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Public Statements

Financial Fallacies


Location: Unknown

By Ron Paul

The recent market volatility brings my mind back to the time after September 11, 2001, and to a time earlier, around the bursting of the dotcom bubble which came to a head around mid-March of 2000. Everyone, from travel agent to janitor, wants to know what the market closed at. Was the Dow up 500 or down 500? How much money was lost today? Which companies are on the rebound?

Times like these are difficult for ordinary people. There's no doubt about that, but the reason the hardworking, down-to-earth American is in this position isn't because of some "fat cat" CEO or some "greedy" Wall Street trader. The fault for our current mess lies squarely at the feet of the government, and more specifically the Federal Reserve. Mr. Paul has gone into tremendous detail about the benefits of sound money and eliminating the Federal Reserve. I won't go into much more detail, if you want to read about that topic check out Mr. Pauls' outstanding articles.

However, I will detail two topics here that not many Americans fully grasp: Privatizing Social Security and short selling. Let's start with Social Security.

I have written in the past about the dangers of our ever-growing mountain of debt related to Social Security. All it manages to do is take from the young and give to the old. It shifts money from hardworking people who have their own bills to pay, and mouths to feed, into the hands of others. This is, of course, morally questionable. But it also robs the young at the expense of the yet-to-be-born. How, you ask? As the dollar becomes ever more worthless (according to Mr. Paul, the dollar is now worth 4 cents compared to its worth in 1913, the year the Federal Reserve came into existence), a dollar today becomes more and more valuable compared to a dollar in, say, 20 years. You literally are losing money (purchasing power) just by holding dollars. So when you invest $75,000 over your lifetime in Social Security, and receive back (being generous) $100,000 in 35 years, you actually are at risk of being a net loser when you factor in inflation.

People, especially older citizens, love to buy into the scare tactics of politicians who try to portray Wall Street as risky, dangerous, and evil. They foster the idea that investing your IRA and Social Security money in the stock market could wipe you out. After all, a stock is just paper that could be worth $500 a share today and $0 in a week, right? Considering the facts (which no one in this discussion really cares about), this argument is absurd. First, it assumes that you will always be 100% invested in risky stocks. Yes, people lost their retirements with the Enron et al scandals, but only if they invested 100% in that company. A proper strategy calls for no more than 5% of your portfolio to be invested in one company. It's not hard to see why, after seeing companies as large as AIG go broke. But it's also not hard to implement in practice. It's laughably easy to set up an account that puts some or all of your assets in investments such as CDs, money market funds, or bonds, which are guaranteed not to "go to 0&#8243; and are in fact insured up to certain limits. Also, the general public overreacts when the market fluctuates.

When you are 60 or 65 years old is not the time to start investing for retirement. At that time you should be invested mostly in low growth, low risk investments such as CDs or bonds. So realistically, no one who is 75 years old would or should really be concerned with the Dow dropping 8% in a day. It's not like they are losing anywhere close to that amount. But here's the kicker. Even if someone stayed 100% invested in "the market" (meaning the S&P 500 or Dow), they wouldn't ever be losing money over a 20 year period. In fact, over even a 5-7 year period the market has fared very well in almost every sample. Sure, the market might go down for a year or even two, but stretch it out to 9 or 10 years and you are always consistently ahead. The point here being, politicians love to drum up fear of "the market" and point to an 8% drop in the Dow as hard evidence. That's akin to trading in your car because the fuel gauge went down by 1/8 today. Set up properly (which the government absolutely cannot do), retirement accounts will always show gains and will always protect your money. Setting them up properly and funding them is the main reason they fail. People take on too many risks, or are underfunded, or withdraw money early. Don't blame the market for your own personal failures. Also, how many politicians are going to live strictly off of Social Security benefits? Anyone with a clue has taken steps to set up their own, personal retirement account. I've had one since I was 18 years old.

Short selling is a method used mostly by large, institutional investors. Basically, it's a bet that a particular stock or investment will decline in value. The short seller borrows the shares or the underlying investment and sells it on the market, hoping to buy it back ("cover") at a later date when the shares decline. Recently, short selling in financial stocks was banned by the SEC to promote orderly markets and market stability, according to the government. Again, the government and media portrayed short selling as an evil activity that only benefits those rich enough to take part in the action. People were profiting from the misery and the decline of the market while ordinary people were suffering "pain at the pump," even as gas prices have been stabilizing.

Does anyone who trumpets this view even have a clue what is really going on? Short sellers are at huge and ever constant risk. Contrary to what politicians will pitch to you, stocks don't regularly drop from $100 to $0 in 3 days. Everyone is constantly rooting the market higher and higher. The media, average Americans, Wall Street, Main Street, and politicians all have a HUGE vested interest in seeing the market rise year after year. Wall Street makes more commissions. Investors have more wealth to spend. Politicians can point to the rising stock market to offset attention on other, more pressing issues. Not only are short sellers taking on a huge risk, they are always fishing for valuable information to be used against this machine of ever rising prices in the market. For example, many short sellers uncover scandals and accounting irregularities before the Feds or other investors do. Short sellers don't automatically buy into the ruse that prices can march higher and higher nonstop. They are the balancing act that keeps markets liquid. Similar to the now infamous "speculators" they are constantly on guard and skeptical. Reminds me of how American citizens used to be back in the days of the Constitutional Convention.

A favorite line of politicians is that short sellers "drive prices down" and they basically bankrupt companies. The implication there is that a sound, thriving business was driven under by some "fat cat" short seller who just had a lot of money to throw around and he made money while all the workers lost jobs and money. This is so laughable I can barely contain myself. Let's just take this as an example. Say Bill Gates decides he doesn't like Wal Mart. So he decides to short a million shares. This might drive the price down by a dollar a share if he's lucky. But he's not done. He shorts another million. Then another. Eventually the stock falls by $2.50. Well, several things would happen well before any real business would "go under" due to a short seller. First, other investors would be scooping up shares hand over fist. Professionals who know how to value a company would look at things like revenue and dividends and would defend the stock. If Wal Mart is valued at $50 and all of the sudden some huge short seller knocks it down to $45, there is real value there. The stock will be higher at some point. But what if the company is smaller and no one is there to defend it? Well, eventually the stock would get so low where other companies would make takeover bids. This would drive the price higher and the short sellers would lose their shirt. You can't short sell a stock into the ground unless there is no one there to defend it. And if there's money to be made by defending a company, people will step up to the plate and buy. The logic that short sellers can simply bury a company by selling it lower and lower is the exact logic people used to justify the dotcom boom. Everyone was just blindly buying stocks that ended up being worthless, but as long as they could sell it to someone else for a higher price, they were safe. Eventually prices come to a true value, and if you are overexposed (whether long or short a stock) you will pay the price. The market is never consistently wrong on a large scale. You can't just buy forever, and you can't just sell forever. Eventually values head toward their true worth.

In summary, privatizing Social Security is the best thing that can happen to all citizens, young and old alike. It doesn't have to go into effect immediately, but once it does, the gains will be enormous. False accusations of "the market" tanking are always taken over a very short sample size, and not a real retirement investment timeline. Short term, the markets are volatile. Long term, which is what retirement savings is based on, the broad market has always come out way ahead, especially when comparing it to fiat money.

Short selling has been villified in the media and by politicians, but the truth is that we don't need more government regularion and oversight. We need more investors who act like short sellers, always digging for valuable information and uncovering both good news and bad and using it to their advantage.

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