| Home | My photos | Forex | My trading | Contacts |
|
|
You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
|
Novices can recognize the persistent cyclic patterns in both stock prices and investor sentimentThe very success of advertising poses a difficulty for the classical economist. For if consumers are completely rational then advertising, which intentionally and unabashedly targets the non-rational, should make no difference at all. Yet by appealing to sub-rational needs and associations the effectiveness of the advertising can be more important than the quality of the product. How can this be? How does this maximize the wealth of society? Independently, the laissez faire picture of many competing entrepreneurs, none large enough to dominate a market, has never been even a good approximation. It has always been advantageous to be large. There may be economies of scale, as well as greater ability to influence costs of raw materials and labor and selling prices of finished goods. Larger companies can also amass political influence and use that influence to enhance their economic status. A larger company can overpower a similar, but smaller, competitor. So even if one starts out with an economy of small entrepreneurs, that economy would naturally evolve into an oligopoly. The incentives motivating oligopolies differ from those envisioned by laissez faire. In a technology oligopoly maximizing profits may be incompatible with progress. New technology can be risky. A breakthrough can change the nature of the game. Companies dominant in the old game might lose their dominance in the new game. So their incentive is to make incremental improvements to their already dominant technology, but not to change the technology itself. It is also to prevent the marketing of new technology, or to copy it and use their financial and marketing muscle to dominate that technology. Consider economic rationality for a large drug company with successful antibiotics on the market. How should it handle the threat posed by colloidal silver? The simplest rational response would be to buy the silver company and/ or its patents and to insure that the colloidal silver never reaches the market. The more efficacious the silver solution, the greater is the incentive to keep it off the market. Perversely, the better the product, the more lives it could save, the less likely it would ever get to market. In the energy oligopoly, the incentive is to maximize selling prices, holding them just below the point that alternative energy sources would be developed. It is also to oppose alternative energy and conservation technologies or to acquire them and prevent them from reaching the market. If the energy oligopoly had a stake in the world economy its incentive might be different. But it does not, so its incentive is to drain as much as possible from the rest of the economy. How does this benefit society? These issues do not involve subtle or technical features of economic theory. Anyone looking at the data can see that the relationship between our trade and our unemployment is just the opposite of the dictates of free market theory. The failure of wages to equilibrate, after generations of free trade and equal access to technology, should be obvious even to non-economists who look at the numbers. Novices can recognize the persistent cyclic patterns in both stock prices and investor sentiment, which have enabled astute stock market technical analysts to compile impressive track records. The consistency with which investment dollars have flowed into the wrong sectors at the wrong times is well known. Financial markets are palpably inefficient. Even most economists now accept the failure of monetarism. Most industries — accounting, advertising, aircraft, airlines, aluminum, autos, banks, broker-dealers, cereals, chemicals, coal, computers, consumer electronics, copper, defense, entertainment, food retailing, forest products, insurance, Internet, homebuilding, meatpacking, newspapers, oil production, oil service, pharmaceuticals, photography, restaurant chains, semiconductors, software, telecommunications, tobacco — are oligopolies, dominated by four or fewer companies. The multiple failures of laissez faire are not just theoretical. The suffering caused by misguided economic policies is painfully real. We accept the suffering as a necessary consequence of the ideal economic system, primarily because laissez faire is so widely accepted and so uncontroversial. In this behavior we deserve Nietzsche’s cynicism: “Men believe in the truth of anything so long as they see that others strongly believe it is true.” Ebullient Markets — Dangerous Economy Mythology, taken seriously, becomes theology. It obscures reality. Our mythology of the free market has little to do with performance. Laissez faire, despite its reputation and despite the abject failure of the opposite extreme of communism, has performed poorly. This conclusion may seem absurd, given the universal agreement — at least within the U.S. — on the wonders of the free market. But reality speaks for itself. Our economic and productivity growth have slowed as we have moved to a purer laissez faire. We have lagged our trading partners with more mixed economies. We have amassed record levels of debt and become dependent on our trading partners for capital. We have seen increasing pressure on our middle class and a growing and dangerous disparity in wealth between the richest and the rest. We have been deluded by bullish stock and bond markets to believe that everything must be all right — for otherwise our problems would be revealed in the financial markets. This is naďve, and dangerously so. History provides an excellent example, the 1920s, which closely paralleled our last two decades. What occurred in both periods was a decline in interest rates coupled with tax cuts for the wealthy. This produced a torrent of funds flowing into the stock market and a surge in debt. The rapid rise in stock prices led to irrational levels of investor buoyancy, to the widespread beliefs in 1929 — which we hold again today — that the market can decline only mildly and briefly and that in the long term stocks necessarily appreciate. Then, as now, this exuberance drove stocks to all-time record valuations. Our parallel to the 1920s extends beyond our financial markets. Pervasive acquisitive materialism characterized the 1920s as well as today, as did the decline of unions. This reflected a social Calvinism that regarded wealth as a sign of grace and poverty, at the very least, as a sign of a lack of ambition and drive. The veneration of the businessman in the last two decades, even the notion of Jesus as an entrepreneur, was expressed in terms that hark back to the 1920s (Barton, The Man Nobody Knows). And, aided by tax cuts for the wealthy, the economic difference between rich and poor attained record levels in the late 1920s, levels only recently surpassed. Even at the top of the political ladder, President Reagan was a great admirer of President Coolidge. One of his first housekeeping actions as president was to replace a portrait of Jefferson in the East Wing of the White House with one of Coolidge. Still, it is our excesses in the financial markets that are likely to cause the most damage, just as they did in 1929. It was widely agreed in 1929, when stock market capitalization nearly equaled GNP, that the health of our financial markets proved the strength of our