The Stock Market, Credit, and Capital Formation


(The epub edition here:

A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply–Fritz Machlup

I won’t kid you, this is a tough read, but it will pay richly. The author was both a businessman and economist who had practical experience during the Great Depression. The book helps you understand cyclical stocks–and what stocks aren’t cyclical? See the review below:

on March 18, 2010
The book was originally published in 1931 in German. It was one of the series of tracts issued under the name of Beitrage Zur Konjunkturforschung by the Austrian Institute for Trade Cycle Research of which F.A. Hayek was the director. The book made its appearance not very long after the stock market crash of 1929 and the latter event had a strong bearing on its subject matter.

Fritz Machlup is a champion of the stock exchange and the book solidly refutes most of the charges that are commonly made against it. The most serious of such charges is that the stock exchange absorbs capital either permanently or temporarily and thus deprives the industries of capital. Machlup answers this charge by pointing out that there may be a permanent absorption of money capital only where this absorption is productive, i.e., where it leads to the formation of new real capital. When new issues are sold in the Stock market, the proceeds of the sale are utilized in the purchase of machinery and other forms of capital goods. In all other cases of security transactions which do not involve any new issues of securities, there is a mere transfer of funds from one person to another. B receives what A pays. The proceeds of the sale of securities by a speculator who withdraws from the stock market flow back into the economic system.

Even when there is a chain of security transactions before anybody withdraws from the stock market, the chance of a temporary “tying up” of funds is greatly reduced by the Clearing House method of offsetting mutual indebtedness among the brokers and jobbers. The settlement procedure adopted by the stock exchange members renders any considerable use of money unnecessary. The private speculator who is not a member of the stock exchange may not avail himself of clearing facilities and the payments between brokers and private speculators may require cash or bank deposits. But even this difficulty is greatly removed by the extensive use by private speculators of what is called “brokerage deposits”. A private speculator who sells securities may leave the sale proceeds on account with his broker until he buys other securities. The broker will not usually maintain idle balances but is more likely to use them to grant loans to other private speculators who want to buy securities.

Customers keep on selling and buying and their accounts with brokers perform the function of money. The balances held by Stockbrokers on behalf of their customers are called “brokerage deposits”. They constitute a special type of medium of exchange and are much used in the security transactions between the regular customers and brokers. It is only in the event of an excess of customers’ withdrawals of balances over new deposits that payment by check is necessary. But even that is unlikely to take place except when a large number of outside speculators who are not regular customers of brokers enter the speculative market. This only happens in times of credit inflation by banks through an “easy money” policy. There may be a temporary tying up of funds in a chain of security transactions only when a large volume of such transactions are carried out with cash or check payments, and that is rendered possible through credit inflation by banks. The blame for temporary “tying up” is therefore on the inflationist policy of banks rather than on stock exchange.

A second charge against the stock exchange is that speculation is at the root of business cycles. The charge is based on three grounds. It is said that speculation causes mal-investment and overinvestment. Secondly, it causes credit inflation and lastly it makes credit dear. The author refutes each of these allegations and concludes that it is not speculation per se but credit inflation which causes all these disturbances both in the capital market and in the money market.

There is nothing inherently wrong in fluctuations in prices of securities. They may be due to changed expectations of returns and transactions may be carried on both in a rising or a falling market without any fresh funds being brought into the stock market. It is only when inflationary credit is placed at the disposal of speculators that new issues of securities are floated at random and funds are absorbed in investments which are unsatisfactory. Inflationary credit whether given direct to industries or to the stock exchange from which it flows into industries causes disproportionalities in the production structure.  (To learn more see: skousen-structure-production). More funds are invested in the purchase of fixed capital and in roundabout processes than is justified by the savings of society. When the flow of inflationary credit ultimately dries up, the fixed capital becomes unremunerative and is either worked at a loss or has to be scrapped. It cannot be said that financing of industry through the stock exchange causes any greater malinvestment or overinvestment than financing of industry direct. The effect of inflationary credit is the same in both cases.

As for stock exchange speculation causing inflation the author argues that one must blame the elastic supply of credit by the banking system rather than the increased demand for funds by speculators in a rising security market. Unless there is a latent capacity and willingness on the part of bankers to extend more credit, the demand of speculators alone cannot cause inflation. If the banks are prevented from inflating credit through regulation of reserves, discount policy, etc., then stock exchange speculation can do no harm.

