John Bogle is well known in the investment community. At Vanguard, he completely changed the way investors think about Wall Street. He has legions of fans, fans who label themselves as “Bogleheads,” reflecting their staunch acceptance of his main investment thesis: turnover kills.
In a recent interview, Bogle commented on the current global financial system, noting that while the amount of money in the financial industry expands, so does active trading. Mutual funds, a savings vehicle of choice, were once turning over only 18% of their holdings each year. Today, Bogle says, funds have turnover as high as 100% - the funds move enough investments that they’re virtually replacing each holding in less than one year.
Trading Isn’t Economic Output
Bogle backs a view that other fund managers also embrace: trading is not a substitute for economic activity. Warren Buffett backs this view. As does Charlie Munger, Warren Buffett’s right hand man, who says in many interviews that Wall Street would be better if it focused on investment and not trading. Wall Street’s millionaires and billionaires are made by short-term transactions of buying and selling hot investments. They’re not making money in the long-term, just making money off many short-term “holdings.”
Wall Street gets rich from transactions. When one considers the fact that most earnings from Wall Street are from the active management of capital, as well as the commissions generated from facilitating each transaction, Wall Street and the financial industry as a whole make money regardless of what the underlying economies would suggest.
Monetary Expansion is a Gift to Finance
One might say that the United States’ rise as the financial center of the world is a false gain. While the US financial industry is one of the biggest portions of the US economy, it contributes little to economic growth and changes in the standard of living. Naturally, the financial sector is empowered by an expansion in the money supply. As long as the money supply grows, so does the demand to manage the money made available. There is no shortage of fund companies willing to manage larger and larger sums of money.
The game cannot continue forever. Expansion of the money supply provides no real value to the economy; it merely devalues the value of dollars held in years past. Meanwhile, investors have to go to the financial markets to keep up with inflation. This cycle creates more funds, more activity, and more transactional profits, which are hardly as valuable as profits in other industries. Providing transactional services is not, as many economics would allege, the same as providing new manufacturing industries, or intellectual services. No real product changes hands; instead firms get rich by selling investments in other firms. These investments exist in their entirety no matter how many people are hired to play financial hot potato.
We can see simply how transactional volume growth creates bubbles and monetary expansion. The housing boom came from a belief that buyers could buy a home and flip it for an immediate profit. The boom in dot com stocks came from the belief that buyers could buy and sell the next day for double the current price. The boom from 1990-2008 was nothing more than a bubble in debt, credit and monetary expansion. It would be hard to argue that in that time of excessive asset valuation growth the standard of living for the average person changed all that much. The growth, Bogle might say, is purely illusionary.