The Matrix Has You

Last modified on June 22nd, 2010

I first started investing in the stock markets around 2000. Since then, I’ve had front row seats to at least two big market corrections. During the first, I was working out at JDS Uniphase in Ottawa, Ontario. If that name sounds familiar, you probably heard about us on the news — in 2001, JDS Uniphase wrote-off the largest amount of goodwill in history, a staggering $45 billion dollars. When I showed up for work that day, news trucks were lined up all down the block, and employees were being constantly questioned as they tried to get into the building. We watched all the interviews take place from a small corner meeting room on the 4th floor, wondering what all of our fates would be. While most of my friends were nervous, I actually thought the whole thing was rather funny. I remember telling people to look at the bright side — our parents would all finally get to see where we all worked.

The second correction was the one most of us remember, sparked by the failure of Lehman Brothers, the bailing out of AIG and the subsequent Troubled Asset Relief Program (TARP). Like many people, the value of my investments plunged nearly 50% during that time period, and are still recovering.

There was once a period of time when the stock market was based mostly on fundamentals. Companies that produced a consistent profit would receive additional investments, and companies that continued to post loses would be sold off. Stock analysts used to look at metrics such as the PE (price to earnings ratio) to determine if a company was overvalued or undervalued. If a stock was to be purchased, someone physically had to go out on the trading floor and purchase it.

Things have changed.

The explosion of the high technology sector, primarily driven by the internet and the information age, caused the landscape to change. Business fundamentals were thrown out the window and replaced with speculation regarding a stock or a company’s performance. While there has always been speculation in the markets, the degree of speculation was unprecedented during that time period, catapulting some stock prices to atmospheric levels with a PE ratio of over 500.

During that same time period, stock traders have slowly been replaced by computers. While those computers haven’t quite become self-aware yet (think Skynet), there are already troubling unintended consequences, one of which caused the market to be suspended in May, and a rash of stock trades to be reversed. If you were an ordinary investor that bought or sold the affected stocks during that time period, you were SOL.

The S&P 500 has long been one of the most useful indices used to measure stock market performance over time. Historically, the S&P 500 has produced average annualized gains of around 12.5%, which lends credibility (at least in theory) to the advice that buying and holding stock is a way to take advantage of compounding interest to help fund a retirement.

The annualized S&P 500 return over the last five years is -0.06%. Over the last ten years, it’s a bit worse at -1.2%. What that means is that for the most part is that if you invested money in the Nasdaq in the last decade, you have probably lost money. Granted, if you took advantage of dollar cost averaging (by buying stock as the market continued to slide), you may have produced some small gains. But chances are the gain realized in those cases was less than 3.1% (the average annual inflation rate over the last 30 years or so), meaning that the purchasing power of your money actually declined during that period.


Conventional wisdom (driven primarily by historical market performance) would dictate that everyone not only remain in the market, but that everyone continue to buy stock as the values decrease, reducing the average price per stock in everyone’s portfolio. That’s a great strategy if the markets return to past performance. But the elephant in the room that nobody wants to talk about is this: what happens if they don’t?

The world is driven not by reality, but by the perception of reality. That’s why it is possible to collapse a bank by doing a bank run. Even if a bank isn’t in financial distress, the sudden rush of people withdrawing money can put it in a state of distress, leading to a self-fulfilling economic prophecy where the bank eventually collapses. The failure of Lehman Brothers is another example of this phenomenon when applied to a company – part of the reason for the collapse was the continued downward pressure on the stock price by people doing naked shorts of Lehman Brother’s stock. We only have to look across the Atlantic towards Greece to understand what happens when people lose faith in the economic viability of a entire country.

Like Neo, we’re all jacked into the Matrix wondering just how deep this rabbit hole is going to go. With a debt-to-GDP ratio of 98%, the United States is on a similar path as Greece, a country that came close to collapsing with it’s debt-to-GDP ratio of 120%. Given that most currencies are still fixed to the US dollar, the collapse of the US economy would be catastrophic on the global stage.

