The Secret of "Supermoney": Sell Your Shares While You Still Can.
The financial experts in early 1967 did not see what was coming: the rise of the price of gold, the devaluation of the British pound, and the beginning of the end of the Bretton Woods/IMF international gold-exchange standard. By the end of 1967, the system had begun to unravel.
In 1968, George H. W. Goodman's best- selling book appeared, The Money Game. He was a very smart promoter, as well as a cogent economic analyst. Not many people are both. As a promoter, he knew that there was no name-recognition for "George H. W. Goodman." So, he chose as a pseudonym the name of a world-famous economist who was long dead, so he could not sue for trademark infringement: Adam Smith.
As "Adam Smith," Goodman launched a new phase of his career, which is still alive and well: books and a PBS TV show (four Emmies), which is even broadcast prime- time in Russia. That's right: Adam Smith in Russia. That name change was one of the smartest marketing strategies on record. It even got "George Goodman" working for him harder: four novels, including one made into a movie, "The Wheeler-Dealers." Incredible.
The Money Game was about the international monetary system. That topic was big news in 1968. Lyndon Johnson's two wars, on poverty and Vietnam, both of which he eventually lost, were being funded by the Federal Reserve System's monetary inflation. Domestic prices were rising, and there was a run on U.S. gold by foreign central banks in March. They were turning in their dollars to the Federal Reserve, and were taking our gold. Gold's price had been fixed by government decree ever since 1934: $35/ounce. Gold was now perceived as a bargain. The dollar was falling in value. Why not trade in dollars for gold? Central banks could buy gold from the U.S. at $35, and then sell it to the public at the higher free market price. It was easy money.
To evade the depletion of our gold reserves, Johnson in 1968 pressured the London gold pool to establish a two- tier price of gold, i.e., fake prices: one for "commercial trade" at a free market price, and the central bank price at $35 price, but only for central banks. This was an admission that monetary policy had failed in the U.S. Of course, double pricing couldn't last for long. There are always cheaters looking to make a few million bucks at no risk.
A few months before, in November, 1967, gold pricing had failed in England, too: the devaluation of the pound. Here is Dr. Orlin Grabbe's (long-e) account of two failures: first by the British in late 1967, followed by Johnson's.
Then in November 1967, the British pound sterling was devalued from its par value of $2.80 to $2.40. Those holding sterling reserves took a 14.3 percent capital loss in dollar terms. This raised the question of the exchange rate of the other reserve assets: if the dollar was to be devalued with respect to gold, a capital gain in dollar terms could be made by holding gold. Therefore demand for gold rose and, as it did, gold pool sales in the private market to hold down the price were so large that month that the U.S. Air Force made an emergency airlift of gold from Fort Knox to London, and the floor of the weighing room at the Bank of England collapsed from the accumulated tonnage of gold bars.
Side note: I had figured out that the devaluation of the pound was imminent about a month before it happened. I had just attended the first-ever hard-money (gold) conference, sponsored by Harry Schultz. I told my parents to sell their holdings in a clunker of a mutual fund and put it all into U.S. $20 gold pieces (double eagles). It was a good move. When the pound was devalued, the price of these collectors' coins -- legal for Americans -- shot up overnight. By the time my report on the conference was published in the Chalcedon Report (Nov. 27), the devaluation had already occurred. Grabbe continues:
In March 1968, the effort to control the private market price of gold was abandoned. A two-tier system began: official transactions in gold were insulated from the free market price. Central banks would trade gold among themselves at $35 per ounce but would not trade with the private market. The private market could trade at the equilibrium market price and there would be no official intervention. The price immediately jumped to $43 per ounce, but by the end of 1969 it was back at $35. The two-tier system would be abandoned in November 1973, after the emergence of floating exchange rates and the de facto dissolution of the Bretton Woods agreement. By then the price had reached $100 per ounce.
The crisis was of course blamed on Swiss bankers. Someone referred to them as "the gnomes of Zurich." The phrase was picked up by the financial press.
On the back of the book's dust jacket, there was a picture of Goodman standing near the bottom of a long flight of concrete steps in front of a large, official- looking building. In front of him was a midget (sorry: vertically challenged man) who was dressed in strange clothes and a leprechaun's cap. The caption beneath the photo said -- I'm going by a 33-year memory -- "The author consults with a gnome of Zurich."
Goodman-Smith's book went into details on the new world of international money. What he predicted pretty much came true over the next five years.
SUPERMONEY
In 1972, Goodman wrote a follow-up book, Supermoney. On August 15 of the previous year, Nixon unilaterally ended the convertibility of the dollar into gold -- "closed the gold window" -- and turned the dollar into the fiat currency we have all come to love. If you had $1,000 on January 1, 1972, you would need $4,244 to match its purchasing power today. (Use the inflation calculator on the Web site of the Bureau of Labor Statistics: http://www.bls.gov.)
Supermoney was about how smart people were making fortunes in the stock market. That was not easy to do in the pre-Silicon Valley days -- or in Silicon Valley today, it appears. The economy was just coming out of a recession in late 1972, when the book appeared. It had been in recession for two years. This recovery was brief; in 1974, we got another recession: Ford's. The stock market had started down in late spring, 1969, in Nixon's first year, and it did not begin a sustained upward move until summer, 1982.
The book described a strategy for making it big. The strategy was simple. First, get an idea for a marketable product. Second, create a new company with a lot of shares. Set aside the lion's share of the shares for yourself. Set aside millions of shares for the public. Third, start marketing the product. Fourth, as soon as you have a winner, sell the public's portion of the shares to the public. If you keep 10 million shares, and the public gets 10 million, and the price is bid to $10, you're worth $10 million.
Bill Gates was 17 years old in 1972. The next year, he entered Harvard. In 1975, he started Microsoft. He quit Harvard in his junior year.
He and his partner Paul Allen understood the principle set forth in Supermoney. Gates is the richest man in America. Allen is #3, behind Warren Buffett.
When I read Supermoney, I immediately thought: "But how do you get your hands on the money? Shares aren't money. They are claims to ownership. You can't spend shares."
Silly me. Silicon Valley companies were hiring extremely bright people to work for them, year after year, decade after decade, not for money, but mainly for stock options. This works for the employees if they get in early enough. It works if the market for the shares continues to expand.
In short, it worked in Silicon Valley until 2000.
In 1972, I kept trying to poke holes in the thesis. "As the founder, if I want to get my hands on the money, I have to convert my shares to money by selling them. But if I have all these shares, how can I sell them without depressing the price?" The answer came to me: "The same way you eat an elephant: a little at a time."
Gates has been selling off billions of dollars' worth of Microsoft shares. Gates has always understood the nature of supermoney. It's called the greater fool theory. I say this as someone who publicly recommended Microsoft shares in January, 1988, when it was $5 a share. (Remnant Review, Jan. 15, p. 6)
I am optimistic, long-term, regarding the computer software company, Microsoft, located in Redmond, Washington. It is the largest software firm in the world, and its 31-year-old founder, Bill Gates, was the first person ever to become a billionaire by owning shares in a computer-related company. (The stock market erased his paper status, but he is still a very wealthy man.)
What is the secret of supermoney? Imputation. The trouble is, most investors don't really understand imputation.
THE DOCTRINE OF IMPUTATION
Imputation was originally a theological concept. Actually, for a few of us, it still is. It refers to the judicial declaration of God: "Guilty!" or -- far preferable -- "Not guilty!" Theologians, at least of the Calvinist variety, explain eternal salvation as God's declaration of "Not guilty!" to specific people on the basis of Jesus Christ's moral perfection, which is transferred judicially and unilaterally by God to sinners.
The concept of imputation was discovered, adopted, and adapted by economists in the early 1870's. They moved imputation from God to man -- specifically, man in his capacity as a consumer. This insight restructured modern economic theory. Economists concluded that earlier theories of economic value had been wrong. These theories had been based on a concept of objective value that inhered in an economic resource. Over the next century, only the Marxists officially retained the concept of objective economic value. (Economists still use it, but not openly. They sneak it in through the back door whenever they speak of "social value" or "cost-benefit analysis," or "the greatest good for the greatest number," or "gross national product.")
Economic value is now said to derive exclusively from decision-making consumers who impute value to consumer goods. That is, they declare something valuable or not valuable -- rather like God's declaration, "Not guilty!" or "Guilty!" If they impute low value to some item, it will have a low price. Not many people will bid a high price for it.
But there is a major difference between economic imputation and judicial imputation. Modern economists think there is no value inherent in the actual objects of consumers' preferences. They refuse to acknowledge economic value apart from imputations by individual consumers. Economic value is imputed, and exclusively imputed.
So, if someone tells you that "gold has intrinsic value," this is not an economist speaking. An economist would say that gold has historic value. He might even say that gold can safely be expected to have future value well above a price of zero. But he will not say that gold has intrinsic value. That concept has no meaning in modern economics.
Now, let's apply the modern economists' concept of exclusively imputed, exclusively subjective value to the price of a share of ownership. Buyers compete against each other in terms of the monetary unit. They make objective money bids based on their individual subjective valuations, i.e., imputations.
