Transcript

Chris Martenson: Welcome, everyone, to this Featured Voices podcast. I am your host, Chris Martenson, and it is January 29, 2019. Now if you’ve been listening to me for any length of time at all, you know that I consider our financial markets to be so distorted and so deformed after far too many years of Central Bank interventions that they no longer deserve to be called markets.

Instead, I put not one but two sets of quote marks around the word “”markets”” to signify just what a travesty they’ve become. A market, as a reminder, it’s a place where buyers and sellers engage in something called price discovery. A “market,” by contrast, is a place where noneconomic players gather to influence prices to reflect certain specific policy aims or where overly large players enact greedy smash and grab operations on the price levels of financial assets.

Now sometimes they smash them down lower to engineer conditions to make money and other times they smash them higher. But with that said, everybody listening to this grew up with the same idea I did marketed to all of us, which is that stocks are a legitimate form of investment. Perhaps the only and most important part of investing.

Stocks for the long haul. Buy and hold. Dollar cost averaging, fundamental analysis. Just employ any of these strategies and that’s the path to building wealth. Now our guest today has another view, which is even more fundamental than my own observations about broken markets riddled with conflicts of interest.

Tan Liu is the author of the book The Ponzi Factor: The Simple Truth About Investment Profits, which explodes some of the most enduring central myths about stocks and stock investing, as he makes the case that the stock market is a scam at a foundational level.

Now if you’re an investor, you absolutely have to hear what he has to say. It’s a very well written book that takes you through stocks or equities and what they truly represent using really simple, really easy yet very solid logic. Now if you’re holding or thinking about buying stocks, you really should be familiar with this logic, so you can at least be a fully informed investor.

Now here’s a bit of background on today’s guest. Tan Liu was born in Beijing, China. He moved to the U.S. when he was six and he was raised outside Washington D.C. and unlike his sister who finished high school and got a scholarship to MIT, Tan took a less traditional path and went straight into the working world.

He was employed as a bike courier after high school and later supported himself through college as a freelance photojournalist for networks such as CNN, MSNBC, and Fox. But in addition to his professional life, Tan has also spent many years volunteering as a youth mentor in D.C. and in Inglewood, California. In 2006, he completed his undergraduate degrees in economics and finance from the American University.

And he has worked for two hedge funds and a trading firm in Shanghai, but spent most of his finance career managing distressed assets for a bank. He officially exited the finance industry in 2015 and now is finishing a master's degree in applied statistics. Welcome to the program, Tan.

Tan Liu: Thank you for having me, Chris.

Chris Martenson: Well, Tan, you say that stocks are, in many cases, indistinguishable from a Ponzi scheme. Take us through that. What’s your reasoning?

Tan Liu: Sure. Well, when it comes to stocks, there are two ways of making money. There are capital gains and there are dividends. Dividends, there’s nothing wrong with that because that comes from the profits of the underlying company itself.

The issue is with capital gains, the whole buy low and sell high gamble that is often promoted. Not often promoted; I would say 99% of the time promoted on CNBC, financial news networks, and also the focus of a lot of financial research.

The issue with capital gains is it comes from other investors. When one investor buys a stock for $100, they’re selling it for $110, that extra $10 or actually $110 they’re getting is not from the company. It comes from another investor who will then need to sell it to yet another investor.

So when one person buys low and sells high, another is also buying high and needs to sell for even higher. And a system where current investors’ profits are dependent on cash from new investors is by definition how a Ponzi scheme works.

Chris Martenson: So let’s talk about what stocks. I love the way you started the book out. You talked about what a stock really should represent. Originally, a stock was representing and it sold as you’re part owner of a company. And that’s, I think still, if I turned on CNBC, that’s all they would represent it as. You are an owner of a company. What’s wrong with that?

Tan Liu: What’s wrong with that is a lot of stocks don’t pay dividends and why are you an owner of a company if the company never pays the so-called owners? It really comes down to that simple fact and it’s funny because over the past year, I’ve debated with a lot of people.

Essentially, all my critics of the book, what they’re ultimately trying to rationalize and argue is that owners don’t need to receive money from the companies they own, which is really twisted. But that’s exactly how it works because when a stock doesn’t pay dividends, there is no monetary connection between the revenues and profits of the company and the actual shares.

And the only thing that’s really increasing is just this Ponzi process of one investor trading money with another investor. And it’s fundamentally different from the money itself that investors ultimately want. No one actually wants to buy stocks and say: Hey, I don’t ever want my money back. I just want stocks and I want to watch that value grow.

And I never want my money back. Wrong. Everyone wants their money back because a stock is essentially completely worthless unless you can get your money back. And every investor that buys stocks wants more money than they contribute.

