GameStop/Wallstreetbets Fuels Hyper Bubble That Won’t End Well


The GameStop hype is irrefutable proof that the stock market has turned into a casino powered by social media. It is leading us to a weak and fragile economy based on incentives, speculation, and a lack of skills. 

What Is Going On?

A subreddit called WallStreetBets (WSB) recently targeted stocks with big short positions to create a short squeeze that propelled Gamestop's share price higher. 

The chart below shows $GME share value during five days from January 21 to 27. GameStop’s share price started under $50 and went from $73 to $60, then $145, $61, 95$, $145, $327, $249, 371, $302 and $347. 

On January 28, $GME skyrocketed to $496. And on the same day, in just one hour, it crashed down to $300.

This was a huge short squeeze, that happened in a few days, and is something that has never been seen before. In terms of percentage, it was high and very volatile.  

A CNBC article titled, “GameStop mania explained: How the Reddit retail trading crowd ran over Wall Street pros” described the historical situation like this: 

What the “passionate investors” are doing is crowdsourcing market manipulation. They are buying call options that force the market makers (MMs) to buy the underlying shares, which obligates short sellers to buy back their shares. 

This creates a feedback loop that drives stock prices higher, then lower, when it crashes down.

George's major concern is that an epic financial event like this is telling us that something is critically wrong with the overall economy. 

How Does A Short Squeeze Work?

A short squeeze can be broken down into five steps: 

  1. It starts with the short-seller. A short-seller borrows shares and immediately sells them back into the market.The short-seller is hoping the stock price falls in the near future. The goal is to repurchase at a cheaper price after the stock price falls, then return the borrowed shares back to their owner (the broker) and pocket the difference.
  2. A stock with a large short position is ideal for a short squeeze which is why WSB targeted GameStop. At the time, $GME had a massive short position exceeding 150% of the underlying shares available.
  3. WSB or any other group then crowdsources a massive purchase of $GME shares and long call option contracts to counter the massive short position.
  4. Market Makers are then forced to purchase enough underlying shares of $GME to cover these contracts, which drives the stock price higher.
  5. Demand from WSB drives the price up and short-sellers are forced to close their positions as the trade now moves against them. Brokers will also force traders to close their short positions and return the shares they borrowed when things get too out of control. This is also known as a margin call.

The short-selling process can sometimes trigger a doom vortex. 

To trigger a short squeeze (doom vortex), the market makers need to buy more of the underlying stock to cover the demands of the market, which drives prices higher.

The shorts get squeezed when prices move against them, and they are forced to buy back the shares they initially sold.  If they don't cover their positions, then they risk blowing up their margin accounts.

This puts speculators in a dangerous position as a stock's price can hypothetically rise to infinity.

It is a very expensive game of musical chairs, where the market makers can drive the prices so high that it deters speculators like WSBs. 

When the stock price inevitably crashes back down, the speculator will lose everything. 

How Is The Economy Being Distorted And Destroyed?

The emphasis shouldn’t be on GameStop, a Reddit thread, or the stock market. We should be trying to understand what this story tells us about our economy and society at large.  – George

Retail investors are lured in by the incentives that big Government has put in place.

George doesn't blame Retail Investors. They are only trying to make rational decisions based on a distorted economy. 

The incentive structure presented by central planners pushes investors further out on the risk curve.

In an economy with no job opportunities that a free market would otherwise provide, normal folks are forced to gamble in the stock market.

The Don’t Work/ Speculate economy (yellow) and the Learn Skills/Work Hard/Save economy.

There are two economies in the image above. The Don’t Work/ Speculate economy (yellow) and the Learn Skills/Work Hard/Save economy (Fuschia). 

The first one is based on asset prices (bubbles), debt, and confidence. The Fed and the Government use low-interest rates, QE, stimulus spending, and Stimmys (stimulus checks). 

This economy is filled with funny money, based on domestic services, and low manufacturing. The stuff we consume is imported from other countries.

As the Fed and Government create more funny money, prices on imported goods increase and we no can longer afford to buy them.

When goods are not imported, there is nothing to buy. Even with currency units, we are broke. 

The Learn Skills/Work Hard/Save economy (Fuschia) is run by the free market. It incentivizes people to learn new skills, work hard, build factories and produce goods and services. 

Regardless of what happens to the currency units, this economy is not held hostage by other countries producing the goods we consume. 

The stock market has turned into a casino powered by social media, as average people try to increase their purchasing power by gambling and speculating.

As their portfolio increases in size, they inch closer and closer to falling off a financial cliff. It's only a matter of time before they lose all of their winnings to one bad gamble.

All that is left is a fragile, weak economy, where people are poor and have no skills.

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