Photo from UnrealityMag

18 responses to “The Matrix Has You”

  1. 90% of the worlds economy is run virtually anyway, so we’re pretty much already in the Matrix aren’t we? My steak tastes


  2. Beth says:

    Reading your economics postings is starting to make me depressed! What would you recommend one do with their money? I’ve been trying to beat down my beast of a student loan debt, but balance it with putting money into my RRSPs, but after reading your postings (as well as some other finance stuff), I’m starting to wonder…

  3. Alex Curylo says:

    “With a debt-to-GDP ratio of 98%”

    Oh, if only.

    Unfunded obligations for Social Security and Medicare alone over the next 75 years are north of $40 trillion and climbing. That’s a present value debt of $350K per household.

    Public sector pension obligations have already bankrupted municipalities, and entire states California not least of them are teetering on the brink.

    Sooner or later, and “later” here is “30 years, at the absolute outside”, the fiat bubble that’s supported all this is going to burst once and for all. Unless we’ve managed to figure out nanotechnology by then so there’s no further need for a credit-based economy, we’re looking at a Dark Ages level technological regression. Good times!

  4. Duane Storey says:

    Yah, that’s true Alex. They also have obligations to Fanny Mae and Fanny Mac I believe, and those aren’t included in any of the debt numbers. Put your arms up, it’s going to be a good ride!

    @Beth – Well, you might want to talk to a financial planner to get proper advice. I think it really depends what tax bracket you are in. If you’re in a high tax bracket, it may make sense to put everything into RRSPs, and then use the refund to pay down your student loan. But if you’re not in a high tax bracket, it probably makes more sense to pay off your student loan first before worrying about RRSPs.

  5. Alex Curylo says:


    Get rid of your debt. All your debt. Do not save a penny whilst you have debt.

    With the caveat that anybody who claims they have any real clue what’s going to happen more than a couple months away is either lying or stupid, it seems like a pretty odds-on bet that we’re far more likely to go into an extended period of deflation, particularly in house prices, than we are to go into hyperinflation as things head toward collapse. See the economy of Japan over the last 15-odd years since the big property crash for what the best bet is our future looks like. And in a deflationary economy, you want no debt. Everything else is trivial next to that.

    … and when we do finally (although the problems they’re having issuing bonds, “finally” may be “next year”…) get to the stage where government throws up their hands and starts running the printing presses so hyperinflation sets in, then it’s time to head for the hills with some chickens and goats, not worry about what’s in your RRSP.

  6. Duncan says:

    The current actions of Governments around the world are going to lead us into a textbook inflationary recession. In the US, the Fed manipulates the CPI numbers to reflect much a much lower inflation level than the reality. Deflation is a mythical beast that they’d rather focus your attention on. In reality, the central banking model is entirely inflationary.

    Joe average should be paying down debts at this stage, and thinking about locking any long term debts in for the longest term available within the next 2 years. RRSP’s should be heavy in Gold, Silver, and oil moving forward.

    The central banks know only one path: low rates and printing money. They believe that sustaining this path will eventually lead to a recovery. Reality is already proving them wrong. Recovery? What recovery? How much more money can they throw at the economy before they realize it’s not working?

  7. Alex Curylo says:


    “Deflation is a mythical beast that they’d rather focus your attention on. In reality, the central banking model is entirely inflationary.”

    What this analysis — conventional, I grant you — misses is the growth of derivatives. Those have to be considered part of the broader money supply. We just barely squeaked on a knife edge past total collapse because of the bottom falling out of those in fall 2008 when people collectively realized whoa there’s actually nothing of value underpinning them, and since then the money out of nothing nonsense dance governments have been doing has been a frantic effort to put off that collapse until … well, until some magic happens that lets us get out of the 95+% deflation of derivatives and credit which it seems at this point pretty much impossible to avoid. And whatever it is that will happen then is literally unprecedented, but it’s probably going to make the fall of the Roman Empire look like a mild recession.

  8. Duane Storey says:

    just barely squeaked on a knife edge past total collapse because of the bottom falling out of those in fall 2008 when people collectively realized whoa there’s actually nothing of value underpinning them

    Hmm, sounds a lot like our currency, no?

  9. Alex Curylo says:

    “Hmm, sounds a lot like our currency, no?”

    Currency, in a credit-based trading economy, is effectively collateralized by the issuing nation’s import consumption. As you can see by looking at who owns foreign US debt.