Nor is stock exchange speculation to blame for making credit dear. The stock exchange is only a convenient means of attracting capital for long term investment. Higher security prices mean a lower rate of interest and hence cheaper capital for industry. It is not the stock market which competes with industry for funds. It is industrial long term credit which competes with industrial short term credit. As a result of higher security prices, in the absence of any inflationary credit, the long term rates fall and short term rates raise which close the usual gap between the two rates and thus exert an equilibrating influence. It is only when credit is inflationary that short term rates may go above the long term rate and the complaint about “dear money” is heard.

In short Machlup reveals inflationary credit as the underlying cause for all those disturbances for which blame is usually laid on the stock market. The book is exhaustive with regard to the field it seeks to cover. It bears every mark of patient research and painstaking reasoning. It is with great delight that the Mises Institute has brought it back into print.

And look what’s coming!


So why do we lose?



Test for Investors; Do you have what it takes to be a value investor?


Test yourself…………….

Each of four cards on a table has a letter on one side and a number on the other, but you can only see what is on the side facing up. What you see are two letters and two numbers:

A         4           D           7

Suppose the rule governing these cards is that if a card has a vowel on one side, it has an even number on the other side. Which two cards would you turn over to find out whether the rule is true? Take no more than twenty seconds.

Now go to the real world: Can you name at least two psychological/analytical errors that you see in this clip. Take no more than 4.5 minutes–length of the clip. The investment bankers each have MBAs, CFAs, Accountng degrees etc. They are SMART!

Total time for test 5 minutes.

2016_templeton   Hand-out to go with the above talk in 2016.    A good discussion of the psychological strength needed to apply value investing principles.

Gold is the worst investment in history

Brian Lund-originally published Feb 5, 2015    Lesson: Think for yourself. 



Nobody wants to be the bearer of bad news. Nobody wants to crush people’s dreams. But in the world of investing, cold, hard facts, not dreams, are what make you money. And the fact of the matter is, historically speaking, buying gold is the worst possible investment you can make.

I am very sensitive to the fact that what I just said has probably caused some readers to go apoplectic, and for that I apologize. I know that I will never convince the gold bugs, inflation hawks or doomsday preppers of this thesis, nor my own personal position that gold will eventually be worthless. But for the rest of you, let me lay out the case to avoid gold as an investment.

The Numbers Don’t Lie

In his seminal book “Stocks for the Long Run,” renowned economics professor Jeremy Siegel looked at the long-term performance of various asset classes in terms of purchasing power — their monetary wealth adjusted for the effect of inflation.

With a $1 investment each in stocks, bonds, T-bills and gold, beginning in 1802 and ending in 2006, Siegel calculated what those assets would then be worth.

Stocks were the big winners, growing the initial dollar investment into $755,163. Bonds and T-bills trailed dramatically, returning only $1,083 and $301 respectively. But the big surprise was in how badly gold fared during that time, only growing to $1.95.

An Inefficient Investment Vehicle

In addition to its miserable historical performance, gold also has many other failings as an investment, not least of which are the cumbersome and inefficient options available to own it and the prevalence of less than reputable salespeople in the precious metals space.

Owning physical gold in the form of bullion has many drawbacks. Wide bid and ask prices on physical gold ensure that the moment you purchase it you are already underwater on your investment. In addition, shipping costs for the heavy metal will further add to your cost basis.

Once you get your gold, you then have to decide how to store it. Keeping it at home exposes it to the risk of theft, fire or natural disaster. Taking it to the bank requires the rental of a safe deposit box, the cost of which will eat into your profit as well.

Firms will store your physical gold on site, but they charge for the service, and the idea of having your yellow treasure held by someone somewhere else, commingled with that of others, is not very appealing.

Enter the Modern World

Ultimately, gold is a legacy investment vehicle from a time before mass communications, ease of global travel, and the internet. It no longer is the default store of value that it once was, and financial and technological advances have made it an investment best suited for collectors and hobbyists, but certainly not for serious investors.

For Full Article Click WayBack

Even money says this post attracts the GOLD IS DOOMED advertisement on the page

Editor: Too bad gold isn’t an investment but just money.

