The Ponzi Factor
| Author | Tan Liu |
|---|---|
| Illustrator | |
| Country | United States |
| Language | English |
| Subject | Stock market |
| Genre | non-fiction |
| Publisher | Quantstyle LLC |
Publication date | February 10, 2018 |
| Media type | Print, e-book |
| Pages | 169 pp. |
| ISBN | 1976949955 Search this book on  . |
The Ponzi Factor: The Simple Truth About Investment Profits is a nonfiction book by Tan Liu that argues that the United States stock market is similar to a Ponzi scheme.
Tan Liu says that this is exactly how profits from capital gains are realized in a typical stock transaction. When an investor buys a stock for $10 and sells it for $11 with a $1 profit, that $11 may come from another investor may then look for another investor who will pay him or her $12, and so on.
The underlying company is not involved in such a transaction, and most shareholders never receive any money from the companies; common stocks are just “Ponzi assets” being shuffled between investors.
Tan acknowledges that there is a speculative connection [1] between capital gains and the earnings and growth of a company, but he stresses that speculative connections are meaningless. Real connections have to be legal, logical, definitive, monetary, which can exist with dividends. He criticizes financial media and academic institutions for focusing on speculative connections and propagating the view that capital gains come from the earnings of the underlying company.
The book explains that the definition of a Ponzi scheme is especially relevant for stocks because the only realistic way to realize the value of a stock is by selling it to another investor. This is not true for legitimate assets like real estate because the value of a house is also backed by the intrinsic physical value of the house itself. An example is, if you can’t sell your stocks to another investor, you’re left holding nothing. If you can’t sell your house to another investor, you’re still left holding a house.
Liu considers dividends legitimate forms of profit, because the money comes from the underlying business rather than other investors: before the 1900s, stocks paid dividends and, according to history, dividends were what made stocks equity instruments because there was a legitimate monetary relationship between the company and their stocks. Capital gains were meant to be a secondary form of profit from trading equity instruments that paid dividends. Capital gains were never supposed to be the primary or only way for investors to make money.
Ponzi Scheme: Proof by Definition[edit]
The basis of the author’s proof lies in the how of a Ponzi scheme is defined, and how capital gains (profits from buying and stocks) are realized.
The Securities and Exchange Commission defines a Ponzi scheme as:[2] An investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.
The author breaks this definition of a Ponzi scheme down to three elements:
- It is an investment system.
- Profits come from other investors, who inject money into the system.
- The investors who are making money think the profits are coming from sources such as the earnings and growth of a business.
A typical stock transaction meet all three of these characteristics: the stock market is an investment system, in which profits come from other investors who are buying and selling stocks. The realized profit for the early investor comes from the inflow of money from new investors. 3) Most investors think the profits from capital gains come from the earnings and growth of the company. This is in line with that which is advocated by the media, by Warren Buffet, Jim Cramer, and in textbooks.
All three conditions are met, and by definition, the way capital gains are typically realized is 5the same as those in a Ponzi s.
(Note: "typical" implies what is in normal practice, not considering rare and unforeseeable events like share repurchases.)
Logic: Hypothetical vs. Observable[edit]
One of the main arguments the book makes involves distinguishing between a hypothetical situation and an observable one
Tan Liu points out that people in finance can only refute his accusation by using hypothetical arguments. He says that in theory shareholders can sue a company and companies can start paying dividends. But hypothetical scenarios may never happen. They are ideas that can’t be proven right or wrong, and also what the philosopher Karl Poper calls unfalsifiable pseudoscience ideas that can’t be proven right or wrong. On the other hand, the Ponzi scenario where investors are shuffling money between each other is an “observable” scenario we can witness every day.
It is illogical to debate something that is observable with hypothetical arguments and finance professionals cannot refute the existence of Ponzi factor with observable and provable facts.
This distinction between observable and hypothetical scenarios is very powerful because it eliminates almost all the typical counter-arguments finance professionals have against the existence of the Ponzi Factor.
Evidence of The Ponzi Factor[edit]
Liu uses what he calls the "Tesla Scenario" and "Google Scenario" to support his thesis. Between 2010 and 2017 the stocks for Tesla Motors rose from $20 per share to over $380; this happened while Tesla Motors lost over $4.3 billion.[3][4]
Liu points out that this would not happen if the stock value is connected to the performance of the company. disconnected from the underlying business.
Google Scenario
The Ponzi factor does not have directionality[clarification needed]. The Google scenario is the reverse of the Tesla Scenario; situations where shareholders can make nothing while the underlying company makes millions or billions.
According to SEC filings, Google made over $28 billion between 2007-2011, but their shares price stayed relatively flat. This means some shareholders made nothing over this four year period while Google recorded billions in profits.
Financial Fallacies[edit]
Tan Liu claims three major fallacies in the introduction:
- Stocks are not Equity Ownership Instruments
Liu does not believe that the value of the stock is connected to the value of a company., and the value of a stock has no “legitimacy.”
no one has any obligations to repay the shareholders anything. Hypothetically speaking shareholders can organize and act against the company, but the companies do not have a definitive legal obligation to their shareholders.
An example is how a share of Google might trade for $900, but Google states in writing that their Class C shares have no voting rights[5], they don’t share business profits with their investors, and Google is only obligated to pay the shareholder the par value of $0.001 for that $900 share. On the other hand, a real estate transaction has legitimacy because the value of the property is backed by the intrinsic physical value of the property itself. The value of a bond also has legitimacy because there is a defined entity that is responsible for repaying the face value.
The book explains the association between stocks and ownership come from history. Before the 1900s, stocks paid dividends and history shows that stocks were legitimate equity instruments at one point because there was a profit-sharing agreement between the shareholders and the companies. Capital gains, which is referred to as “Ponzi profits” throughout the book, come from other investors. Stocks were always transferable and there was always the potential to sell it for a profit, but capital gains were meant to be a secondary form of profit. It was never meant to be the primary or only way for investors to make money. Stocks were legitimate equity instruments that paid dividends in the beginning, but it’s not how stocks work now.
- Stock value does not equal cash
The second claimed fallacy is the idea that the asset value of a stock is the same thing as cash, which Tan Liu later defines as the “Universal Error.” When people see a share of Google that is trading at $900, he believes that they will assume that is $900 in "real money. But the value of a stock is notional . Liu believes that money is finite and traceable, and what investors ultimately care about and want.
- The Stock Market is Positive-sum for Investors; the assumption that the stock market is positive-sum for investors, and the system produces more wins than losses. This is why finance firms can label their products and services as investing rather than gambling, and why 18-year-olds can open online trading accounts.
However, the positive-sum assumption has never been proven. There is no database that tracks investor losses, and no one knows how much investors have been winning or losing over the years.
The reason why people think the stock market is positive-sum is that they believe in the second fallacy and think that people must have made money because the stock market has grown to $30 trillion. However, a real positive-sum situation needs to consider the wins and losses of all the investors that are involved—which includes the last investors holding $30 trillion of imaginary money that doesn’t exist.
References[edit]
- ↑ "Redacted Tonight 196". RTTV. Retrieved May 31, 2018.
- ↑ "SEC Definition". SEC. Retrieved May 31, 2018.
- ↑ "View Filing Data". www.sec.gov.
- ↑ "View Filing Data". www.sec.gov.
- ↑ "Document". www.sec.gov.
This article "The Ponzi Factor" is from Wikipedia. The list of its authors can be seen in its historical and/or the page Edithistory:The Ponzi Factor. Articles copied from Draft Namespace on Wikipedia could be seen on the Draft Namespace of Wikipedia and not main one.
