Detour on Easy Street

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of the American stock market boom, 1982—2000, tens of millions
of Americans began to believe that they will be able to retire
rich. This was always an illusion. They bought shares way too
late in the cycle. The masses always do. But Greenspan’s asset
bubble, 1995—2000, persuaded millions of Americans that Easy
Street is wide and level. It never is. Thrift Lane and Discount
Road are where the money is, but they are side streets, unpaved.

The middle
class’s illusion of easy retirement is becoming more visible,
year by year: the stagnant stock market. But no one who has adopted
a pleasant fantasy ever wants to abandon it. Economic reality
eventually forces itself on men’s consciousness, but usually only
after the magnitude of the on-paper losses have become inescapably
visible to their wives.

Most Americans
will retire into poverty: those who become dependent on Social
Security/Medicare. But their poverty will be American-style poverty,
meaning a lifestyle beyond most people’s dreams a century ago,
or even a decade ago in China and India.

Maybe 20%
of them will retire in comfort, if they retire before 2015. Most
of these 20%, who live in the post-2015 world, will see their
lifestyles decline as their pension fund income shrinks with the
fall in the value of money. The best hedge against inflation,
as Ludwig von Mises once said, is age.

A few people
will retire rich and remain well off, maybe 20% of 20%. But there
are always big winners in every generation.

The performance
of the stock market since 2000 points to the dead end of Easy
Street. The stock market has gone nowhere. Stock brokers’ assurances
to clients that "now is the time to buy" are common,
but they are less and less believed. Stock brokers in Japan had
the same message after 1989, but the Japanese stock market today
is still only about 25% of what it was in late 1989. Few investors
in Japan believe Japanese stock brokers any longer. Anyone who
did believe them after 1989 is much, much poorer than if he had
simply bought long-term Japanese government bonds and then gone

The steady,
relentless decline of the Japanese stock market after 1989 was
not random. Yet American economists, because they believe in random-walk
investing theory, in 1990 would not have predicted what has happened.
They would not have seen what would have been obvious to an Austrian
School free market economist, namely, that the 1985—89 stock
market boom had been a bubble created by central bank inflation,
and the stock market would not soon recover. That it would decline
as much as it has for as long as it has would not have been obvious,
even to an Austrian School economist, but that it would not recover
soon would have been.


In the 1970s,
became the rage in academic economic circles. Academic
economic circles are filled with salaried college teachers, mainly
employed at taxpayers’ expense. These scholars spend their early
careers seeking academic tenure, i.e., personal immunity from
the free market. Nobody can fire them merely for being wrong.
They may preach a modified version of the free market, but they
seek a personal arrangement that is reminiscent of medieval guild

economists invest in two things, mainly: their homes (heavily
mortgaged, like everyone else’s) and their pension fund, which
is probably run by TIAA-CREF. They do not invest their own money
by themselves.

theory is based on a highly sophisticated series of mathematical,
statistical, and historical studies, all with a simple conclusion:
"No one can consistently beat any investment market if the
market is large and allows open entry." This conclusion comforts
academic economists, who find in it solace for the fact that they,
despite their Ph.D.’s, cannot beat the stock market or the bond

The unstated
corollary of random walk theory is this: "Warren Buffett
is a myth."

The theory,
stripped of its equations, rests on a theory of discounting. This
theory concludes that the competition of all market forecasters
leads to a collective assessment that is the best that anyone
can consistently attain. The economic future has been discounted
by the stock market or bond market more accurately than you or
I can do it. (Remember: "There is no Warren Buffett.")
Today’s market price for a capital asset reflects the best assessments,
backed up by money, of all participants. "Put your money
where your mouth is, and then shut up. The market will speak.
Listen to the market."

Every time
I think of random-walk theory, I think of Johnny Carson in his
"Amazing Karnak" costume. The turban was the key. I
also recall fondly that, as he approached the table from which
he would make his amazing correlations, he would trip over the
step. Every time.

Karnak worked
backwards. He was given a sealed envelope, which he placed at
his forehead. He then intuited the answer, which he would tell
the audience. Then he tore off the end of the envelope and blew
into it, extracting the paper with the question on it, which he
would then read aloud. The routine went something like this. Answer:
"He shot down 27 Japanese fighter planes in World War II."
Question: "Why was Mitsuo Yokomoto kicked out of the Japanese
Air Force?"

economists also work backwards, just as Karnak did. It goes something
like this. Answer: "They received the Nobel Prize in economics
in 1997." Question: "Why
were Professors Merton and Scholes able to lose investors $3.5
billion as advisors to Long Term Capital Management in 1998?"

