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financial markets. In fact. I encouraged a brilliant young man who trades for me not to go to college by offering him a job and telling him that he could leam what he needs to know about the markets much better and faster on his own than he could in most university systems. Through observation and experience, he is leaming how the world really works and is rapidly b ecoming a fine trader.

On the other hand, I know of a securities analyst, an economics major with five years experience at a major firm, who, when asked if she thought the U.S. govemment debt would ever be paid off, replied, "No, it will probably continue to grow." When then asked how long the debt could continue to grow without lenders losing confidence in the govemments ability to repay, she replied, "I dont know, but eventually theyll just have to write it off. After all, its just paper!" Just paper!!?? Incredible!! Shell watch in horror in the next bear market, when bonds and stocks keep making lower lows. Unfortunately, judging from the countless number of people I have talked to with similar views, this kind of thinking is the rule rather than the exception, and it is traceable to a poor or misguided understanding of basic economic principles.

You cant reverse cause and effect. The so-called economic "gurus" in Washington cant create prosperity with the stroke of a pen on a new bill in Congress. Economics isnt a mystical realm nor the province of geniuses or specialists with some kind of special insight akin to religious revelation. Many policy makers are

little more than political cowards who are afraid to tell special interest groups th at they cant have something for nothing. Instead, they develop elaborate schemes to try to cheat reality by overspending, while evading or ignoring the inevitable results of their programs -inflation or recession. And they do it in the name of economic principles.

In his so-called "new economics," John Maynard Keynes formalized and gave quasi-scientific status to economic fallacies that are as old as civilized man. He provided a rationalization for govemment intervention into free markets, for gov emment control of the supply of money and credit, and for policies of irresponsible deficit spending and inflationary expansionism. With very few exceptions, the intellectual community has taken his fallacies as axiomatic principles and expanded them into a hopelessly complex system of terms, symbols, and mathematical equations. It is no wonder that most people are either bored or intimidated by the study of economics.

If you are bored or intimidated by economics, it is partly because politicians and members of academia have for years been declaring that our society and the interworkings of the markets have become too complicated for the average man to cope with on his own. The "complex economic issues" of our modem world, they contend, must be carefully weighed against one another, and a balance must be struck between the "ideal" and the "practical."

They foster the view that only govemment, supported by countless task forces, high-paid consultants, and innumerable subcommittees and bureaucratic agencies can find the tight set of "compromises" to manage the mixed bag of interests in our nation. They allege that the govemment should manage the economy by inflating the supply of money and credit to encourage production, while simultaneously taxing the "excess profits" of the most productive industries; by deficit spending to provide the "underprivileged" with "equal opportunity," while forcing the businesses that might have been able to employ them to provide minimum wages, matching social security contributions, and unemployment insurance; by imposing trade barriers to encourage domestic industry, while simultaneously providing "developing" third world countries with low cost loans or outright grants so that they will be our "friends"; by subsidizing the price of wheat, sugar, soybeans, milk and other agricultural products to "maintain the independence and competitiveness of the American farmer," while giving away the surpluses or selling them at a loss to foreign nations; and the list goes on and on.

My true reaction to this view is not fit for print, so Ill temper it by saying: "Dont let them kid you!" If you balance your checkbook each month and un derstand that you cant operate with a negative balance indefinitely, you already know more about economics than most govemment policy makers. They and their countless contradictory programs and laws, which cost American producers (by producers I mean not just industries, but anyone who eams a living) a huge percentage of their income each year, are just shapeless, colorless pieces in a jigsaw puzzle with no meaningful solution. But with the tight knowledge, you can make those pieces fit into your puzzle; you can tum govemment irrationality into dollars in the bank.

I place economy among the first and most important virtues and public debt among the greatest of dangers; we must make our choice between economy and liberty; or profusion and servitude. If we can prevent the govemment from wasting the labors of the people under the pretense of caring for them, they

will be happy.

-Thomas Jefferson

In this statement, Jefferson used the term "economy" in two slightly different senses. When he said economy was "among the first and most important virtues," he meant careful and thrifty management of public revenue. When he said we have to choose between economy and liberty, he was addressing the question of where the focus of govemment should be whether govemment should expand its purse and provide public services or focus on protecting life, liberty, and property.

Jefferson understood better than any political leader in world history that govemment "profusion" can only be paid by "the labors of the people." He knew that a growing govemm ent budget and an extension of the services govemment offers "under the pretense of caring for [the people]" can only come at the expense of private property and individual liberty.

Unfortunately, over the last two centuries the people of this nation, through the selection of their political leaders, have chosen profusion over liberty to the extent that many of us now labor about 1 day in 3 to pay for govemment extravagance. And even that is not enough. With deficits consistently higher than $100 billion a year, future generations will inherit a financial burden that, if not arrested soon, will be impossible to bear. Jefferson has probably wom holes in his funeral clothes tuming over in his

As a trader, speculator, or investor you make money by buying and selling market instruments in anticipation of price changes or value appreciation and depreciation. To do this well, you have to acquire a basic understanding of why people exchange things, what a market is, who participates in it, how a price is arrived at, why price changes occur, what will bring them about, when they will occur, and so on. In addition, because govemment intervention into the markets causes more price volatility than any single factor, you have to understand how govemment policy affects market conditions. Like a joumalist seeking the tmth in writing a story, you have to ask and answer the questions: Who? What? When? Where? Why? and How? Answering these questions on a general, fundamental level is the province of economics. Answering them in particular for a specific market is the province of market forecasting. Economics provides the fundamental ideas needed for accurate market forecasting.