But if investors are the only ones contributing money into the system, how on earth can they all make money from it? That’s really the bottom line. A stock without dividends is really just a Ponzi asset and there is no monetary connection to the company.

So therefore, it’s not a real equity instrument at all and furthermore, we can see this because some people say oh, well stocks are real property. How can it be real property if literally companies can print this stuff like toilet paper at any time they want? Real property takes time to replicate.

Try replicating a house. How much labor does that cost? How much resources does that cost? Try replicating a stock. It takes a signature. Companies are printing billions and millions of these things every single day. It’s not real property if you can just literally replicate it and just throw it out to the so-called market and just have people gamble on it anytime you want with almost no effort at all.

Chris Martenson: Now I want to get to this idea of gambling versus investing. Because there’s a great point you make in the book but I really want to make sure we drive this home. So there are really only two ways you can get money back after you throw money into the stock market.

So let’s say I buy, I’ll just make some numbers up. I’m going to buy a share of Google for $1000. I don’t know what it’s trading at right this minute. So I put my $1000 in and there are only two ways I get my $1000 back or more. One, I have to sell that share to somebody else and if I do well, somebody pays me more than I bought it for.

And if I do poorly, they pay me less. The other way would be through dividends. Now the only thing that really identifies that you have an ownership stake in the company though is if they give you money back in the form of a dividend. A company has no ability really to influence what your share price is you’re going to get back.

We’ll get to corporate share buybacks in just a minute. But otherwise, once it’s out in the secondary market, their shares are just floating around and people are buying and selling them, hopefully for more than they bought them for. But your point, which really needs to be elucidated, is the only way you get more money for your share is if somebody else gives that to you.

It’s not floating around out there in the market somewhere. It’s sitting in somebody else’s bank account and it has got to be liberated from their bank or brokerage account and come back into yours. Right?

Tan Liu: That’s correct and I will also add that the only foreseeable way. This is very important. The only foreseeable way is that because the critics will argue oh, but Google could pay dividends. Or Google could buy back stocks later or something like that. But those are hypothetical situations.

You can’t compare a hypothetical situation about what a company might do in the future compared to the Ponzi process, which is completely observable, completely provable, and something we can witness every single day. You can’t debate an observable event with something completely hypothetical.

The only foreseeable way people can get their money back, yes, is by selling it to another investor.

Chris Martenson: Alright and let’s cover this idea of dilution, which is the idea that a company might have a million shares outstanding. But with the stroke of a pen, they might have 1.1 million shares outstanding for a ten percent dilution. This is happening all the time, isn’t it? A lot of companies pay with options to their senior employees.

Tan Liu: Yeah.

Chris Martenson: So they are constantly “paying” but they’re paying with obviously other investor money that exists out in the market. Because if I’m an executive in a company, I get stock options. I now take those to the market and I release them to the market. I sell them and I take that cash. So this is happening all the time too, isn’t it?

Tan Liu: Absolutely, yeah. Tesla Motors, their shares outstanding practically doubled since 2010. They started around 95 million they reported in 2011. Now they’re at 172 million and god knows what they’ll be when their Q4 comes out next week or later on this week.

Amazon as well. Over the past 20 years, they printed about 131 million shares and what’s so funny about the dilution thing is how does a market cap formula work? The market cap formula works and the way they value a company is by multiplying the price and the shares outstanding.

So needless to say, we all established that dilution is a negative thing for shareholders. But in the market cap formula that everyone uses to value a company, it actually increases it. The reason why Tesla is worth twice as much now is because they printed twice as many stocks by now.

So we’re actually touching on a slightly different subject now but the finance formula that I’ve looked at that people would use are literally ludicrous and they use them all the time. But yeah, it actually rewards dilution, the market cap formula.

Chris Martenson: So this is a really important point and I want to get into this more. Because you did a wonderful job taking us through a number of fallacies that exist around the stock market. Let’s get to the first one, which is that stocks are equity instruments that represent ownership. You’re calling that a fallacy. Why is that?

Tan Liu: Yeah. Because one, there’s no monetary connection like I mentioned and two, if we look at some stocks right now like Google. They don’t even have voting rights to actually half their shares, which makes about 600 billion market cap. Half of their shares are C shares.

So those things don’t pay any dividends and there’s no voting rights. So you own that thing for $1000. You’re not going to get any money from Google and you’re not allowed to say to Google what you want.

Chris Martenson: So what do I own?

Tan Liu: Exactly. What do you own? And the whole idea about voting is also completely garbage. I’m not going to go into too many details about that but it’s very obvious if you look at the difference between Google A shares that do have voting rights and Google C shares that have no voting rights.

The difference in trading price off of let’s say $1000 is about a dollar or two dollars. So let’s just assume economics are in play and stuff like that. What that’s saying is that the right to vote has absolutely no premium that exists at all and also, you could also look at it this way.