Misconceptions about gold S&D

Seek Out the Opposing View; Passive Investing


Ganging up on Gold

Because I hold gold related investments, I always seek out the opposing views to test my thesis.  On the recent 5% fall in gold, a chorus of bears came out.

Natixis offers three main arguments for this call, only one of which makes sense, at least “technically”, if you will:

“For 2017 and 2018, we think that the biggest factor influencing the price of gold is the expected path of U.S. interest rate hikes,” the analysts said. “Also, we do not expect further rate cuts by the [European Central Bank] or [Bank of Japan] as this is likely to damage their banking system especially in the case of Europe.”

Natixis economists are expecting to see the Federal Reserve raise interest rates by 25 basis points three times next year: June, September and December.

Not only will higher bond yields raise gold’s opportunity costs but they will also boost the U.S. dollar, providing another headwind for the precious metals, the analysts explained.”

So when you read the above, always ask for theoretical and empirical evidence of the authors claims.  Is there any long-term correlation between US interest rates and the dollar price of gold?  And why?   More here: Ganging up on gold

Some negative comments on gold is spot-on like


More perspective……………..





Passive Investing

……The most successful professional investors like Warren Buffett, Paul Tudor Jones, John Templeton, George Soros and Jim Rogers, know this well. Their methodologies are even built upon the idea that an intelligent investor can get ahead by taking advantage of those times the crowd becomes irrational, the antithesis of the EMH and MPT.



Study Stoicism to Improve Your Investing and Your Life


Objective judgement, now at this very moment,
Unselfish action, now at this very moment,
Willing acceptance, now at this very moment, of all external events.
That is all you need.

To me that captures the three disciplines (perception, action, will) very nicely. It tells you how to see the world, how to act in the world, and how to come to terms with the world. It is indeed all one needs. You could spend a lifetime trying to just live that quote.

Understanding Stoic Philosophy may help you as an investor maintain rationality, control unwanted emotional reactions, and develop clear thinking for better choices which is, after all, what investing is all about.

The essense of philosophy is that we should live so that our happiness depends on as little as possible on external causes. –Epictetus

  1. stoic-week-2016-handbook-stoicism-today
  2. philosophical-meditation
  3. the-stoic-philosophy-murruoft
  4. the-stoics-1975

Stoicism in six minutes

Why Do Value Investors Do Poorly?

gallowsIt is the emotional nonprofessional investor who sends the price of a stock up or down in sharp, sporadic and more or less short-lived spurts. The professional investor has no choice but to sit by quietly while the mob has its day, until the enthusiasm or the panic of the speculators and nonprofessionals have been spent.” –J. Paul Getty

Can You Explain This?

Starting on page 4, this money manager explains his firms consistent underperformance.   Do you agree or disagree? Why?  A lesson for investors.

wedgewood_view_3rd_quarter_2016_client_letter (Start on page 4)






There’s no such thing as “passive investing.” As Ben Graham defined it in his magnum opus, Security Analysis, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Because passive strategies entail zero analysis of either of these qualifications they are, by definition, speculative. And those adopting them are speculators, not investors.

Like “jumbo shrimp,” “virtual reality,” “old news,” or “living dead,” the term “passive investing” is thus an oxymoron.

My point here is not to shame everyone who has embraced passive in recent years. There are plenty of good reasons to go passive, namely to dramatically lower your costs. My point is that if you want to call yourself an “investor” you need to do a little bit more thinking about the prices and fundamentals of risk assets than just buy at any price and hope. I think Jesse Livermore said it best in Reminiscences of a Stock Operator:

The average American is from Missouri everywhere and at all times except when he goes to the brokers’ offices and looks at the tape, whether it is stocks or commodities. The one game of all games that really requires study before making a play is the one he goes into without his usual highly intelligent preliminary and precautionary doubts. He will risk half his fortune in the stock market with less reflection than he devotes to the selection of a medium-priced automobile.

Embracing passive investing is exactly this sort of ‘cover your eyes and buy’ sort of attitude. Would you embrace the very same price-insensitive approach in buying a car? A house? Your groceries? Your clothes? Of course not. We are all very price-sensitive when it comes to these things. So why should investing be any different?