Armed with the tight basic economic principles, you can develop a logical method of market forecasting, rip through the masses of data, and discard the trash that will burden you when making decisions. You can start with a single correct idea, observe market data, and derive conclusions that are both sensible and accurate. You can listen to the opinions of the analysts and "experts" and test their conclusions according to basic premises that are unchanging in their validity, knowing that where there are contradictions, there are mistakes. In short, you an compete effectively with people who have much more particularized knowledge than you do.

Its not how many facts you know but the tmth and quality of what you know that counts. I know a man who I personally watched answer every single question on Jeopardy correctly-and yet he blew out as a trader. He spent countless hours developing ingenious but faulty strategies to predict market behavior. I admire the mans raw intellectual capability, but he has a problem when it comes to trading-he has never identified the basic principles which govem market behavior.

The purpose of this chapter is to identify and define the basic principles and terms of economics so that later, I can show you how to apply them to anticipate changes in the business cycle and make money with your knowledge. Like the picture on the cover of a jigsaw puzzle, these principles act as the guidelines for piecing together the puzzle of market forecasting.



Weve reached this state because bad ideas, not just econ omic ideas but philosophical ideas, have been adopted and put into practice. Americans have been duped into thinking that there is no absolute tight and wrong-only a balance of relative elements, that life is enormously complex and nothing is simple, and that therefore it is best to leave economic policy in the hands of the "experts."

I am not writing a philosophical treatise, but nothing is more absolute than life or death and life means economic survival. I wont tell you that everything is simple, but I will tell you that most things are not as complex as they seem. I cant describe every mistaken economic notion and then refute it, but I can supply you with the basic definitions and principles that I know are right and appeal to logic and the size of my bank account, not the conventional wisdom, for confirmation. So let me start from scratch by answering the question, "What is economics?"

Economics is the study of a branch of human action. According to economist Ludwig von Mises, "It

is the science of the means to be applied for the attainment of ends chosen;----[It] is not about things

and tangible material objects; it is about men, their meanings and actions."4 In other words, it is the study of the instruments, methods, and actions available to human beings for attaining their goals. This definition serves as the first principle of economic analysis and market forecasting; understanding it is a prerequisite for integrating all other principles into a unified, coherent system and profiting from your knowledge.

Most economics texts would define economics more like this: the study of the "production, distribution, and use of income, wealth, and commodities."5 While it is true that economics is concerned with these things, this is not a true definition. It implies, for example, that income and commodities already exist and that they stand apart from wealth. It assumes a level of development such that distribution is a major concern. In short, it assumes that people exist at a high level of sophisti

cation in society, when in fact that very sophistication is the result of fundamental economic principles that apply first to the individual, even if he is alone on an island.

Consider, for example, Daniel Defoes character Robinson Crusoe. His actions demonstrate concretely and clearly the fundamentals of individual economic behavior that lead to the formation of a market economy. Stranded on an island visited only by cannibalistic savages, Crusoe first devised a method of acquiring more food than he imme diately needed and storing it so that he could redirect his efforts toward achieving other necessities. He used the time he saved to build shelter, provide for his defense against the natives, and manufacture clothing. Then through industry, ingenuity, and management of time, he simplified the process of acquiring essentials and went on to produce other luxuries as time allowed.

The keys to the process of increasing his standard of living were evaluation, production, saving, investment, and innovation. He evaluated the ends and means available to him and chose the alternatives that best addressed his needs. The value of each thing that he sought was set by his judgment according to his perception of what was most needed, the means available to obtain it, and what it would cost him to get it relative to the alternatives. He produced the essentials necessary for survival and saved enough of them so that he could invest his energy into developing other products that he needed or desired. The price he paid at eac h step was the time and energy he spent according to his own evaluation of his needs. What he gained on balance in the exchange was his profit. If he made mistakes, and his efforts were futile, he suffered a loss. His actions were a matter of exchange, the exchange of a less desirable state for a more desirable one. At every step, he managed his time; he made choices based on the consequences of his options in the short, intermediate, and long term. As he became more and more sophisticated through technological innovation, the cost of essentials (in terms of time and energy spent to achieve them) diminished and he could afford to spend more of his time in the pursuit of "luxuries."

The concepts Ive emphasized in explaining Crusoes actions are generally ass ociated with actions and results in a market economy. In fact, a market economy is simply the result of the same concepts applied in a social context. Evaluation, production, saving, investment, and innovation are requirements for mans survival and growth according to his nature as an individual, rational human being.

Properly considered, economics is the study of the means available to sustain life as a human being.

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