Voting only works if you’re a company and you issue these stocks and you issue a set number of votes and that’s that. But the problem is that’s not how it works. The companies can manipulate these votes. One is through dilution like we just talked about, which is they could just print more votes.

Another is they just do these shady splits and all kinds of things which I can’t even imagine, which basically lawyers get to it and they have all these ways. Google shares weren’t all C shares before. Half of them weren’t C shares before. Google shares at one point were all A shares.

In 2014, they did a shady split where half of them were C shares and half of them were A shares. So voting only really works if there’s a set number of votes and that’s that. But the reality is in the voting system when it comes to stocks, these companies can manipulate these votes at any point in time they want and they do manipulate these votes a lot of times.

So yeah, the voting thing itself is also not there. But most importantly, I think people forget that the reason why stocks were equity instruments to begin with is that they all pay dividends, according to history. Before the 1900s, all stocks paid dividends and there was a monetary connection between the shareholders and the companies that they owned.

That’s how stocks were supposed to work. It’s supposed to be that simple. You buy a piece of a company. They make money, you make money. But that’s not how stocks work now. This idea that stocks can literally have no dividends and these companies can make billions and never pay dividends indefinitely.

Or that these companies can continue losing money and keep printing stocks, in the case of Tesla and many others, is a new concept that came out over the past 100 years or so. So the way that stocks work now is fundamentally different from how they actually were designed to work and how they worked before the 1900s.

And a stock without dividends when there is no monetary connection to that company should never be seen as an equity ownership instrument.

Chris Martenson: With equity ownership implying or even definitionally including the idea that you have some ownership stake in the company. Meaning you would have voting rights. You would have some claim to the assets and you would have some claim to the cash streams that were coming out, the profit streams that were coming out of this. So what is the definition of an equity if it provides none of those things?

Tan Liu: Yeah, exactly. It doesn’t fit the definition at all and what does fit the definition of how capital gains work is that it fits the definition of a Ponzi scheme. Because the only way you’re going to make money is by taking it from another investor and what the earlier investors think is that they’re making money from the underlying company when it’s not.

It’s actually coming from another investor. But it does not meet the definition of equity because equity you’re supposed to have an ownership instrument. You’re supposed to receive money from the company. But if you’re not actually logically connected there, then it’s just simply not there.

Now I will add though is there a connection at all between the stock price and what the company does? Yeah. It’s called a speculative connection. Speculative. But you know what else exists in terms of speculative connections? Everything has a speculative connection; everything.

I could draw a speculative connection between what I’m going to eat for dinner and the performance of a basketball player. So everything has a speculative connection. There are pseudoscience ideas that are not quantitative, not logical but simply speculation. That’s it.

So that’s the issue. It’s like yeah, there’s no monetary connection and these are nothing more than speculative instruments based on speculative connections with a company.

Chris Martenson: Well, now a whole giant machinery exists out there, Tan, of course, to keep this whole thing going. Because with a rising stock market, it signals to people all is well and they tend to be happier and they like to borrow more and spend more. So that’s where the consumer consumptive model that we’ve got, lots are in support of that.

But what you’re saying is you have one example in the book, which is still very applicable today and you mentioned it already. So I’ll bring it up. Tesla. So at the time you have a chart that picks it up, it’s probably trading at around $40 a share where you pick it up and it goes to $450 or something in the timeframe.

During that period of time, it had lost over ten years cumulatively about $4.5 billion. So what’s the thinking that has to be in place for somebody to say this is a great investment? I want to own this.

Tan Liu: Right. You mean from a finance person’s point of view or something like that?

Chris Martenson: Yeah. What’s the mindset? You have to believe in something and the belief is I’m going to get my money back. This company is going to make a ton of money.

Tan Liu: Yeah. So the classic belief that people would apply to that is the stock price represents, is a reflection of future cash flows. That’s a classical theory they’ll apply. Now that’s just complete garbage because one, that’s not provable. Sure, it’s a stock price now because it’s based on something in the future.

Well, you know what? I can’t prove you wrong but you can’t prove yourself right either. That’s called pseudoscience. Furthermore, if we look back at Tesla, then let’s say okay. So based on that theory then, in 2011, I guess the shareholders must’ve thought that their stock is going to accelerate up to $380 and over the next five or six years while the company loses $4.5 billion.

Was that their thinking? Seriously? If we apply that logic, oh it’s a future cashflow. It’s the expectation of future cashflow. Well, now we are in the future. Now looking back, actually I’m just going to quote the statistics as of now, not in the book.

Now looking back, Tesla has lost $6.5 billion over the past eight years and the whole logic of this whole idea of oh yes, prices reflect future earnings. Well, we look back at 2010 and we see what happened is if that is true, then investors literally thought that this company was going to lose $6.6 billion and their shares are going to double, which is why they invested and why they expected the stock to go from $20 to $380.

It makes absolutely no sense at all but that’s exactly what that theory implies. Looking back with the benefit of hindsight.

Chris Martenson: Yeah, looking at that chart, a high of $380 there. So this whole idea is that it’s really important to just bring it back to basics. Because listen, what you’re really doing here is countering decades and decades of really aggressive marketing.

I keep thinking back to I’m sure you’re familiar with it, the lunch scene. The famous lunch scene in Wolf of Wall Street. I love this scene between Leonardo DiCaprio and Matthew McConaughey where he basically is to the young ingenue, Matthew is saying listen.

Our job is to take home cash in our pockets at the end of the day. Your job is to keep them fully invested. If you have another idea and he makes money on it, you’ve got to get the next idea. So it’s selling, selling, selling, and selling this idea. But if you strip all that away.

Forget the marketing. Really, you’re putting money in today because you want to get more money back in the future. There has to be a mechanism for getting your money back in the future. So if you take a company that’s not paying any dividends, you only have one mechanism available to you to get more money back and that’s to sell it to somebody else for more. Have I missed anything in that story?

Tan Liu: No, you’re absolutely right. I think it’s the biggest perhaps smoke and mirror that’s there is people still…over the past year, one thing I realized is that there’s a serious difference between knowing and realizing. As in a lot of people will say, actually I’ll say everyone would be comfortable saying yeah, I know a stock isn’t real money.

I know it’s just paper profits. They don’t have a problem saying that. But if you ask them the same, if you rephrase that and say can you literally say to yourself that if I have $40,000 in my 401k, I have zero dollars? That statement is equivalent to saying stocks aren’t real money. It’s paper profit.

A lot of people will have problems saying that second statement. What they will say is yeah, I have zero dollars, but I can sell it. But. They’ll always add that but. But don’t say but, just end it right there. Don’t add anything to it and that’s the difference between knowing and realizing.

So even though what we explained is exactly how stocks work, which is yeah, you have to sell it to someone else. And if you actually have $10 in your stock account, you have zero dollars and if you have $10 million, you also have zero dollars.

There’s no difference there. You have zero dollars right now in real money. But a lot of people will have problems acknowledging that and it does take time to acknowledge that. So a lot of people will listen to what we’re saying but still say yeah, but I’ve got to hedge my money.

I’ve got to make my money grow. Your money is not growing if you’ve got zero dollars in there. The only way you’re going to get it back is by taking from somebody else later. Money does not magically grow like that and that’s the issue with a lot of the way that people think.

So yeah, it is just a system where you have to get it back, get your money back from someone else and people forget that when they own a stock, the moment they buy that stock, their money is gone. It’s gone and the only way they’ll get it back is by selling it to a different investor.

Now I will also add that this is fundamentally different to, a stock is fundamentally different from a house and a car. Because I get this a lot. Isn’t that the same thing as buying cars and the same thing as buying a house? No. They’re totally different.

Because if you can’t sell a house, what have you got? A house. You can’t sell a car, what do you have? A car. If you can’t sell your stock, what do you have? Nothing. So this is the issue. Stock is essentially worthless unless you can sell it to another investor and unfortunately, that’s just the only foreseeable way that most investors will get their money back.

Chris Martenson: Well, but Tan, I have a lot of Google C shares. Clearly they have some value. They have par value, right?

Tan Liu: Par value? Yeah. Right in the front of the SEC 10k. Par value of .001 dollars. One tenth of a cent. Yeah.

Chris Martenson: So for every ten Google shares, you’ve got a buck. No, sorry. You’ve got a penny.

Tan Liu: Yeah, exactly.

Chris Martenson: Alright. So a small loose thread from before but it has been sticking in my craw for years. This whole idea that, and I hate the marketing behind this, that companies are returning cash to shareholders when they engage in a share buyback. Do you agree with that or disagree with that phrasing?

Tan Liu: It is a big assumption. I disagree with that phrasing completely because they don’t focus on the dilution aspect, which is that companies issue shares before and after the buybacks too. Google, for example, engaged in a share buyback of five million shares in 2016.

Well, that’s what they announced and they probably did but if you look at their SEC 10k, you’ll see that their shares outstanding did not decrease by five million shares. It actually increased by three million shares. So if they did somehow buy back five million, they also somehow put another eight million out there.

So the whole idea that share buybacks do actually return something to the investors is a myth and not just based on the examples that I said. There’s another economist. I think his name is Robert Arnott, who worked on ERP research, as well.