All of the would-be sellers of shares are competing, driving down the price. All of the would-be buyers are competing, driving up the price. Sellers compete against sellers; buyers compete against buyers. From this continual competition come actual sales at specific prices. The share price of the final transaction at the end of the day is then imputed by the stock market's indexing system to all of the outstanding shares, including shares owned by investors who have no intention of selling (at today's price).
The imputation is of price is objective. A computer can count the number of shares sold at specific prices in any time period. The stock market's index is therefore objective. But the imputed economic value that undergirds the objective price of the shares is subjective.
Are we agreed? I hope so.
CAPITALIZED VALUE
OK, let's consider to the concept of capitalized value. Multiply the number of shares times the most recent price, and you get the capitalized value of the company. Or do you? This capitalized price is objective. But is the value objective? No. It is subjective. It is the product of imputations, and most of these imputations are implicit. The decisions of a handful of people who decide to make an exchange are surrogates for all owners -- millions of them in some cases. They decide as representatives -- economic representatives -- of all of the other owners.
This is economic democracy. Sometimes, the results of economic democracy are as stupid as the results of political democracy -- not often, but sometimes. On April 6, 2000, I wrote this in Remnant Review.
One of the most popular Internet companies to buy is Cisco Systems. It sells hardware for the Internet. There is no doubt that it is a company with a huge growth potential. It is growing 2.5 times faster than Microsoft is. But investors pay for that widely perceived potential. The P/E ratio is around 200. There is no dividend. It has a market capitalization of over half a trillion dollars -- three times larger than Dell Computer, and over two times larger than IBM, which has a P/E of 30. It is now larger than Microsoft. Am I to believe that Cisco Systems is a better buy than IBM? . . . .Warren Buffett would not buy Cisco Systems shares. It pays no dividend, so it would not qualify as a Graham/Dodd company. Its book value would be hard to estimate. It has earnings, unlike most dot.com companies. Amazon has a negative earnings/share: -$2.2. Cisco is a giant by comparison: 37 cents. But IBM has $4.12.
In early March, both Merrill Lynch and Lehman Brothers recommended buying Cisco. I could not find any advisory service on cnetinvestor.com that recommended selling it. Its price was around $70.
That was then. It ended in 2000. You can see the 10-year chart of the rise and decline of Cisco here: Cisco mania.
THE DESTRUCTION OF CAPITAL
When the NASDAQ fell from 5040 to 1500, trillions of dollars of capital was wiped out. But the economy did not collapse. There is a reason for this. It wasn't productive capital.
The destruction of NASDAQ capital was supermoney capital. It was capital based on imputations of utterly naive late-comers who had bid up the final price of the shares. They arrived in 1997 and continued to bid up prices. Yes, they lost a lot of money. Some of them lost everything. They converted real money into hypothetical money. This became supermoney for those few who sold their shares to them. But there weren't that many of them: buyers or sellers.
For the vast majority of NASDAQ share owners, it was neither real money nor supermoney. It was hypothetical money. The could not have sold their shares at a profit without collapsing the market.
Here is a fundamental economic concept: it was not a loss if you couldn't have sold anyway. Losses occur when you miss an opportunity. Only a handful of holders had an opportunity to sell at a profit.
Those ill-advised, hype-driven souls who bought the shares after 1996 until March 10, 2000 did give up real money -- money that could have bought anything -- in exchange for a participation in an insane dream. By late 1999, the 207 P/E was obviously an impossible dream, but they kept buying until March 11, 2000. But they gave up non-leveraged money -- real money -- to buy a piece of the dream.
Currency is non-leveraged money. Money-market fund money is almost non-leveraged money. Nobody holds either to make a killing. We hold is so as not to be killed.
With supermoney, you can get killed. It is super- leveraged. It is based on the greater fool theory of profitability.
From 1997 to 2000, greater fools poured their money into to the NASDAQ, especially the digital sector. They dreamed the dream, and they got their heads handed to them. Such is the world of supermoney. It works for those who got in early.
Am I saying that a supermoney stock investment is basically a legalized chain letter scheme? Yes. And, lest we forget. . . .
Last week, Gates sold off another $2 billion in Microsoft shares.
So, the capitalized "value" of Cisco is now a fraction of IBM's. My point is this: it always was. The vast majority of shareholders could not have converted their holdings at the capitalized price. This is of course true of any asset. If consumers change their minds, the value of the shares disappears, and objective capitalization disappears with it.