economy. Economists justified the inflated stock prices and valuations of those years by claiming that we had entered a new era of technology-driven growth. Those assurances, though widely accepted, proved to be false. At its 2000 peak, stock market capitalization nearly doubled GNP. Similar assurances, offered by contemporary economists, that a new era of technology-driven growth would justify even higher valuations are no more credible. Our previous record in stock valuations occurred in 1929, along with record enthusiasm for stocks and record financial leverage. We have now surpassed those records. Even technically, the Dow Jones Industrial Average is more overbought than at any other time in its history, trading at 250% of its 10-year moving average. (The only previous time the Dow came close to being this overbought was 1929. The NASDAQ and S&P are even more overbought.) With respect to valuation: (i) Using a 10-year moving average of earnings, as recommended by Graham and Dodd to smooth out short-term fluctuations, the price-earnings ratio for the S&P 500 was recently 40% above its previous record, achieved in 1929. (ii) In the past 130 years, the S&P never sold at three times the net present value of its dividends, and only twice (1929 and the mid-1960s) did it sell at twice that net present value. Both of those times the S&P subsequently declined by more than 50% to trade at less than the net present value of its dividends. At its 2000 peak, the S&P sold at nearly five times the net present value of its dividends. (iii) The price-to-book-value ratio for the S&P Composite is 4.7 times its average over the past 50 years. The price-to-sales ratio is 2.5 times its average over the past 50 years. (iv) The q ratio (designed by Nobel laureate James Tobin as a measure of equilibrium in stock prices based on historical valuation) is the most overvalued in history. To make matters worse, interest rates appear to be bottoming and may soon embark on a new secular advance. Rising interest rates would turn an important component of equity valuation negative. Record valuations within a rising interest rate environment bode ill for equity prices for the next decade. With respect to investor enthusiasm, the number of investment clubs has risen from 7,500 to 40,000 in just the last decade. Half of our population, an all time high, own stock. This widespread enthusiasm is reflected in the ratio of the dollar value of stocks traded to GNP. The previous peak in that ratio was 130% in 1929. It subsequently declined to 6% in 1940, and as recently as 1974 it was only 10%. Now it is over 300%. Despite record investor enthusiasm, the market acts tired. Even though equity mutual funds had net inflows of $20 billion per month from April 2000 through September 2000, the S&P Composite declined by nearly 5%. How much money would have to flow into mutual funds to produce significant gains? What would happen if investor confidence were to wane and the flow of money into mutual funds were to decline, or even turn negative? How sharply might the market decline? Of course, investors today believe it is different now. After all, as financial analysts are fond of reminding us: “We are richer than ever before; with more surplus cash for investment purposes than ever before.” Similarly, one of the most respected mathematical economists has written: “Stock prices are not too high…. We are living in an age of increasing prosperity and consequent increasing earning power of corporations and individuals. This is due in large measure to...inventions such as the world has never before witnessed. The rapidity with which worthwhile inventions are brought out is the result of the tremendous research laboratories of our great technology companies. Applications of these inventions to business means greatly enhanced earning power. This is a new and tremendously powerful factor… which never before existed.” This sounds impressive. The surplus cash could be the source of a new advance in the market, and new technologies could drive earnings growth at a faster rate, justifying higher price-earnings multiples and lower dividend yields. But there are no guarantees. Indeed, this is not the first time such arguments have been made. Investors in 1929 held similar beliefs. The quote: “We are richer…,” taken from The Wall Street Journal, was published on October 4, 1929. The passage glorifying our technological advances was written not by Alan Greenspan, but by Irving Fisher in The New York Times of September 5, 1929. Perhaps we should consider the wisdom of Robert Farrell: “The four most dangerous words in investing are ‘It’s different this time.’” The speculative bubble in the financial markets obscures the reality that we achieved faster economic growth, greater productivity growth, higher rates of savings and investment, and a more broadly based prosperity during the mixed economy of the New Deal and the subsequent extension of those policies by Truman and Kennedy. Despite our roaring stock market, the reality remains that our trading partners who have more mixed economies are growing faster than we. They have higher rates of savings and investment, greater productivity growth, lower levels of poverty, and greater improvement in standards of living. They have made inroads into our technological leadership. The reality remains that more than a century ago, countries with wellfocused mixed economies, Bismarck’s Germany and Meiji Japan, grew faster than did the purer free enterprise economies of Britain and France. Inversely, recent transitions toward laissez faire by Russia and Mexico have impoverished the great majority of their citizens. Nor is this unique. The relatively pure free market economy of the Industrial Revolution in eighteenth and early nineteenth century England did little for the quality of life of the vast majority of people. Laissez faire “doing its thing” produced environmental degradation and grinding poverty. For many, was only with government intervention in the mid-to-late nineteenth century that quality of life improved beyond that of the fifteenth century. Laissez faire has not provided a service to this country or to any other. The fact that state-planned communism is disastrous does not support the opposite extreme, pure free market economics. Neither does the fact that free market economics is amenable to strict mathematical modeling, given that the models bear so little resemblance to reality. Free market economics has been appealing to us — just as it was previously appealing to the Dutch and the English — because it provides an advantage to the economically dominant player. This is true not only in international trade, but also in the domestic arena. Capital has inherent advantages and naturally wishes to protect and extend those advantages. But those advantages bear the seeds of their own destruction. Without intervention to protect the middle and lower classes, a free market economy can drain money from those classes to create an extreme concentration of wealth. Historically, such a concentration of wealth has destabilized societies and adversely impacted the security and standard of living of even the wealthy. This has happened again and again. Unless we remove the blinders of classical economic theory and open our eyes to this historic pattern, it will happen yet again. |
|
|||||||||||||||
Previous Issues
|
| ©2007 Olesia | Home • My photos • Forex • News • My trading • Contacts |