Value Managers Discussing Performance With Customers

Damodaran Valuation Lecture at Google

Valuation Readings:


Or take Buffett’s Course

I don’t understand why business schools don’t teach the Warren Buffett model of investing. Or the Ben Graham model. Or the Peter Lynch model. Or the Martin Whitman model. (I could go on.)

In English, you study great writers; in physics and biology, you study great scientists; in philosophy and math, you study great thinkers; but in most business school investment classes, you study modern finance theory, which is grounded in one basic premise–that markets are efficient because investors are always rational. It’s just one point of view. A good English professor couldn’t get away with teaching Melville as the backbone of English literature. How is it that business schools get away with teaching modern finance theory as the backbone of investing? Especially given that it’s only a theory that, as far as I know, hasn’t made many investors particularly rich.

Meanwhile, Berkshire Hathaway, under the stewardship of Buffett and vice chairman Charlie Munger, has made thousands of people rich over the past 30-odd years. And it has done so with integrity and a system of principles that is every bit as rigorous, if not more so, as anything modern finance theory can dish up.

On Monday, 11,000 Berkshire shareholders showed up at Aksarben Stadium in Omaha to hear Buffett and Munger talk about this set of principles. Together these principles form a model for investing to which any well-informed business-school student should be exposed–if not for the sake of the principles themselves, then at least to generate the kind of healthy debate that’s common in other academic fields.

Whereas modern finance theory is built around the price behavior of stocks, the Buffett model is centered around buying businesses as if one were going to operate them. It’s like the process of buying a house. You wouldn’t buy a house on a tip from a friend or sight unseen from a description in a newspaper. And you surely wouldn’t consider the volatility of the house’s price in your consideration of risk. Indeed, regularly updated price quotes aren’t available in the real estate market, because property doesn’t trade the way common stocks do. Instead, you’d study the fundamentals–the neighborhood, comparable home sales, the condition of the house, and how much you think you could rent it for–to get an idea of its intrinsic value.

The same basic idea applies to buying a business that you’d operate yourself or to being a passive investor in the common stock of a company. Who cares about the price history of the stock? What bearing does it have on how the company conducts business? What’s important is whether you can purchase at a reasonable price a business that generates good returns on capital (Buffett likes returns on equity in the neighborhood of 15% or better) without a lot of debt (which makes returns on capital less dependable). In the best of all worlds, the company will have a competitive advantage that allows it to sustain its above-average ROE for years, so you can hang on to it for a long time–just as you would live in your house–and reap the power of compounding.

Buffett further advocates investing in businesses that are easy to understand–Munger calls it “clearing one-foot hurdles”–so you can come up with more reliable estimates of their long-term economics. Coca-Cola‘s basic business is pretty staid, for example. Unit case sales and ROE determine the company’s future earnings. Companies like Microsoftand Intel–good as they are–require clearing much higher hurdles of understanding because their business models are so dependent on the rapidly evolving world of high tech. Today it’s a matter of selling the most word-processing programs; tomorrow it’s the Internet presence; after that, who knows. For Coke, the challenge is always to sell more cases of beverage.

Buying a business or a stock just because it’s cheap is a surefire way to lose money, according to the Buffett model. You get what you pay for. But if you’re evaluating investments as businesses to begin with, you probably wouldn’t make this mistake, because you’d recognize that a good business is worth buying at a fair price.

Finally, if you follow the Buffett model, you don’t trade your investments just because our liquid stock markets invite you to do so. Activity for the sake of activity begets high transaction costs, high tax bills, and poor investment decisions (“if I make a mistake I can sell it in a minute”). Less is more.

I’m not trying to pick a fight with modern finance theory enthusiasts. I just find it unsettling that basic business-school curricula don’t even consider models other than modern finance theory, even though those models are in the marketplace proving themselves every day.




Mining for Gold; Secular vs. Cyclical


I’m addicted to placebos. I’d quit but then it doesn’t matter–S. Wright

Secular vs. Cyclical and more


The Base Rate Book


the-base-rate-view-by-mauboussin  I wonder if readers will find this useful.  We last discussed base rates here:














I post these charts for a historical reference point. I do not use them to predict where prices will go.  Note though that rising CinC (currency in circulation) doesn’t always correlate to rising asset prices.

Update: Oct 6th: A contrarian: