“Like champagne, bull markets remove inhibitions.” –James Grant
My readings over the last several weeks have consisted primarily of David Stockman and Jim Grant– two sane voices in the insane financial world. Each have contributed wondrous thoughts and reflections on the nature of 21st century finance, which is primarily a story of the “corruption of capitalism” (to use Stockman’s phrase) and the rise of bubble finance. This tragedy of course, is a result of the slow and pernicious takedown of free markets, especially in the area most people refuse to look: money and banking.
The consequences of the financialization of the world, which began to manifest as “fiat money” was disconnected to its underlying commodity (gold) in the 1970’s, eventually led to a corruption of financial culture– not only the culture of Wall Street itself, but also down to the way Main Street treated its relationship with savings and “investments.” There was a catastrophic shift in the mentality of the people as the Fed moved forward to an era of what David Stockman calls “Prosperity Management.”
The middle class in America forgot all about the importance of savings and frugality and instead bought into the lie that one’s future would be “taken care of” if only it threw its money into the stock market. An important mechanism for the allocation of scarce resources into productive investments, the stock market is a vital piece of a free market capitalist economy. But when the United States government decided that money, credit, and interest rates would be controlled and managed solely by the whims of the central planners, no longer having anything to do with the multi-century long underlying commodity of gold, the stock market quickly became a betting center–a gambling house.
It was due to this transition that people forgot all about the necessity of savings and frugality– dismissing these as artifacts of a long gone era. No, the rise of bubble finance propelled middle class America into the delusion of easy riches and perma-prosperity that would come merely by throwing what they had into the stock market. David Stockman writes in The Great Deformation:
Neither the Greenspan Fed nor the mad money printers of the Bernanke era which followed ever leveled with the American public about the sobering truth evident in the saga of these high flyers [the big-cap companies which experienced a mighty bubble effect during the 1990’s –CJE]; namely, that there is no such thing as effortless, instant riches on the free market.
Yet, instead of coming clean and embracing sound money policies which would have induced the American middle class to revert to frugal living and saving for retirement, the thrust of Fed policy since the dot-com crash has been to perpetuate the lie. Accordingly, the massive baby boom generation that desperately needed to save has remained enthralled to the financial delusions that the Greenspan Fed foisted on the public.
Unfortunately, this wrong-headed policy has not only made the Federal Reserve a hostage of Wall Street, but it also has warped and deformed the very foundation of the nation’s economy. Having fostered a bull market culture of stock gamblers during the 1990s, the Fed simply broadened the casino’s offerings after 2001 to include housing, real estate, and derivatives.
By so doing, it kept the party going for a spell, but in the process implanted the most pernicious possible error in the workings of the American economy; namely, the belief that savings out of current income is unnecessary and even counterproductive because higher savings would allegedly reduce consumption expenditures and the rate of GDP growth.
Under the Fed’s new prosperity management régime, by contrast, the buildup of wealth did not require sacrifice or deferred consumption. Instead, it would be obtained from a perpetual windfall of capital gains arising from the financial casinos. In this manner, the historic laws of sound finance were mocked by the nation’s central bank: households would grow steadily richer, even as they enjoyed the luxury of borrowing and consuming at rates far higher than the sustainable capacity of their incomes. The bull market culture had now totally deformed the free market.
This culture is everywhere I look. I haven’t been around long in the investment business, obviously. I’ve yet to go through a bear market. Only two years in; but I’ve noticed it. It’s all around me. I read the “advice.” I digest the “financial planning” industry’s trends. It’s already tiring. It’s difficult to make sense of it– who would buy stocks at these price levels? With the S&P 500 priced for negative real returns over the next 10-12 years (see John Hussman), what will happen when people begin to realize that their “wealth on paper” doesn’t reflect the reality of needing to purchase the necessary goods and services to last the rest of their lives?
James Grant, writing in 1999 (right before the dot com bubble burst), reflected on the madness of people rushing into the stock market:
Watching “Wall Street Week” and reading The Wall Street Journal– especially the very accessible “C” section– the public has recalibrate its investment expectations. If the S&P delivers 20% a year, year in and year out, people ask, why settle for less? Why settle for a paycheck when one can elect to receive stock options? And if five million Americans (according to Forbes) are day trading for fun and profit on the Internet, why settle for professional money management? […]
How the daytime soaps stay on the air is beyond me. Everyone seems to be speculating or watching others speculate. I use the word “speculate” advisedly. An investment is a speculation to the extent that its success is contingent on a forecast of uncertain events. […] On the other hand, an outright purchase of the S&P 500 is a rank speculation. At prevailing levels of valuation, its success depends critically on the continued unfolding of what might conservatively [be] described as a state of world perfection.
What is the risk if, instead, there were imperfection?
One year later, of course, the world found out precisely the risk.
And yet, people are still speculating, still buying the overpriced S&P 500. Still immersed in the culture of Wall Street based on the assumption (which was proven false in the dot-com crash as well as the housing crash) that the Fed can push this thing up forever. Or perhaps they don’t even know that the Fed is behind it. Perhaps they think “this is just the way capitalism works.” Well, it isn’t. This is the way monetary bubble blowing works when a central bank is given the authority to do with the money supply whatsoever it wills. In any case, most “will not see it coming.” And I’m not talking about a sudden and drastic stock market crash. Of course, that could very well happen. But it could also be that the market simply makes lower “highs” and lower “lows” as it completes a massive, albeit slow and painful, path to the bottom. Mish Shedlock provides the following chart of Japan’s experience:
Whether by sudden collapse or by painful drowning, it seems to me that the Wall Street gambling-for-riches culture is on its final leg. It’s a great tragedy that Bull Market culture and the expectation of Fed-guaranteed riches has disseminated itself throughout the western world. It is a culture born out of the failure of governments around the globe to keep their monies sound and the subsequent bubble-economies that inevitably rose up via the desire of the central banks to engage in “prosperity management” via the mechanism of money and banking manipulations.
Capitalism –and economic prosperity– require the accumulation of capital. This is the opposite of the capital consuming impact of financial bubbles, which result from the artificial increase in the supply of credit via central banks.
Many have not realized the dangers of the Bull Market culture. It lasts for a time. But in the end Stockman’s observation is right on the money (so to speak): “that there is no such thing as effortless, instant riches on the free market.” Many learned the hard way in 2000 and 2008. But these lessons were swiftly forgotten as the Fed swept in to save the day. In this way as well, the Fed refuses to let the public endure a teachable moment.
Let us not forget the ever-applicable (perhaps, increasingly applicable) words of Murray Rothbard:
“Every time there is a long boom, by the final years of that boom, the press, the economics profession, and financial writers are rife with the pronouncement that recessions are a thing of the past, and that deep structural changes in the economy, or in knowledge among economists, have brought about a “new era.” The bad old days of recessions are over. We heard that first in the 1920s, and the culmination of that first new era was 1929; we heard it again in the 1960s, which led to the first major inflationary recession of the early 1970s; and we heard it most recently in the later 1980s. In fact, the best leading indicator of imminent deep recession is not the indices of the National Bureau; it is the burgeoning of the idea that recessions are a thing of the past.
More precisely, recessions will be around to plague us so long as there are bouts of inflationary credit expansion which bring them into being.”