Nov. 21, 2022

FTX Is Not Capitalism

You've undoubtedly heard of FTX, the significant Crypto exchange going down in flames. A group of 30-somethings operated FTX, which appears to have been a giant fraud. One that stole the wealth and savings of millions and, as it unfolds, threatens several political careers.

I first heard of Crypto when several people began asking me what I thought of this hot new "investment." As we'll see, I don't consider FTX an "investment," but on with the story.

Everyone I spoke to could hardly wait to purchase one of these Cryptos, especially as the price kept increasing. The longer they waited, the greater the opportunity cost. I'd seen this all before, and it's what I call "greed finance," not true capitalism.

In the early 1970s, I was a young stockbroker just beginning my career. I soon found out that my clients had a rich history of investing. Most were older and had been in the stock market for years. I invited one particular gentleman out to lunch, and we enjoyed a wonderful afternoon, with him telling me about his experience as a "capitalist."

His father was an early investor in International Business Machines, now IBM. IBM was a corporate titan. And for those who may not be familiar with IBM's history, this was one of the real winners in the market. Begun in 1911, and by the 1970s, the company was already over 60 years old.

For the next hour, I listened to the complete history of IBM, how it had grown, what its current prospects are, and how it was a solid investment. My client explained that IBM stock had made his family wealthy for two generations as he had inherited his stock from his father, an early investor in IBM.

The conversation then turned to what it means to be a capitalist. Many, particularly on the left politically, back then, looked at capitalism as corrupt. Then, like today, capitalism was under attack. The stock market had just been through a significant crash. Little did we know at the time, another market crash was just around the corner.

The "Go Go Mutual Funds" of the late 1960s plummeted in price as these highly leveraged funds could not withstand the market decline.

So, my client brought me back to today's reality. Capitalism, he explained, is the owner of the production. Buy a company that makes things, he told me. A company with a good balance sheet and bright prospects for its product. A future IBM.

Of course, he was right. The type of advice that you heard a lot of back then. It's what most people consider an investor to be, a capitalist—someone who is thoroughly aware of a company's prospects, from the balance sheet to the income statement. A capitalist invests in a corporation that provides a valuable good or service. Investors are corporate owners. And as Adam Smith would put it: investors/capitalists own the means of production.

And here's the important part: We know that a successful corporation's product or service is valuable because it's a success in the market. IBM sold real computers to real businesses. An objective measure of IBM's value. We can precisely determine IBM's income from the number of computers it sells.

So, what did FTX provide as a product or service?

Some will argue that their product was their token (FTT) and their service was the exchange itself (FTX). But these fail in two regards. First, there appears to be little or no backing for the tokens (FTT), and, what financial support did exist, could be removed through a "back door."

Secondly, there was no objective price mechanism and no open market transactions. The price of tokens, for instance, was entirely subjective. As one wag put it: just because you issue a billion FTT tokens and say they're worth a dollar does not mean you are a billionaire.

So FTX fails the "capitalist" test in three ways.

First, it was not viable. What backing that FTX claimed to exist was able to be removed by the "back door," this was pure fraud.

Second, there needed to be an objective price mechanism. FTX set prices, especially on the tokens (FTT), which were purely subjective. We've watched accurate market action in the past week as owners in FTX have tried to liquidate, and in this "objective" market, they have little or no value.

And finally, people who bought FTX were not owners of the business. They were merely holders of a transaction slip. Just like writing a check, it does not make you the bank's owner. Check writing is a financial transaction, while stock ownership is true capitalism.

When you boil it down, FTX certainly wasn't capitalism. It was, however, financial fraud on a level we've never seen.

Econ Briefs

About an hour before the markets open, there is a lot of red on my computer., Energy, Equities, and Precious Metals Futures are all lower currently. At the same time, the bond complex shows some marginal gains.

The important news so far is that China is poised to once again go into lockdown. Over the weekend, China reported its first Covid death in nearly a half year. If China were to go back into total lockdown, it would slow the global economy again. Oil is trading lower on the possibility that China's economy may slow. West Texas Intermediate, the benchmark American Oil, is below $80 per barrel.

In addition to the specter of a slowing China, the overhang of the Crypto Market's carnage remains as regulators and investors sort through the full impact of the FTX collapse.

There are no significant economic reports this morning.