Basic Capital Flow Analysis: Knowing What Questions to Ask

Basic Capital Flow Analysis: Knowing What Questions to Ask Basic Capital Flow Analysis

Knowing What Questions to Ask

The outcome of any serious research can only be to make two questions grow where only one grew before.
Thorstein Veblen
Good questions outrank easy answers.
Paul A. Samuelson


If we know why groups of investors and issuers buy and sell securities, and if we can predict how long these reasons might persist, we have a basis for anticipating security price trends.

There are important forces that drive capital flows over the long term, even decades.

However, to discover what these forces might be, we have to ask the right questions. There is no simple formula that tells us what questions to ask.

Capital Flow Analysis: A New Technique

Flow of funds accounts have been around for half a century, and the U.S. government spends millions of dollars preparing these tables every quarter.

However, this valuable resource has had remarkably little impact on the common understanding of capital markets.

For example, the fact that U.S. corporations have been buying back more stocks than they issue for a generation --- in a net amount of more that one trillion dollars --- is hardly ever mentioned in the press.

In this sense, Capital Flow Analysis is a brand new technique, little understood, barely recognized, and with extremely sparse literature. In the first decade of the 21st century, most of those practicing Capital Flow Analysis will be pioneers.

Because the field is so new, there are, as yet, no cookie-cutter recipes that tell us what questions to ask when studying flow of funds accounts.

Thinking Outside The Box

One problem may be that economists are trained with biases that make it difficult to ask the simple, obvious, commonsense questions that are necessary for Capital Flow Analysis.

Unless we know what to look for, the flow of funds tables might be a meaningless blur of numbers.

In this lesson, there are examples of questions might be useful, but the list is not exhaustive.

The challenge is to come up with useful questions; in this lies the secret of good analysis.

Some Possible Questions

To detect and understand the trends that move capital markets, there are certain things we may look for when reading flow of funds tables.

Here a few lines of inquiry, some of which are discussed in detail in other lessons:

When reading instrument tables:

When reading sector tables:

When researching the market for a class of security:

When researching market sectors (players):

Developing a Working Hypothesis

By viewing the flow of funds tables by instrument and by sector in the light of price trends, and by examining the cultural, institutional, and fiscal/regulatory context of each security and player group, it usually is possible to develop a cogent 'story' or hypothesis that seems to explain capital flows.

Although it takes a lot of work to develop a useful hypothesis about capital flows and price trends, the institutional, cultural, and fiscal/regulatory frameworks of markets and players often persist for long periods. There are certain themes or patterns of behavior that may serve for years or even decades.

Once we have a working hypothesis, this may continue to be valid for quite some time. We don't necessarily have to redo our research that often, but instead can focus on certain items to be followed or studied in greater depth.

By maintaining a long-term view of capital flows, we are more likely to interpret correctly short-term changes.

Capital Flows Must Be Seen In A Larger Context

Reading to expand our understanding of society, history, and the many technical aspects of capital markets pays off when trying to interpret flow of fund accounts.

Just as a security analyst knows what questions to ask when looking at a balance sheet or income statement, the capital flow analyst must have similar insights when reading flow of funds tables.

Much of the information on this site is intended to provide examples of the kind of questions and issues that are relevant in Capital Flow Analysis.

However, the goal is to stimulate the student into developing new questions, constantly improving the quality of analysis.

Before proceeding, check your progress:


In the first decade of the 21st century, Capital Flow Analysis was:
Choice 1A standard course in educating MBAs.
Choice 2Well-known throughout Wall Street.
Choice 3Almost an occult science.
Choice 4Taught in Economics 101 at universities.
In order to extract meaning from national flow of funds accounts, you must:
Choice 1 Be skilled in differential equations.
Choice 3 Look for head and shoulder formations.
Choice 2 Know what questions to ask.
Choice 4 Seek the efficient frontier.
Many forces that cause price movements in capital markets and that are reflected in national flow of funds accounts, can be expected to:
Choice 1 Change from hour to hour with order flow.
Choice 2 Be reversed easily by newspaper editorials.
Choice 3 Persist for months, even decades.
Choice 4 Relate to long-term historical trends.

Basic Capital Flow Analysis: Knowing What Questions to Ask  learning module : continued >

lesson: 1 | 2| 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10

Suggested Reading in Capital Flow Analysis

'Extraordinary Popular Delusions and the Madness of Crowds', Paperback, Charles Mackay

A complete repackaging of the classic work about grand-scale madness, major schemes, and bamboozlement.

'Devil Take the Hindmost: A History of Financial Speculation', Paperback, Edward Chancellor

Drawing colorfully on the words of such speculators as Sir Isaac Newton, Daniel Defoe, Ivan Boesky, and Hillary Rodham Clinton, this book is part history, part social science, and purely illuminating.

'The Mind of Wall Street: A Legendary Financier on the Perils of Greed and the Mysteries of the Market', Hardcover, Leon Levy, Eugene Linden

Markets and motivations from the point of view of the founder of the Oppenheimer Funds

'Infectious Greed: How Deceit and Risk Corrupted the Financial Markets', Hardcover, Frank Partnoy

A general overview of the financial scandals of the 1990s and the new century.

'Asking the Right Questions: A Guide to Critical Thinking', Paperback, M. Neele Browne, Stuart M. Keeley

This highly popular book helps readers bridge the gap between simply memorizing or blindly accepting information, and the greater challenge of critical analysis and synthesis.

copyright | privacy | home