He had this ratio that he developed which basically shows that the overall market dilution always exceeded buybacks by about two percent every year. So it’s not just me with these ideas but the idea of dilution and the calculations of it have always exceeded buybacks historically, as well.

So whenever CNBC or somebody talks about buybacks, it’s a very false statement because they don’t pay attention to dilution. But I will also add though that there are companies that do, do legitimate buybacks, too. And you do see their shares outstanding decreasing.

Like Apple, I noticed, because they pay dividends, probably, they do want to buy back their shares so they pay less later, which makes sense. But they do exist. So not all of them are scams but to simply assume that buybacks are legitimate is a false statement. Because there’s a lot more to it than that.

Chris Martenson: Well, I agree. I think part of my reason I don’t like the phrase, which you added to, by the way. The whole idea that it should be net buyback. So if the net buybacks are still negative, it’s still a dilutive year for that particular company.

So that’s not good for shareholders. But there’s already a mechanism for returning money to shareholders. It’s called a dividend.

Tan Liu: Yes, and not only that but dividends are far more fair to returning to shareholders. Because every shareholder gets it. The buyback is…look. There’s a reason why buybacks were illegal until like 1982. Because it was a clear way that companies could manipulate it.

Now even if they have a positive net buyback based on what you said a year, who’s going to know they’re not going to issue 100 million shares the next year or two years later? That’s the whole issue with this whole idea of votes and being able to just print whenever you want is that these companies can literally just print and dilute whenever they want.

Chris Martenson: Right and another important point I just really want to put an exclamation point on that you made there is that when you do a share buyback, that’s not returning money to shareholders. It’s returning money to some shareholders who choose to sell in that moment.

Everybody else gets nothing from that except an apparent bump in how much their stock might be worth potentially. But it’s not returning money to shareholders. That’s called a dividend. That happens to everybody. Everybody gets the same cut. Doesn’t matter when you held your shares. If you held during the dividend period, you get that. Right?

Tan Liu: Yeah, exactly. It’s much more fair and it’s also much more noticeable too for shareholders. Also, whenever these companies do, do buybacks, which is really rare in general. It’s really rare and really what they return even when they do a legitimate buyback is really miniscule based on how much they’ve taken over the years.

Chris Martenson: Yeah. So I want to keep reiterating this point though. A Ponzi scheme then is some sort of a scheme where continued money flowing in from new investors is required to pay off old investors. Right?

Tan Liu: Yes.

Chris Martenson: So you had a second fallacy that you talk through. I want to make sure I call it out because I’ll go to a third one. I just want to make sure people are clear on this. The second fallacy was that the asset value of a stock is the same thing as cash. So you’re making this point that we have this, I forget what the number would be today.

But in your book, you talk about a $30 trillion stock market. That’s apparently its value. There are a lot of people collectively, pensions and individuals and all this stuff, looking at their statements and individually summing it up going we have $30 trillion to our name, which we can now plan on what we would do with our $30 trillion. But you’re saying they actually don’t have $30 trillion.

Tan Liu: No, not at all. There’s only $1.6 trillion in circulation in the monetary system and about $3.8 trillion in existence in the whole US economy. Now that’s a monetary base and if you want to talk about the M2, which is probably the most lenient measurement of money, I think it’s about $11 trillion or something like that.

But which is still really far off from $30 trillion. Really far off and yeah, $30 trillion market cap is equal to zero dollars in real money. The whole idea of market cap and stuff is that it’s based on a formula that comes from the exchange of money, which is based on how much the last price of a stock was traded for multiplied by the shares outstanding.

Now let me give you a funny example. This was not in the book but this is something I looked into over the past couple months. I can actually make Apple shareholders increase their net worth by $48 million, if I want to, by contributing one penny more into the stock market.

This is how it works is that Apple shares, there are about 4.8 billion shares outstanding. Let’s assume that it’s trading at $150 right now. That $150, the market cap is going to be multiplied by 4.8 billion. If I buy just one share of Apple for $15.01. One share, one more penny.

Chris Martenson: $150.01.

Tan Liu: Once cent. One penny more. That one penny will be multiplied 4.8 billion times and everyone who owns Apple will see the collective value increase by $48 million by my one penny. So that’s a real simple math example just to show you how messed up the market cap formula is.

Chris Martenson: Well, let’s bring up Apple then because it wasn’t that many months ago, Tan, that it was allegedly worth more than $1 trillion. So all the people collectively holding Apple were saying yeah, we own more than $1 trillion. Today it’s worth a little under $750 billion. So where did that quarter trillion dollars go exactly?

Tan Liu: Yeah, that’s the whole thing. The value of a stock is just an idea. It is purely cerebral and imaginary. It’s fundamentally different from real money that people can possess, hold it, or hide it under their mattresses. The value of a stock comes from the exchange of money and it’s fundamentally different from the money itself that is being exchanged.