Always, it
comes back to this. Answer: "Warren Buffett." Question:
"What is the longest-running urban myth in investing?"

If random-walk
theory is correct, then the next move of the stock market is random.
All known facts have been discounted in the only way that counts:
"Gentlemen, place your bets." So, your chance of betting
the next market tick, up or down, is the same as calling heads
or tails when flipping a non-loaded coin.

The theory’s
personal investment conclusion is this: "Don’t waste your
time studying the stock market. Buy a no-load index fund."

Its unstated
corollary is this: "The best minds who do all that sophisticated
work and put all that money at risk are boneheads. They should
instead buy an index fund."

The collective
investment conclusion is this: "When everyone takes our advice
and does this, the world’s single no-load index fund’s assets
should be allocated among all stocks by random distribution."
Think of a guy named Joe frantically flipping coins. If all the
best minds stopped trying to beat the market, then Joe and his
coin would be the best asset-allocation strategy that anyone could
legitimately hope for.

Except for
Warren Buffett.

The stock
market is walking. It is not walking randomly. Where is it walking?


Andrew Smithers,
his ID says, is the founder and chairman of Smithers & Co,
which advises leading fund-management companies worldwide on asset
allocation. He also advises the likes of us once in a while. These
days, his advice is anything but random walk. It’s more like non-random
run: "Fire! Fire! Run for your lives!"

In the May
16 Sunday Times of London, his article appeared: "The
longer you play, the more you lose." He made this observation:

most articles about investment, which tell people how to make
money, this one will try to persuade you not to lose it. Shares,
bonds and property are all overpriced and even more recondite
things such as gold seem to lack appeal.

Well, that
surely takes the wind out of everyone’s sails. Then what’s good?
Cash. He means near-cash assets. There isn’t enough actual cash
in the system to let everyone get more than a few coins and a
couple of low-denomination bills. Digits rule the capital markets.

Cash is
the thing to hold and we are lucky in Britain that money on
deposit gives a decent return. This is a rather negative view,
but please blame the markets rather than me.

It’s a lot
more negative in the United States, where we have no such luck.
After income taxes and price inflation, the return on cash today
is negative.

The problem
is, he says, that stocks performed admirably for almost three
decades, 1973—2000: in the 10% per annum range, even after
price inflation. But. . . .

Long periods
of high returns can be obtained only if shares become thoroughly
overvalued and they are inevitably followed by long periods
of poor returns.

We are
in the early years of one of these poor periods.

This brings
us to random-walk theory. Smithers compares investing to playing

If you
play roulette, the chances of red coming up on the next spin
of the wheel are never influenced by the number of times red
has come up recently. Stock markets are different; the past
is a guide to the future. But it’s not much of a guide for the
short term.

So, Smithers
is a random walker with respect to the short run (undefined).
But at some point (undefined), the market’s walk will become a
stagger. Maybe even a fall.

in overvalued stock markets is like playing roulette —
the longer you play, the more certain you are to lose money.
Although the odds against you on each spin of the wheel are
small, over time this small disadvantage turns into a near certainty
of loss. Investors who hold shares today may make money in the
next 12 months, but the chances are that most of them will lose.
Over the next five years the odds will worsen.

At this point,
he went into a lot of economists’ mumbo-jumbo, such as the Q ratio.
That’s a form of etiquette for economists, rather like shaking
hands. No one pays any attention to the details. What matters
is his conclusion. Here is his:

Using the
Q ratio or the cyclically adjusted p/e, and looking at either
the American or British stock market, the most optimistic conclusion
is that shares are about 45% overvalued.

Well, then,
what about bonds? If stocks are headed for bad times, will bonds
be a safe haven? No.

their prospects are not very good either. Government bonds yield
some 4.5% in America and 5% in Britain.

the Bank of England is aiming at an inflation rate of about
2% a year, this suggests that the real return — after allowing
for rising prices — will be in the 3% region. This is a
little on the low side, particularly when the budget deficit
is so high and the economy appears to have little spare capacity.

There is
a high chance that the Bank will push up short-term interest
rates, and when this happens bond prices are far more likely
to fall than rise.

Bond yields
now are not much better than the return on cash, which has the
added advantage that your investment cannot go down in price.

In the United
States, cash does go down in price, i.e., it falls in relation
to prices in general, especially after the IRS takes its percentage
off the top. But I digress. Smithers then begins to hum a favorite
tune from Snow White, namely, "Some day my prince
will come."

