20k on sensex - Part - II

Alright, as promised in the last post, this is the second story. I have already boasted a lot about being in the second economic cycle of my career, I will assume people are well aware of the context.

As an amateur trader I bought some share and took some exposures in the futures and options. Within no time sensex was at 20k (December 2007) and I was making over 50% returns on my portfolio. All my beliefs were suddenly transformed, I discarded all former beliefs of safety and continuous saving for the future, which perhaps my Dad had taught me by example. I thought share market is where people become rich. Though I was warned about the downside all the time, but I had only seen market going up in my life thus far, and I thought I knew everything about the world.

However, I often asked myself a question, "What is the value I am creating in the world, that entails me to this kind of money in my job or otherwise?". And frankly no matter how I justified it, I knew there was a loop-hole in each explanation. Simply because -How can a mere graduate sitting in an air-conditioned terminal create so much value? If I compared my efforts to a farmer who is toiling in the sun to produce food grains, I felt he might be more useful to this world than I am. (No-offense to people making big bucks on a terminal :D, I am only presenting a perspective)

I had asked this question to my boss, and to others, whom I considered to have wisdom. Somehow, I didn't find an satisfactory answer. The answer came to me when the markets crashed, and it went all the way down to 9k :). In fact this continuous downturn transformed my question itself. Now I wanted to know "why does recession happen?" I started searching answer to my new question desperately.

The answer that I have arrived thus far is elucidated by this small story:

There was a small village in which there were only two families of Ram and Shyam. Both families complemented each others needs. Shyam's family produced wheat, rice, vegetables, cotton, cloth, etc. The other family tamed animals and produced milk, meat, utensils, furniture, etc. Both families used to exchange excess of their produce with each other in a barter system. Shyam being an intelligent guy introduced concept of money to do the trade. Rather than exchanging good directly, money made trade more convenient. The price of the goods were to be decided in the same ratio as they were earlier exchanged subject to availability. Eg. if 1/2 Kg of rice was exchanged for a 1 Litre of milk then price of rice will be 10 Rs/Kg and price of milk will be 5 Rs/Litre. However Shyam being the intelligent guy who understood these calculation, took Ram into confidence and fixed price of good to favor himself. Eg. He priced rice at 11 Rs/kg and milk at 5 Rs/Litre.

Initially both the families started off with 1000 Rs each so that trade could start. And with time slowly Shyam started getting richer (Meaning he held more cash than Ram did). However Shyam did not stop, he continued amassing cash. There came a day when ram was not left with a single penny. That day Ram realized that there is some "jhol" in the market. From that day onwards he stopped giving goods to Shyam in exchange of currencies. In a single moment Shyam wealth of Rs 2000 became zero, because it was only paper afterall.

So next time you see people getting paid more than the value they are creating (including yourself), You should know that another recession is just round the corner. And if you don't believe me, wait a little :P