Confidence has now faded in the Dow/S&P 500, but faith is not yet
gone. There is a difference. Confidence encourages buying. Faith
retards selling. Confidence is based on this belief: “I can get
rich with my money invested here.” Faith is based on this belief:
“I won’t get poor with my money invested here.” In contrast, faith
in the NASDAQ has departed. The NASDAQ is a dead armadillo, a Texas
There is a parallel phenomenon in politics. Confidence in politics
is the belief that, as a nation, we will be able to solve life’s
most pressing problems through political action, mainly legislation
at the level of national government. Faith is different. Faith in
politics means that by seeking political solutions, we will not
destroy ourselves. Confidence in politics is the belief that things
can get better through politics. Faith in politics is that things
will not be made worse through politics.
Because of the legacy of the twentieth century, voters in the industrial
West have become convinced that politics is superior to economics
in providing their basic protection. They believe that politics
can fix the economy when things don’t work out the way they had
hoped. If things go wrong, Congress need only pass new laws, and
the Executive branch need only create new layers of bureaucracy
to enforce these new laws. When bad news hits, there are cries of
outrage from voters, who insist that “something must be done to
prevent this from happening again.” This is an implicit admission
that all of the previous laws have failed to keep this terrible
thing from happening. Voters insist that “we need more of the same”
to make things work right. Congress goes along with this, or at
least it does after enough of the incumbents lose at the next election,
which changes the allocation of political power.
When a national electorate’s initial response to a turndown of the
economy is that “government must do something,” faith in government
is still alive. But when this faith is limited to fixing the market’s
temporary failures rather than substituting political power for
it, then confidence in government is gone.
The public’s faith in Social Security is the test of faith in our
era. Nobody expects to get rich through Social Security, but almost
everyone expects to be kept in comfort. When that faith smashes
into the statistical reality of $25 trillion in unfunded liabilities
(including Medicare), faith in government will depart.
The collapse of the Soviet Union in 1991 shook the faith of the
left-leaning intellectuals in the West. Nothing that the Communists
did for 75 years had shaken their faith that the State is a means
of social salvation. But, overnight, the loss of power of the USSR
broke that faith. The USSR had visibly gone bankrupt. The reality
of Soviet poverty could no longer be concealed. Gorbachev came begging
to the West for money. Then he was tossed out. This was all too
much for the West’s intellectuals, who had worshipped at the shrine
of State power for three generations.
Free market economists had taught from the beginning that the State
must not be trusted with sufficient power to shape the economy.
Socialism is, as Hayek called it in 1944, the road to serfdom. If
the State can help you by taking away the other guy’s money, then
it can also hurt you by taking away your money. Power-seeking politicians
are more likely to hurt the masses than help them, Hayek argued.
The most ruthless men will get on top.
Over the past decade, leftist intellectuals have lost political
influence. Those who have preached free market economics have gained
political influence. Clinton was unable to get his original economic
agenda passed. His socialized medicine plan crashed in 1993. This
helped get a Republican Congress elected. He really did reduce the
federal government’s power over local welfare programs. Today, a
free market economist and former college professor of economics,
Dick Armey, is the House Majority Leader.
But not for long. We are seeing the end of the 1994—2002 Republican
hegemony in Congress. The Senate is now in the Democrats’. Armey
will not run again. J. C. Watts won’t, either. The sagging stock
market is opening up opportunities for the Democrats.
We are now entering a kind of ideological no-man’s land. Confidence
in the State’s ability to heal society’s pains has faded. The left
has lost this confidence, and the right never had it. But confidence
in the stock market as a means of achieving wealth for the middle
class has also faded. The cheerleaders who thought the NASDAQ was
the road to wealth have had their portfolios smashed and their mouths
silenced. The public has begun to suspect that the Dow is not going
to perform the miracle of comfortable retirement living, either.
The stock market’s volatility is evidence that there is substantial
skepticism out there which will prevent any bull market move above
12,000, or perhaps even 10,000. None of this was foreseen by the
experts in early 2000, any more than they had foreseen the collapse
of the Soviet economy in 1986 or the collapse of the Soviet Union
Faith in both politics and the stock market remains. There are few
voters who believe that the stock market can fall to such an extent
that those who keep their money invested in it will become impoverished.
