The GameStop Trade and the So-Called Reddit Army: Why it Matters

While the financial news this week was all a buzz with stories about GameStop and the other dead or decaying companies which saw their stocks soar to meteoric levels, few, if any, of these stories cared to cover the economic impact and financial repercussions caused by a complete misallocation of capital by a social media herd on Reddit. Most of these stories either glorified in what they assert will be a new “democratization” of Wall Street, touted the generational battle between Gen Y and the stodgy-suited Boomers, or reveled in the losses incurred by individuals and hedge funds who chose to short, or bet against these companies. But no one seemed to care or ponder the implications for capital markets, in particular, or capitalism, in general.

First off, let’s get one thing straight, I don’t care about individual’s choosing to invest, trade, or speculate on their own. How can someone, like me, who loves markets not wish or hope that others adopt his same passion? I am not going to make the argument that this move towards “democratization” creates undue moral hazard or exposes the unwitting to financial harm or ruin. In fact, as a pure capitalist, I say bring it on; because here’s a dirty, little secret: losses are a necessary and brutal fact of a capitalistic system. And to borrow and twist a Churchillian statement, capitalism is the worst economic system, except for all others. So, I say bring on the risk takers, bring on the profit-motivated, bring on the gains, and bring on the losses. God knows I’ve had my share of both of them, but only the losses can educate me. Losses are a tuition paid for that education. Unfortunately for me, and I’m not alone, I’ve had to retake some courses many times. But for our losses we would never learn or improve.

My problem with the coverage of the “crash up” in GameStop, AMC theaters, GSX Techedu, and even Tootsie Roll is that they are ignoring both the short-term and long-term financial and economic impacts. Additionally, they, the financial media, are failing to discuss what the root causes may be for all of these market “irregularities.” Stumbling on to this topic, however, they may discover, like turning on the lights in the kitchen in the middle of the night, some unsettling cockroaches lurking in our financial system. Let me first cover the longer term implications of this ramp up in this basket of equities. The purpose of financial markets, I know in this day it may seem antiquated, is to most efficiently allocate capital and put it in the hands of the companies and people who can put that capital to the most productive use. Capital markets are an essential component of a capitalism. Optimizing the efficient use of capital ensures that our economy and productivity will grow. What has taken place over the past number of trading days is a distortion and bastardization of this process. Capital is being distributed to companies that are in decay, companies that are as relevant to today’s economy as Blockbuster Video was 10 years ago. Carried to its extreme this will divert capital away from growing companies designed to take our economy forward. Ultimately the loser of this misallocation is the death of the US economy.

Yesterday we saw, what I believe, was a misguided response of no-cost brokerage firms in response to this distortion. Many of these firms responded by cutting off trading in these “crazy” stocks. Outrage among the herd of buyers of these stocks ensued. Again I never think a capitalistic system should get in the way of people risking, losing, and making money. While I get it that they must have been extremely frustrated having their access restricted, but should they really be surprised. These firms were offering them free commissions. When in history does someone getting something for free think that they are really the customer. Paying a fee or a price buys you certain rights—if the cost is zero you better be aware that there is a real, paying customer somewhere in the chain. That customer is the trading firm or hedge fund on the other end paying for our order to be routed to them. So from that standpoint I have to say to them: you get what you pay for.

The last point on this issue I would like to address is the villainization of short sellers taking place on social media. Many of these people are calling for banning the practice of short selling. Short selling is the process of one participant betting against the price of a company’s stock. Many feel that it isn’t fair to “sell something you do not own,” I will tell you that short sellers provide a valuable role in capital markets, helping improve the overall efficiency and ultimately reducing downside volatility. Short sellers also prevent runaway markets. Our financial system is becoming more and more inflated and consequently more and more fragile. By preventing or limiting sellers we create greater runaway asset inflation. On a final note, I usually feel that in a debate once you introduce a comparison to Nazi Germany you’ve lost the argument, but I feel like breaking my own rule. Back in Nazi Germany they had a rule which prevented any stock transaction from taking place at a price which was not an all-time high. I don’t have the volume figures for this time period but I’m going to assume trading volumes were exceptionally low. This system worked great at keeping markets up, thus giving the impression of a robust economy. But after the war ended, when the Allies took over the transition in West Germany, they rescinded this rule. The next day the market fell 90%.

Thanks for reading,

Zach and Dave

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