The Main Elements that are Wrong with our Economic System – First Item on my 10 Point Checklist of Dec 9/10
Understanding the Difference between a) The Financial System & b) The Manufacturer of Cars or Appliances
Both manufacturers of goods, such as electric can openers or vehicles; and manufacturers of financial goods sold to you, provide a service and/or good that is needed by the capitalist society.
The financial industry creates bonds, or shares of companies, or financial derivatives. In essence they manufacture these instruments and sell them to you. A manufacturer of vehicles does the same.
But there is quite an essential difference. The goods sold to you by the vehicle manufacturer have a warranty attached to them and if something goes wrong, the manufacturer stands behind his product and fixes the wrong…… except in the financial industry. There it is BUYER BEWARE. The items manufactured by the financial industry are treated differently, and wrongly so. Once you buy, they wash their hands of the product.
They try their best to sell stuff to you, and they make a very nice commission or profit when you buy something, but they couldn’t care less about it after you have bought it.
This is at the heart of the issue. The average citizen believes that the financial system is very complicated and that one requires extensive education and experience in order to comprehend how it works.
Economists and Academics
In some respects this is true. There are many famed economists that have spent a lifetime studying cause and effect of economic systems and attempted to define theoretical practices of dealing with money flow, and cycles. Very educated people have devised methods of measuring money flow, of measuring inflation or the lack of inflation, and so on.
We should respect these people as they bring great value and understanding to all manner of financial subjects. They range from actuaries to academics, from private organizations, public organizations, to NGOs, and many others. Some believe that governments should flood the system with money in ‘down’ times and restrict money in ‘good’ times. Some believe in laissez-faire, that is hands off and let things work themselves out. There are as many opinions and theories as there are people studying these subjects.
I will leave the theory and understanding to others. I will dwell on the obvious practicalities.
The Financial System is Judged Weirdly & Wrongly
It does not take genius mental ability to see some basic truths. Essentially, the financial system is judged on a different basis than any other industry.
We look at a product and usually can touch or feel it, or can use it to perform some task. We judge the usefulness of a computer by how it works, or of a wireless device by how it helps us. We drive a car and we feel whether it works well or not.
There is no similar simple understandable measurement of how well an individual sees the financial system working. Instead we rely upon reading or listening to the daily news. There we learn if unemployment is up or down. We hear statistics as to this or that and we form judgments.
Mostly we fail to comprehend where these numbers come from. We see houses not selling by driving down a street, or whether our neighbor is having difficulty in finding a new job. But translating this into complicated economic theory – well, that is an entirely separate matter that we leave to others.
How Do We Get Economic Information on Which to Make Investment Choices?
We rely on our Investment Advisors and on our Bankers. Never mind that these people are in the business of selling financial products to you and have vested interests in what they are selling to you. Since we have no other way that we trust to figure out what to do, we trust them.
We buy mutual funds because we have a belief that is sold to us over and over again, that “they know best.” What they really know best, is what product to sell to you that makes them the biggest commission. We buy mutual funds because they are “safe” and the people behind them “really know” (sic).
What they really know is how much commission they get every single future year that you are invested in that fund, so long as you keep your money there.
How Does the Financial System Work?
The Advisor That You Rely On
The advisor that you are relying on, gets his/her information from the company that he/she is working for. In some companies, they are required to sell only their own company’s products, in others, they sell a combination of their own products and everyone else’s products.
The commonality (with some exceptions), is that each of these people is judged by who they work for, ONLY on the basis of how much they sell. They get paid commissions or salary on how much they sell.
No-one cares how well what they have sold performs.
That is irrelevant. If it doesn’t perform well, they bring up the subject of BENCHMARKS, which is a fancy convoluted way of saying that if you lose money, probably others have lost more money than you have lost. WHAT INCREDIBLE NONSENSE.
An essential fact that most people don’t understand, is that when you hire a financial advisor, that person gets paid depending on how many investments they sell to you. No one cares whether the investments do well or do poorly, except you. The incentive is only geared towards selling more stuff to you.
It is really quite interesting that we have allowed this convoluted system to continue. We hire an Advisor, who supposedly advises us, and yet the only way that Advisor makes money is by selling more crap to you.
Does this seem like a good person for you to rely upon?
In our next blog, we will talk about the company that the Advisor works for and the way that company makes money.