As equity
markets usually overshoot when they are falling, there is a
strong chance they will move from being overvalued today to
being significantly undervalued in a few years. If Wall Street
fell by a third, it would be fairly valued, but on past experience
it could easily become undervalued and fall to half today’s
level. Having cash to invest then will be a great advantage.

Next, he
takes on the British urban housing market, which isn’t as wild
as Australia’s, but is wilder than the United States’ housing

The value
of Britain’s housing stock as a proportion of GDP has probably
never been as high as it is today. The last time things were
as out of line as they are now was in 1973, when we had the
secondary banking crisis.

what, exactly, do we know? This:

What we
know is that the markets are overvalued; what we don’t know
is whether the next spin of the roulette wheel will turn up
red, black or even green, the bad "one in 37" chance,
when nearly all the punters lose.

He doesn’t
mention the obvious: buy a negative index fund like Rydex Ursa.
If he’s right, you’ll make money.


is not really like playing roulette. Capital markets are not a
game. Well, not entirely. Gambling is not creative. It does not
produce wealth. It offers ways to make money by bearing risks,
but these risks are imposed by the game itself, not by real life.
Winners gain at the expense of losers. The game has odds, and
the house runs the game so as to benefit the house.

If you understand
the rules, you can identify the house.

The house
in today’s world is obvious only to a few players. The house is
a cartel of central banks and their large commercial bank beneficiaries.
It really is a house because it creates special rules that are
enforced by law. It therefore imposes unique risks that the free
market would not impose. Like a roulette wheel, the system is

If you are
in the division of labor economy, you have to play the cartel’s
game. But the game’s rules don’t cover every contingency. The
game has unintended consequences. So, we have to become entrepreneurs.
We have to forecast the future. We have to put our money where
our mouths are, or at least where our brains are. We had better
know the cartel’s game.

To understand
the cartel’s game better, click


Capital markets
perform many important services, not the least of which is removing
money from people who don’t efficiently serve the desires of consumers,
as demonstrated by consumers’ spending decisions, and transferring
it to people who do.

But what
about companies that meet the needs of consumers but which rarely
or never turn a profit? These firms are great for consumers but
not so great for investors, especially those investors who got
in late. Such companies can continue to subsidize consumers, but
only by luring in new investors. This transfers money from investors
to consumers by way of high-paid senior executives. Investors
think it’s an investment in the booming future. In fact, it’s
a huge wealth-redistribution program for the consumers in the
present. It is as if the consumers were running a roulette wheel,
and the investors were lined up to put their chips on the table.
"Round and round it goes. Where it stops, nobody knows."
This is the house talking, of course.

The transfer
of wealth from investors to consumers was what the NASDAQ bubble
was, 1996—2000. That was what the Nikkei bubble was, 1985—1989.
As a book buyer, I love Amazon. I am not an investor in Amazon.
I love to receive subsidies based on other people’s faith. "Now
faith is the substance of things hoped for, the evidence of things
not seen" (Hebrews 11:1). But I do not like to pay subsidies.

says there is a pattern in today’s markets. The move of the stock
market was upward for almost three decades, despite the day-to-day
fluctuations. He thinks that upward moves that are not matched
by upward productivity are not sustainable.

The problem
is, how has this been sustained so far? I have an answer: By lots
of people coming into the stock market who have in fact been the
beneficiaries of other people’s rising productivity. The broad
masses of the public have become two-income families. They work
longer in order to pay 30% to 40% of their income to the government.
They have not stayed ahead of price inflation. But members of
the upper 20% have prospered, as usual. They are the main buyers
of shares, along with the pension funds. They have bid up share
prices. The would-be retirees have kept their money in the stock
market, and the people who have in fact prospered from this economy
have joined them as investors.

This can
go on until these people, who are fast approaching retirement
age, at last decide to retire. Then the stock market’s move, despite
fluctuations, will become a downward move. I think Smithers’ estimate
of 45% overvaluation is wildly optimistic in the long run.

But will
the stock market go up until the shareholders start retiring?
Not if China’s booming economy goes into a slump, taking Asia
with it. Not if interest rates rise in the United States because
China’s central bank decides to stop buying U.S. T-bills with
its newly counterfeited yuan.

We are still
waiting for the Dow and the S&P 500 to reach their peak of
2000. Four years after the hoped-for 10% per annum increase, the
stock market is down. There is no enthusiasm for stocks. There
is still hope — hope based on Snow White’s song about the
prince. Meanwhile, most people sing another song, "Hi, ho,
hi, ho; it’s off to work we go."