So the reason why billions and trillions can disappear from the market at any moment is because it’s an idea. There are always zero dollars there. It’s just a belief and it’s different from the belief in money value. That’s completely different but it’s really just a belief that hey, I think I have $10 million in my account. No, you don’t.

It’s zero dollars and that’s why that idea can fluctuate. If I had $100, if anyone had $100 sitting on their table right now, no rumor, no slander, no myth, no book can ever make that money disappear or grow. Because it’s there. But if there’s nothing there and you’ve got nothing but an idea, yeah.

Billions can lose at any moment. Millions can lose and trillions can lose at any moment because there’s simply nothing there and all you’re working on is this idea that it’s $1 trillion.

Chris Martenson: Well, Tan, that has been a very enduring idea and in your third fallacy, you raise that the stock markets are a positive sum for investors, producing far more winners than losers, is a fallacy. First, describe what you mean by positive sum, so people have an idea around that term.

But really, I want to talk about why is that the fallacy? Because people are convinced. I go to a lot of investing threads and chat rooms and whatnot and people are convinced you just put money in. Don’t try and be smart. Don’t time it and it will grow and that is a positive. It’s very strong for people, that idea of positive growth in the stock market.

Tan Liu: Yeah. Well, positive sum basically means that overall, it has actually given investors back more than they contributed on average. So there could be losers; there could be winners. But overall, if you add up all the winners and losers, most of them are winners or basically there are going to be more wins.

It’s a fallacy because one, there’s no database that even tracks investor losses. Based directly on what you just said, which is that they see their money grow, so to speak, and they saw their $10,000 portfolio go to $20,000 over the past five years, the issue is that’s an idea. They have zero dollars still.

Their money isn’t really growing. This is part of the difference between knowing and realizing. They say they know but they don’t realize they have zero dollars. So this whole idea about stocks returning something positive is a complete myth.

Not only because of the lack of database that tracks investor losses but people don’t quite understand that the real returns to equity are embedded in something called equity risk premium research and it is a highly debated subject, in terms of what stocks have actually returned to investors.

When people actually talk about and quote numbers like the stock market has returned ten percent over the past century or something, they’re not actually quoting what stocks have actually returned. What they are quoting is the S&P 500 index and there are several issues with that in itself.

This part wasn’t in the book but it’s in my next book later. But here’s the issue with the S&P 500. One, the S&P 500 completely ignores the hundreds of thousands of stocks that have been delisted over the market over the past century or so.

But even worse is that the S&P 500 isn’t actually composed of 500 stocks. It’s actually composed of thousands of stocks that were on the S&P 500 list over the years. What the S&P 500 does is it captures the best performing stocks deemed by the S&P, best 500 stocks every single day.

But if a company goes out of business that’s on the S&P, they’ll simply just drop it off and replace it with a new one. So this is why if you think about it Apple, Google, these are on the S&P 500 now. But these companies weren’t around back in 1928 or 1970.

It’s because they replaced the underperforming companies with these new ones. So the S&P 500 is not actually based on a basket of 500 stocks. It’s actually based on a basket of thousands of stocks and they only took the best performing surviving ones and kept recording those returns.

So again, not only does the S&P ignore all the stocks that have been delisted from the market overall. It also ignores the thousands of stocks that the S&P 500 itself delisted from its list over the years. So you’ve got double survivorship bias there and most people don’t actually understand how that’s even calculated.

This is why financial advisors and all kinds of people just simply quote it without even understanding where those numbers come from. So this idea that overall people have been making money is a complete fallacy. Because no one tracks how much money, real money, investors have actually lost over the years.

And what they’re really quoting is a really biased index that has severe survivorship bias.

Chris Martenson: Obviously, there’s that really old joke. I think it comes from the 30s where somebody is in a Wall Street broker’s office and the broker’s showing how successful they are. And they proudly take them to the window and wave across the harbor and say look. Look at all the yachts we have.

We’re a very successful firm and the customer asks but where are the customers’ yachts? And it’s back to that Wolf of Wall Street scene again that I just cited and it comes down to this idea that when we look at the proprietary trading desks of JP Morgan, Goldman Sachs, etc., they are reporting, have been reporting whole years where they had zero days of trading losses, which implies zero risk.

You have firms like Citadel and Virtu, which are doing high frequency trading, which are also reporting uninterrupted zero trading day losses. Always pulling money out of the market. Now how is it possible for big firms like that to pull tens of billions of dollars out of the market and have it still be positive some? Where is that cash coming from? Do we not have a basic accounting problem here?