    When credit flows cease — which, as I was pointing out to Duncan, has to be considered deflation as credit is now inseparable from formal currency measures — the whole house of cards collapses. That *almost* happened two years ago; for a while there it wasn’t a safe bet that supermarkets would have food on the shelves in a month. This farcical “quantitative easing” nonsense has greased the skids enough to keep things functional so far, and probably for the near to midterm future, but anybody who doesn’t realize that we’re still skidding faster than ever really needs to pull their head out of the sand.

  10. Duncan says:

    Do you see China becoming more of a consumption based economy moving forward as the greenback and other currencies lose purchasing power relative to the yuan?

  11. Duncan says:

    The derivatives issue is huge. It’s like taking a dollar coin, then placing mirrors at various angles to create 40 reflections and calling that $40 dollars. Even worse is when it turns out the apple was just a hologram all along!
    Regardless, the intrinsic value of the fiat currency is zero. Everything, including the derivatives was priced based on false, unproven and often outrageous assumptions. While Central banks have been able to print money and “sweep” the derivatives issue under the rug for the moment, they will have to pay the piper eventually. That’s why Gold is now acting as it’s own currency of sorts. When the world finally loses all confidence in fiat currencies, they will collapse in tandem. I wouldn’t be surprised though if Governments made gold ownership illegal and confiscated as much as they could in final desperation.

  12. Duncan says:

    Replace apple with coin in my statement above. Doh! Shouldn’t be reading about the iPhone while typing! 🙂

  13. Duane Storey says:

    @Duncan – that actually happened in 1933 – the US government (Roosevelt) made it illegal for people to own gold and forced people to convert it into US dollars.

  14. Alex Curylo says:

    Possibly in the short term it’ll move that direction. But if the yuan is allowed to find its natural level, then exports collapse. If not, then we have the low grade mutterings about trade wars we’ve seen the last few years. Since how the dynamics of that work out are driven by political decisions, nobody can make any sound predictions.

    In any case, looking forward China’s real problem is that the one child policy is going to bite them hard when their working age demographics collapse in another 15-20 years. Put simply, China will get old before it gets rich. Declining native birthrates are going to be an interesting challenge for all industrialized nations in the next few decades — the current contretemps in Greece are the first foreshocks of that — but China’s going to hit the wall all at once compared to any other nation on earth. Those will be interesting times indeed.

  15. Alex Curylo says:

    That was a forced devaluation, yes, but paper dollars were still externally redeemable for gold.

    The really important collapse of US currency was Nixon cutting all ties to gold in 1971, after the reserves had been cut in half since World War II and it was quite clear that they would completely disappear in short order.

    Once that happened, we were well and truly into the game of musical chairs with the world’s currencies, the whole thing propped up only by mutual delusion. It must end eventually in either hyperinflation or massive deflation, because existing debts are too large to ever be paid off in even what currently passes for sound currency. The only possible way out of this is for our manufacturing efficiency to attain such a magical level that production becomes free enough for the whole credit economy to be obsoleted before it falls down around our ears. So cross your fingers that the nanotechnology boffins create us powers unto gods before the dreary mathematical reality crushes us. There pretty much isn’t any other practical alternative left at this point.

  16. Duncan says:

    What if the US decided to just start buying up gold in the near future? If they could accumulate more than any other nation, if their dollar collapses so be it! They’d have already traded worthless money for gold that would be worth an astronomical sum at that point? Food for thought?

  17. Duane Storey says:

    @Duncan – that’s one option. Or, you can just encourage your citizens to buy it and seize it all at the appropriate moment!

  18. Alex Curylo says:

    Some of the more fevered swamps around the Internet are pushing the rumour that exactly that is the plan, dismantling the US Federal Reserve and replacing the US dollar/Canadian dollar/Mexican peso with a gold-backed “amero”.

    Personally I think it’s about as likely the existence of the strategic reserve herd of gold coin pooping unicorns they’d have to have to create the necessary gold without the whole world figuring what’s up and bringing on financial Armageddon immediately … but who knows, a hard reset of the currency is one of the slightly less catastrophic options available overall. Maybe.

Leave a Reply

Your email address will not be published. Required fields are marked *