Wise investors must ask themselves this: "What is the likelihood that many other investors in one stock will try to sell at the same time?" The issue here is liquidity. The less likely that shareholders will sell, the more liquid the stock is. But the more liquid the shares, the less the possibility of a supermoney play. The early comers made the strategy work -- the Watson family, in the case of IBM, long before I was born -- but the late-comers haven't a chance.
Cash is liquid. IBM is less liquid. At some price, one of these days, Cisco may even as liquid as IBM.
Cash is not supermoney. IBM shares are not supermoney. Cisco shares used to be supermoney. Not today.
The NASDAQ is set up for investors who dream of wealth through supermoney, but most of whom are in fact the targets of those who collect supermoney. Supermoney comes into existence only when the late-comers show up, checkbooks in hand.
There are people who bought supermoney stocks in 1995 or 1996 think they could have sold. Well, they could have, but only to the greater fools. Had many of them actually offered to sell, the boom would not have occurred. The capital created on the NASDAQ would not have been created. The prices would have stayed stable or even fallen.
Am I saying that there was no capital created by the boom? Not "none," but far, far less. The NASDAQ makes possible high-risk ventures. A few of them survive. A few create wealth for the public. That's why a NASDAQ or any capital market is a good thing. But there is a conceptual difference between capital and supermoney. Capital is the tool that leads to consumer satisfaction. Capital markets do create this. Unfunded ideas are only ideas. Consumers are not benefited. But whenever I read about Silicon Valley as the creator of enormous wealth, I saw mainly illusion. The corporations' capitalized share prices were for the most part not capital. They were mostly pools of supermoney for the techies who got the venture capitalists to put up the money.
There were losers in the debacle: investors who arrived late, holders of supermoney who did not sell but who could have. But we are not speaking of large numbers of investors, for supermoney cannot be collected by large numbers of investors. That is the nature of supermoney. Supermoney is the joint creation of a minority of founders and very early investors who then lure in dreamers of great dreams who have very little common sense -- "You don't get something for nothing" -- and who don't understand the nature of this market.
There may be a wealth effect of booming supermoney share prices. "Look, Madge, we're rich." To which Madge should reply: "Let's take the money and run." To convert supermoney into real money, you must sell to the late- comers while they are still coming through the door, checkbooks in hand.
YOUR RETIREMENT PLANS
The liquidity of the S&P 500 is based on one fact, and ONLY one fact: most investors are expected not to sell until it's time for them to retire.
Anyone who offers any other explanation for the liquidity of the conventional American stock markets today had better have powerful evidence that the savings habits of workers under age 55 are about to change from "yuppie" to "Japanese housewife."
Keep these three words in mind every time you think about your retirement portfolio in relation to your expected needs:
The standard estimate -- naive beyond belief -- is that your retirement portfolio must generate an income stream that is 70% of your pre-tax income today.
Let's apply Pareto's law to that one: 80% of Americans will not attain such a portfolio by thee time they retire.
What about the 20% who do? About 20% will call their brokers and say, "Sell!" About 80% won't, and they will see their portfolios erode.
If half of your portfolio is in stocks, then you need this portfolio to generate 70% of half of your present income. If you make $60,000 a year, your stock portfolio must generate 70% of $30,000. That's $21,000 a year. Stocks pay 1% in dividends after fund management fees. At 1%, you will need a stock portfolio of $2.1 million.
Next year, maybe?
You need some supermoney. Sorry about that.
CONCLUSION
I am saying that the conventional stock markets are essentially the NASDAQ. I'm just not sure in which year.
The conventional stock markets are supermoney markets. What is holding them up is the fact that most people who are share holders are still in the work force. They have not looked at the underlying economics of these markets: the looming lack of liquidity as baby boomers retire. The baby-boomers are like all those folks who owned NASDAQ shares, 1997-March 10, 2000. They think they have money. They don't. They have supermoney. To get real money, they must convert leveraged supermoney into non-leveraged money by selling their shares.
Most of them won't make the conversion in time. That's the sad fact about conversion. People procrastinate.
Supermoney is not real money. Capitalized value that is based on supermoney isn't real capital. It's leveraged, hope-based, pre-retirement based, supermoney-capitalized value.
Let's put this picture into perspective: it's the Confederate bond market in early 1862. No; it's worse than that. In 1863, Lee might have won. I look at the retirement statistics. What do I see? Pickett's charge.
What's coming? Think of that scene in "Gone With the Wind," where Thomas Mitchell tells Vivian Leigh not to worry, they have plenty of money: good Confederate bonds.
In my version of the movie, Rhett Butler is played by Bill Gates. No mustache. Normal ears. Glasses. He has just bought Atlanta. After the fire.
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