Tan Liu: Oh, yeah. There are tons of basic accounting problems. If they’re taking money out of the market and investors are the only ones contributing money into the market because Google certainly isn’t. Then that money has to be coming from investors, which of course makes them have incentive to keep the smoke and mirror going.

It’s as simple as that. If Google is not paying back anything into the market, companies like Google, Berkshire, they’re not paying anything back into the market. And these banks are taking cold hard cash out of the market. It really comes down to that simple aspect. Where is the cash coming from?

I don’t care about these stories. I don’t care about these theories that you can’t prove. I want to know about the cash. Where’s the cash? Just follow where the money is because ultimately that’s what investors care about and if you guys are taking cash, cold hard cash out of the market.

And they’re not coming from the companies, well we’d better look to the only source that is contributing money into the market and that is always the investors.

Chris Martenson: Exactly. So Tan, look. Equities are a claim on something. Bonds are a claim on something. Hopefully you have a nice senior bond, so you’re in front of the line. Oops, it’s PG&E. It turns out some banks just got some debtor in possession financing and now they’re senior to your formerly senior claim.

Rules change, all that stuff is a moving target but let’s make this simple again. Look. The future earnings of a company, as they say, that’s what you’re claiming when you have an equity. But ultimately, those companies then are a claim on something else, tangible and real.

So logical question here for me: how is it possible for those claims, the claims of the equities, to allegedly be growing at ten percent a year? When their true claim is on the underlying economy and that’s growing at half that rate on a nominal basis. It feels like a math problem to me.

You can’t compound something at ten percent that’s a claim on something growing at five percent. It just doesn’t work.

Tan Liu: Yeah. This was actually what Bill Gross mentioned a couple years ago, too. He basically said equities are a Ponzi scheme in that respect. No, it doesn’t work and with respect to how this growth is happening, they’re talking about really the growth in the price, which is really derived from the exchange of money between investors in the Ponzi process.

So yeah, in the same way that Tesla stocks can shoot up from $20 to $380 while they lose billions, it’s the same process. The stock itself is just getting Ponzied up in terms of this exchange process and it can indeed go very high because it’s completely separate from the fundamentals.

It’s completely disconnected from, in Tesla’s case, the profits of the company and in your example the fundamentals of the economy itself.

Chris Martenson: The numbers just don’t add up to me and of course, in my world, what we spend a lot of time doing with my audience is we’re also looking at the idea that this era of growth that everybody has formed all of their ideas around how the world works. Well, we always grow.

The economy is always four percent bigger or in China’s case seven percent bigger. But when something is compounding at seven percent a year, it means it’s going to be twice as large in ten years and in 20 years it’ll be four times as large and that’s just how compounding works.

So we look at that and we say well that can’t continue forever. You can’t compound infinitely on a finite planet. So if we’re at the end of the growth phase, which I think we are. We have now 15 years of global data that says wow. The last 15 years’ growth was a lot lower than the prior period.

So we’re trending downward. So here’s a question. Equities still look really ridiculously expensive to me by historical measures. You’re saying they’re a Ponzi scheme. Can’t disagree with that by logic. But stocks as they are priced today seem to be saying a lot of growth is coming and soon.

So what are equities worth in a world of either flat or even negative growth? Assuming that view comes to pass.

Tan Liu: What are equities worth? Well, if the equity doesn’t pay dividends, it’s worth zero.

Chris Martenson: Alright. That’s a good place to start.

Tan Liu: Yeah, it’s worth zero because it’s just a Ponzi asset and the only way you’re going to get money back is by giving it to another investor. Now the equities that do pay dividends, then you’ve got to look at some fundamentals because those things do actually have a monetary connection to the company.

So that’s a little bit different. So I don’t know exactly what that would be but basically yeah, the equities that don’t pay dividends are just Ponzi assets and the equities that do, fundamentals and things like that matter.

Chris Martenson: Well, I had a guest on a while ago, Tan, who talked about the small cap stocks and the Russell 2000 and said look. They’re reporting a PE of 84 but when you go to how this is actually calculated, they put it right in their methodology.

They say oh, by the way, any companies that have no earnings, we excluded them and anybody that had a price earnings over 40, we called it 40. So they did that whole same thing where it’s basic survivorship bias plus also this truncating to get things back down towards a central mean.

But as a group, they’re yielding something where if you were honest about it, you’d say I’m going to put a dollar into this basket of stocks and I’m going to hope that they return it in 100 years. That would be the earnings profile as it currently stands.

So the only way you can make sense of that in my world is by assuming a very high rate of future growth indefinitely, for decades and decades.

Tan Liu: Yeah. I guess so. So can you repeat that, the example you just mentioned? In terms of they put $100 in there and they’re waiting for 100 years to return.