There will
come a time when getting a job as a Wal-Mart greeter will be regarded
as a triumph. I expect to live to see that day.


As consumers,
Americans are experts. We get so much practice. As savers, we
are not equally skilled. The savings
rate in the United States is still ahead of the growth of population,
but not by much. As Ludwig
von Mises wrote almost half a century ago,

What raises
wage rates and allots to the wage earners an ever increasing
portion of the output which has been enhanced by additional
capital accumulation is the fact that the rate of capital accumulation
exceeds the rate of increase in population. . . . What has improved
the wage earners’ standard of living is the fact that the capital
equipment per head of the men eager to earn wages has increased.
Anti-Capitalistic Mentality
, Van Nostrand, 1956, pp.
88, 89).

a look at the Table 1 in the following series of tables.
were produced by Dr. Margo Thorning, who has been monitoring this
information for at least a decade. The top line, "Net Private
Domestic Saving," shows what has been happening. From 1960
to 1985, it was just under 10%. From 1986—1990, it fell to
just under 8%. In 1991 to 2001, it was down to 6.2%. In 2001,
it was a little over 2%.

Private Domestic Investment" was 8.6% in 2001, a figure fairly
constant for four decades. But "Net Inflow of Foreign Saving"
was over 4% in 2001, higher than ever before. Foreigners provided
U.S. capital by buying U.S. owned assets. American consumers are
spending the money. We are running a $500+ billion a year current
accounts deficit with foreign nations.

As shown
in Table 1, U.S. domestic saving available for private investment
has declined from an average of 9.7 percent of GDP over the
1960—1980 period to only 4.9 percent from 1991—2001.
Thus, an inflow of foreign saving has provided much of the wherewithal
for the surge in investment during the latter half of the 1990s.

So, domestic
saving and investment are falling in the United States. There
is an ominous shift in Americans’ mentality, i.e., the 20% of
Americans who provide most of the saving. They are beginning to
act as if they were exclusively wage earners. So, Americans are
ceasing to be a nation of net investors. The economy is rising
today because investment is still positive, although the rate
of increase is declining. But we are steadily eating our seed
corn. We are selling our capital abroad.

have the legal right to do this, and should have this right. But
Mises warned against this present-oriented outlook.

To content
oneself with what one has already got or can easily get, and
to abstain apathetically from any attempts to improve one’s
own material conditions, is not a virtue (p. 4).


I am convinced
that Smithers is correct. The end of the compound rate of return
in the American stock market, 2000—2004, is a herald of things
to come — if things go well. But he does not think things
will go well. He thinks the stock market will decline. So will
the bond market. He isn’t even optimistic about gold.

I am more
optimistic about gold than I am about stocks and bonds. Gold is
little more than a blip in the overall economy. A tiny increase
in demand, worldwide, will push up its price. But the overall
trend of the American capital markets is unfavorable, because
saving and investment are slowing in America.

There has
also been enormous misallocation of capital because of decades
of monetary manipulation, all over the world. This has led to
a vast increase in debt. The problem that we are now facing, worldwide,
is the fact that the free market will eventually find a way to
reallocate this capital and also reallocate the ownership of debt
and its underlying capital assets. How can this be done without
suffering a cataclysm? No one knows. But Austrian economists know
this much: the likelihood of an inflationary cataclysm is more
likely in a world of central banking than a deflationary cataclysm.

The alternative
to this market-imposed re-allocation of capital and ownership
and prices is a continuation of the present misallocation: the
steady erosion of the value of money and the steady increase of
debt. This process is sometimes called "pouring good money
after bad." In the case of central bank policy, however,
it’s more like "pouring bad money after slightly less bad
money" until there is no monetary value at all. It is a world
in which, to quote John Schaub, "nothing down" becomes
"nothing left."

When the
re-allocation comes, you had better be out of debt for anything
that can easily be repossessed. If you can’t afford to lose it,
own it debt-free. But remember this: you can afford to lose most
things if you can repurchase similar things with cash in the secondary
markets. Also, if you can make your monthly payments, a lender
will not repossess your home. There will be too many repossessed
homes on his books. Just meet your payments.

This means
that you had better keep your job. Conclusion: keep improving
the skills that enable you to keep your job. Then start accumulating
cash. Buy some re-possessed homes. Creditors will be anxious to
sell them.

As to beating
today’s stock market, I recommend Smithers’ opening words:

most articles about investment, which tell people how to make
money, this one will try to persuade you not to lose it.

31, 2004

North [send him mail]
is the author of Mises
on Money
. Visit
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