymond,
Thank you for your response. Please consider these points.
"The Federal Reserve controls the money supply. They are the only ones that can expand the money supply or contract it. And they accomplish this through "Open market operations," either buying or selling securities.”
You are correct that a principle way Federal Reserve Open Market Committee (FOMC) controls money supple is through the sale or purchase of securities. However, the Fed also controls money supply by determining which securities are marginable vs. non-marginable and by setting margin requirements. A recent example occurred in January when they raised the maintenance requirements on many internet stocks to 100%, effectively wiping out their money multiplier effect.
[Example 1: I buy $10,000 of stock on margin. It doubles in value to $20,000. I can withdraw $10,000 from my margin account. The money supply has increased by $10,000. The amount I can withdraw is set by the Fed as part of Reg T, which generally requires 50% margin. If the Fed were to set Reg T to 75%, I would only have been able to withdraw $5,000. Thus the money supply would have only increased by $5,000. When the maintenance requirement is set 100%, no money can be withdrawn and the money supply has not increased.
Example 2: I bought 2,000 shares of a stock at $2. Marginable stocks below $5 per share require 100% maintenance. When the stock hit $4, its value had doubled, but no increase to the money supply had occurred, since I could withdraw no money. Recently, the stock closed at $8. Now that the stock is over $5, I could withdraw $8,000 from my account, 50% of the market value. (Or, I could buy an additional $16,000 of stock, which I did.) That $8,000 is a real increase in the money supply.
Example 3: Last September, I heard someone joking about a question he got from his daughter, which was effectively “When the market went down, where did all the money go?” (an excellent question!). The answer is: it ceased to exist. The value was gone. (Pointedly, it did not all go into the accounts of shorts, although some certainly did.)]
“Now, if it were true that stock price advances increased the money supply, you'd be in effect saying that stock prices could cause inflation since rapid increases in money supply cause inflation (and who will argue that the stock market hasnt rapidly increased?)"
Again, you are 100% correct! And, in fact, I believe the expanding equity market IS causing inflation that is flowing from the financial markets into the real economy. Case in point: Upper-middle to upper class homes in north Jersey are selling OVER their listing prices. [I know of a case where a buyer brought a cashier's check for 102% of the listing price to a showing, only to lose to someone who brought a check for 105%!] Did north Jersey suddenly get smaller or more desirable? Did real estate agents suddenly start feeling charitable? No way! This phenomenon is only happening for homes priced $400,000 and up, i.e., where the target buyers have major financial assets. Homes for the average Joe Sixpack aren't selling over (or even at) offering price. That's cause Joe doesn't have $200k in stock that has swelled to $600k (or $1M that is now $3M). People with discretionary financial assets are definitely feeling wealthier today, versus a year ago. I believe Greenspan sees this, but finds it a tolerable consequence of the liquidity injected to stabilize the world last fall (3 rate cuts + FOMC actions). This is inflation creeping into the real economy from the financial markets, but I don't believe it is a major factor to Greenspan because the sector of the population affected is relatively small (<5%?). True, workers with 401k exposure to equities are having a pleasant surprise, but they are not withdrawing their 401k assets in droves to step up from their $150k homes to $450k houses. I think Greenspan is focussing on incipient inflation in the labor markets, which is a large scale factor in the scheme of things (affecting ~30-40% of population?).
We began this conversation discussing whether investing in stocks is a zero sum game. Options and futures are clearly zero sum games: A hedger sells risk to a speculator. The hedger gets the cash. The speculator gets the market return. Whatever the speculator gains, the hedger has lost (and vice versa). Stock investment is the ownership of productive assets, which over time create wealth. The standard of living for the entire society goes up as the wealth increases.
BTW, equity investing being a positive sum game doesn't mean that shorts and longs don't trade returns. They do. However, if the average short interest is 2 to 4% (call it 3%), then for every 33 long positions, there is one short position (approximately!). If the stock in question goes up, one long gains what the one short lost, netting each other out (yes, zero sum - No increase in money!). The other 32 longs enjoy their portion of the increase in the money supply. (I know I do!) One might wonder, “If only 1 investor in 33 is short, how can they affect the market so much?” Since a great portion of stock doesn't trade, the shorts are a much bigger percentage of active market trading. [Who doesn't trade? Founders with $60 stock at a cost basis of $.07 per share. Buy & hold long term investors. >>Index funds<< (who have 35-45% of all equities?) People who hate taxes. My aunt.]
Thanks for your comments.
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