Most voters and investors are convinced that the State can and will
do something to keep this from happening. They still believe that
political intervention into the operations of the free market can
keep the economy from turning negative. They still have faith that
the free market will not fail them, just so long as Washington keeps
passing laws. They still believe that Congress is wiser than they
are. After all, their money is on the line. Their money is invested
in the stock market. They are responsible as investors. But they
still believe that Congress can give wise direction to the bureaucrats
who enforce the law, and the result will be a stock market and economy
that do not fall. There can never be another major depression, voters
believe, because Congress can pass laws and the Federal Reserve
System can create money. They still believe that responsibility
for the preservation of their wealth can be transferred to the government.
The Federal Reserve System can indeed create money. It buys government
debt, which serves as the nation’s monetary base. Take a look at
the expansion of M-3, beginning in 1995. The NASDAQ bubble began
stabilized briefly earlier this year, but has now resumed its upward
trend. Last week, it rose by $44 billion. The week before that,
by $33 billion. This cannot go on if a new wave of price inflation
is to be avoided. Greenspan admitted this in his July 17 testimony
before the House Banking Committee.
policy actions this year, the Federal Open Market Committee has
recognized that the accommodative stance of policy adopted last
year in response to the substantial forces restraining the economy
likely will not prove compatible over time with maximum sustainable
growth and price stability. But, with inflation currently contained
and with few signs that upward pressures are likely to develop
any time soon, we have chosen to maintain that stance pending
evidence that the forces inhibiting economic growth are dissipating
enough to allow the strong fundamentals to show through more fully.
This was his way of saying that the economy is still mired in slow-growth
mode. Yet the rest of his testimony predicted real economic growth
above 3%. Then why is the FED unwilling to allow short-term rates
to rise? Why is it still inflating? Isn’t it time to slow the growth
in the money supply? One reason why it is time to stop inflating
is this: the median consumer price index is rising at more than
3% per annum. This statistic is not widely reported by the financial
press. It measures the core rate of price change. What we hear is
that consumer prices are barely rising. The median CPI says otherwise.
In one area, Greenspan’s testimony was as pessimistic as anything
I recall in his 14 years as Chairman. This had to do with corporate
fraud. The entire monitoring system broke down, he said. He blamed
“infectious greed” — this, from a former follower of Ayn Rand,
greed’s greatest apostle in history. He called for unspecified alterations
in the legal order. In short, he sounded like a Democrat running
for office. He put the blame for the breakdown of the monitors on
the stock market’s bubble, which the FED’s monetary policies had
created — a cause-and-effect relationship he did not mention.
No one except Ron Paul blows the whistle on the FED, and no one
blew the whistle on Enron, Global Crossing, and WorldCom. Greenspan
years, shareholders and potential investors would have been protected
from widespread misinformation if any one of the many bulwarks
safeguarding appropriate corporate evaluation had held. In too
many cases, none did. Lawyers, internal and external auditors,
corporate boards, Wall Street security analysts, rating agencies,
and large institutional holders of stock all failed for one reason
or another to detect and blow the whistle on those who breached
the level of trust essential to well-functioning markets.
corporate governance checks and balances that served us reasonably
well in the past break down? At root was the rapid enlargement
of stock market capitalizations in the latter part of the 1990s
that arguably engendered an outsized increase in opportunities
for avarice. An infectious greed seemed to grip much of our business
community. Our historical guardians of financial information were
overwhelmed. Too many corporate executives sought ways to “harvest”
some of those stock market gains. As a result, the highly desirable
spread of shareholding and options among business managers perversely
created incentives to artificially inflate reported earnings in
order to keep stock prices high and rising. This outcome suggests
that the options were poorly structured, and, consequently, they
failed to properly align the long-term interests of shareholders
and managers, the paradigm so essential for effective corporate
governance. The incentives they created overcame the good judgment
of too many corporate managers. It is not that humans have become
any more greedy than in generations past. It is that the avenues
to express greed had grown so enormously.
the recent breakdown of protective barriers resulted from a once-in-a-generation
frenzy of speculation that is now over. With profitable opportunities
for malfeasance markedly diminished, far fewer questionable practices
are likely to be initiated in the immediate future. To be sure,
previously undiscovered misdeeds will no doubt continue to surface
in the weeks ahead as chastened CEOs restate earnings. But even
if the worst is over, history cautions us that memories fade.