Chris Martenson: Yeah. If the average price earnings is 100, what you’re saying is I’m willing to put a dollar in with the expectation that it’s going to return 1/100th of that in the next year. So you’re waiting 100 years to get your money back from earnings. Not saying they’re going to give your earnings back but that’s what that would point to. Right?

Tan Liu: Yeah, it would be. My whole thing with the whole growth and what people are going to get back is with respect to cash and dividends. I don’t care about capital gains because capital gains are just zero sum by design and negative sum in practice.

Because you can’t really say capital gains return anything. Even if the earlier investors get their money back, the latter ones are down that money. So by design, they’re just zero sum. So whatever the price is in terms of the appreciation in the underlying asset based on capital gains, I don’t even consider that to be any kind of return at all.

All I care about is the cash. All I care about is the dividends and how much money the investor is going to make from the company itself.

Chris Martenson: Well, speaking of this idea of negative sum, not even zero sum. The financialization of the overall economy in the United States and many other industrialized nations has been extraordinary. Starting from the time the whole idea of financialization really kicked off in the mid-80s to currently, I think banks went from about four percent of the economy to financialized returns around 40% of profits.

It’s astonishing. You worked in a corner of that for a period of time. I’d love to get your point of view now as somebody who maybe has exited and doesn’t have a lot to lose by giving your honest impression. But you worked in the hedge fund industry. What sort of value do hedge funds create?

Tan Liu: I don’t think they create a whole lot of anything. When I first started my hedge fund career, I think in 2007, I read Alan Greenspan’s book Age of Turbulence. And in it, he analogized hedge funds as basically taking out the inefficiencies in the market. The grease between the gears, so to speak.

Because there was inefficiency between banks and bigger institutions. So he saw hedge funds as these little guys going in there and taking inefficiencies out of the market. That’s what I agreed with because I was ignorant back then. But over the years, after I worked with them for a while, I realized especially my second hedge fund I talk about in chapter one.

A lot of them are just basically trying to figure out ways to game the system and really, if anything, they’re making things less efficient and they’re just taking money out of the system in very scandalous ways. And that money, of course, has to come from other investors.

So the whole hedge fund industry, I’m sure there are some decent ones. There are exceptions but overall, I think it’s a total scam because they’re just people who are trying to game the system. And overall, we simply have absolutely no idea, again, back to the idea of there’s no database that tracks investor losses.

Of whether or not the hedge fund industry is actually creating any wealth for society and if they’re simply actually just contributing more to the gamble. They’re clearly not treated as a gambling instrument. Sure, people out there will say oh yeah, it’s gambling. They’re not treated like that because why?

You can be 18 and you can invest in a hedge fund. You can be 18 and open a trading account. If you think they’re gambling, then treat it like gambling. Make it 21. So I don’t care if people think hedge funds are gambling. They’re not treated as gambling, but they should be.

Not only hedge funds but also just stocks in general. So my perception of hedge funds is they’re a total scam. Because we have absolutely no real data on their success and performance and based on what I’ve seen, they don’t actually make things more efficient.

If anything, for every efficiency they make, they also contribute a lot less efficiency in other areas by trying to complicate things and trying to game the system and take money out of the system.

Chris Martenson: Well, did any hedge funds build any bridges last year?

Tan Liu: Yeah, that’s a good point.

Chris Martenson: I mean creating something of value. They make money; I get that. But you wrote in your book, you said, “The things that are legal in finance are far more destructive than what is illegal in finance.” And I assume at least some of that, you’re referring to your period of time there with the life insurance products. Right?

Tan Liu: The life insurance products and also just overall stocks. The fact that Google C shares exist with no voting and no dividends and it clearly meets the definition of a Ponzi scheme. But yeah, it’s insane how people don’t quite recognize it for what it is.

Chris Martenson: Absolutely and people, we’ve been talking with Tan Liu, the author of The Ponzi Factor: The Simple Truth About Investments, which you can find at Amazon. I got it on Kindle. It’s really well worth your time even if you want to just come in and dismiss it and critique it or something like that. Good luck because it’s just very simple logic. Tan, you’re working on another book, you mentioned. What is that?

Tan Liu: The main title is going to be The Ponzi Factor and it’s going to have a different subtitle. Essentially, what it’s going to be is the first book that you just mentioned is very readable, more of a story that anyone can understand. The second book is also going to be very readable.

But I’m also going to focus a little more on the academic side, on the formulas and things like that. Like I explained with how the S&P works and how the market cap formula rewards dilution and how people can create millions and millions of dollars’ worth of value for overall investors by just contributing a penny into the stock market. So it’s going to focus a little more on those aspects as well.

Chris Martenson: Excellent. Well, Tan, thank you so much for your time today and best of luck with that future book and all your future endeavors.

Tan Liu: Thank you for having me, Chris. I appreciate it.