Investment Theory: history and sociology in Capital Flow Analysis
Investment Theory: Flow of Funds Analysis
Applied History and Sociology
In order to reach useful conclusions in Capital Flow Analysis, we must discard some economic theory.
Economics has become a pseudo-science with fanciful mathematical posturing.
As Professor Paul Ormerod states in Death of Economics,
'orthodox economics is in many ways an empty box'.
Economics has become a pseudo-science, not based on experiment or impartial observation.
Instead of lessons from the real-world, we see fanciful mathematical posturing.
When practicing Capital Flow Analysis, economics should be viewed as a popular creed that guides government policy and provides justification for corporate actions.
These widely-held beliefs may be false, but they have a profound effect on the motivation of players in capital markets.
No Need For Fancy Math
In flow of funds analysis, we do not need mathematics that go beyond the capacity of a ten dollar hand-calculator.
When analyzing flow of funds accounts, we do not need advanced mathematics.
It is more useful to read books on history, sociology, culture, and on the technical aspects of securities and market institutions, than to bother with learning stochastic calculus.
When analyzing flow of funds accounts, we do not need advanced mathematics.
In fact, Benjamin Graham's remarks in The Intelligent Investor are relevant for practitioners of Capital Flow Analysis:
“Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market, the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions we draw there from.
In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common-stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra.
Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment "
Putting The Securities Market In Context
The view of the world that is relevant to Capital Flow Analysis is one of long-term evolution and change.
Capital Flow Analysis views the market in terms of long-term institutional evolution and change.
The stock markets of 1860, 1920, 1980, and 2003 existed in distinctly different social and political environments.
To make sense of long-term trends, it is necessary to place the market in context of changes in social movements, demographics, culture, occupations, technology, religion and ethics, education, health and medicine, and other aspects of society.
In other words, the market should be seen as a far more complex phenomenon than the simplistic supply and demand charts of economists, prettied up with fancy mathematics.
Historical and sociological context is essential.
Ten Important Capital Flow Themes
In the next learning module,
, we discuss some of the major themes that are relevant to explaining the Great Bubble of the 1990s.
Most of these themes are likely to continue to be relevant in the 21st century.
There are many other themes that could be discussed, some of which appear in the Essays section of this site.
The ten themes discussed in the next learning module are:
The Common Stock Legend:
Over the last fifty years, tens of millions of Americans have come to uncritically accept investment in common stock as safe and prudent, whatever the price.
Demographics:
The composition of American society has changed dramatically over the last two hundred years with profound implications for capital markets.
The Asset-Lite Movement:
Mass production of MBAs by American universities has brought liberal economic dogma to corporate headquarters, resulting in a shortage of equities.
The Baby-Boomers:
The post World War II population bulge — the so-called demographic pig in the python — has produced a self-indulgent generation that is now moving towards retirement and liquidation of assets.
Buybacks and Options:
Short-term thinking of corporate executives and fund managers has produced a trillion dollar buyback movement that has driven stock prices up for a generation.
Workers' Capitalism:
In 1860, two-thirds of Americans were capitalists, in business for themselves. Now less than five percent are self-employed. A massive cohort of non-entrepreneurial workers expects to invest in a shrinking supply of equities.
Democracy's Snare:
By the 21st century, the number of Americans in government employ or beneficiaries of government payments shifted voting power to those living off taxes collected from the private sector.
End of the Great Age:
During the 21st century, the number of old people may equal the number of young for the first time in history. Population growth may slow or come to a halt, for the first time since the 17th century.
The Mighty Dollar:
Prosperity in the United States since the 1980s, has been driven by easy money resulting from the rest of the world using the dollar as a substitute for gold in international trade. This has led to an increasing trade deficit that is not sustainable.
The Five Horsemen:
It is impossible to predict future capital market flows because of uncertainties about war, leadership, population change, technology, and new economic dogma.
Each of these themes has a potential impact on capital flows and prices.
For example, the expansion of voting public employees may reach a point that public servants control the outcome of elections.
Themes are shorthand for complex sociological and historical trends.
This would bode ill for economic growth, since higher taxes will be to the advantage of the voting majority.
With such prospects, it would be difficult to justify high price earnings ratios for equities.
Themes are a useful tool in Capital Flow Analysis because they are often recurring and serve repeatedly to explain player motivation and market trends.
Themes can be used as short hand for complex sociological, historical, economic, and demographic trends.
Slow Moving Events are Hidden From the Media
Some of these themes present arguments that seem clear enough on examining flow of funds accounts, although the topics are virtually unreported in the popular press.
The popular press fails to report important topics the moves capital markets.
For example, during the 1980s and 1990s, American corporations bought back one trillion dollars more equity than they sold as new issues.
This enormous withdrawal from the supply of equities was a major cause of the Great Bubble of the 1990s.
Nevertheless, the topic has been rarely mentioned in the media.
- One reason is that economic dogma and the Efficient Market Hypothesis do not contemplate a shortage of equities.
- Another reason is that buybacks are extremely profitable to Wall Street, and although contrary to the long-term interests of investors, it is Wall Street that pays for ads on television, in newspapers, and in magazines — not investors.
Thinking Outside the Box
Capital Flow Analysis differs from traditional ways of studying securities. It requires 'thinking outside the box'.
Popular beliefs of market players are sociological artifacts to be studied.
It is necessary to regard popular beliefs of market players as artifacts in a sociological exhibit.
This may be difficult to do when we ourselves are part of the times and the culture.
After spending a hundred thousand dollars to earn an MBA degree and being immersed in a work environment in which certain ideas are regarded as dogma, it may be difficult to look at the capital market in a new light.
Before proceeding, check your progress:
Self-Test
Which type of background knowledge is most relevant to Capital Flow Analysis:
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In Capital Flow Analysis, the term 'themes' refers to phrases that are used as:
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The 'Buybacks and Options' theme is relevant to Capital Flow Analysis because:
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learning module : Completed
Next Learning Module:
"A History of the American People", Paperback, Paul M. Johnson This American History is required reading for Capital Flow Analysis. |
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How the Clinton administration formed a symbiotic relationship with Democratic-leaning Wall Street movers and shakers |
"Masters of Sociological Thought: Ideas in Historical and Social Context", Hardcover, Lewis A. Coser An overview of all the great social theorists. |
"The Cash Nexus: Money and Power in the Modern World: 1700-2000", Paperback, Niall Ferguson A radical new history of politics, with unsettling conclusions about the future of capitalism and democracy. |
"Debunking Economics: The Naked Emperor of the Social Sciences", Paperback, Steve Keen Keen reveals the fatal flaws in neoclassical economics, showing that today's Masters of the World (economists) are merely Naked Emperors. |
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Prof. Nelson argues that economics is the modern secular religion, complete with a priesthood (economists), a sacred text (Samuelson's "Economics") and a plan of salvation, (material progress will solve the problem of mankind) |
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In 1900, London was the world financial center. The fall of the British Empire is relevant to Americans today. The information in this excellent history is useful for Capital Flow Analysis. |
"Wealth and Democracy: A Political History of the American Rich", Paperback, Kevin Phillips Much of the wealth of America's rich comes from the "power and preferment of government". This explains the "limousine liberals" who vote for Democrats. |
"Press Bias and Politics: How the Media Frame Controversial Issues", Hardcover, Jim A. Kuypers A meticulous study of media bias. |
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Americans have been fed a mash of confusing financial and economic information. This information has distorted popular understanding of how the economy really operates. |