Thus, it is incumbent upon us to apply the lessons of this recent
period to inhibit any recurrence in the future.
Notice the last sentence: “Thus, it is incumbent upon us to apply
the lessons of this recent period to inhibit any recurrence in the
future.” What, exactly, did he have in mind? As usual, he refused
to get specific in his testimony. But what is obvious is that he
senses the fact that the investing public has lost confidence in
the market’s ability to protect their interests. He therefore called
for “us” — he was testifying before Congress — to “apply
As to the future of the stock market, “Perhaps the recent breakdown
of protective barriers resulted from a once-in-a-generation frenzy
of speculation that is now over.” Greenspan’s words reflect the
perception by the public that the days of wine and roses are over
for the stock market. The goal now, he seemed to imply, was for
the government to intervene and for the FED to keep interest rates
low. This will not bring back the stock market’s boom. It will merely
keep the system from crashing.
Public confidence in the stock market as the road to universal personal
wealth has faded. Confidence in the government has also faded. Greenspan
admitted that the institution of government had failed, along with
the accounting profession. “Our historical guardians of financial
information were overwhelmed.” Furthermore, he warned of the possibility
of permanent U.S. government deficits.
there are also signs that the underlying disciplinary mechanisms
that formed the framework for federal budget decisions over most
of the past fifteen years have eroded. The Administration and
the Congress can make a valuable contribution to the prospects
for the growth of the economy by taking measures to restore this
discipline and return the federal budget over time to a posture
that is supportive of long-term economic growth.
is not the same as “will.” The Administration is determined to launch
a war with Iraq, probably without Congressional approval. When was
the last time any nation fought a war with a balanced budget? The
next time will be the first.
Public faith in both the stock market and the government remain.
People still believe that disaster is unlikely. That’s why Greenspan
can continue to present testimony about slow, steady progress as
being likely. He understands the new psychological conditions. He
is not appealing to public confidence; he appeals to public faith.
He offers hope in slow, steady economic progress, but not the high
rapid returns that would be necessary to make middle-class dreams
about retirement come true.
Greenspan’s rhetoric is never too far ahead of the general public’s
expectations. When the FED-induced stock market boom was on, 1997—2000,
he blew. He has now made it clear that it is not rational to expect
anything except slow, steady economic growth, at best. A return
to the stock market experience of the late 1990’s is unlikely and
undesirable, he said.
Confidence is gone. Faith remains. Confidence created the stock
market boom. Faith is what keeps people in this market when they
Without confidence, capital investment disappears. Businessmen are
still refusing to invest. Look at “Real Nonresidential Fixed Investment.”
Look at “Nondefense Capital Goods Orders.” They are still negative.
is why all talk about a booming economy is whistling past the graveyard.
The S&P 500 has not collapsed in the way that the NASDAQ did. There
is still sufficient resistance to selling to keep the market from
a meltdown. People are holding on and hoping for the best. They
still have faith in the stock market. They don’t think it can make
them poor. But they no longer believe that it can make them rich.
The same shift has taken place in the public’s assessment of the
As an investor, you must decide: What will provide your security
in your retirement years? The stock market? The government? Or your
own personal productivity?
The public no longer believes that there will be great wealth ahead.
That confidence was part of what Greenspan described as “a once-in-a-generation
frenzy of speculation that is now over.” But the wave of panic-driven
selling has not arrived. Faith is still alive.
When the sell-off hits, men will be thrown back on their faith in
government. Only when that faith at last expires in a wave of broken
promises will men decide to trust in their own productivity.
I suggest that you make that mental transition now. Avoid the rush.