Dented Dreams

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familiar rule of stock market investing is this: "When
the Federal Reserve System raises rates, the stock market falls."
Everyone believes this in retrospect. But at the end of a stock
market boom, when the FED starts raising rates, almost nobody believes
it. "This time, it’s different."

should the rule be true? It has to do with the discount we apply
to future income. It also has to do with the way in which the FED
raises rates.

is a kind of wide-eyed belief among otherwise sophisticated investors
that the FED can raise rates merely by announcing that it intends
to raise rates. While it can raise the overnight rate at which banks
lend to other banks — the federal funds rate — it can do this only
because bankers believe that a policy announcement by the FED will
soon be accompanied by a change in FED policy. What change?

raise short-term rates, the FED must restrict its rate of monetary
expansion. That is, it must purchase fewer government debt certificates.
By purchasing fewer debt certificates, the FED creates fewer fiat
dollars with which to make the purchases. This reduces the rate
of newly created fiat money. This reduces the flow of new loanable
funds into the banking system.

for new loans does not normally fall as rapidly as the FED reduces
the flow of new money into the economy. Banks that have lent more
than their reserves allow must by law cover the shortfall. This
means paying more for overnight money. So, the price of overnight
money rises, i.e., the federal funds interest rate.

still want to borrow money. Banks still want to lend. The demand
for loans tends to be "sticky." It stays up there. People
think the good times will continue. They want to buy now, pay later.

FED’s reduction of money creation is what the longest-serving Federal
Reserve Board Chairman, William McChesney Martin, once described
as taking away the punchbowl when the party is really getting rolling.
But it takes time for the effect of the reduced flow of fiat money
to make itself felt in the economy. Short-term rates rise. Then
borrowers begin to re-think the cost of borrowing.

they cut back.

anticipation of the likely effects of any cut-back in borrowing
by employers, stock market investors begin to sell shares. The profitability
of owning shares in a time of economic slowdown looks less promising.

of this has to do with the way in which the FED raises rates. The
FED does not permanently raise rates by handing out a press release
that says, "We will decree higher rates." It does so by
having Greenspan tell Congress something about protecting the dollar
against inflation. Then the Federal Open Market Committee (FOMC)
backs up Greenspan’s words by reducing the rate of purchase of government


statistics of the adjusted monetary base confirm the change in policy
of the FED. Beginning in late September, the FED really put on the
brakes. Then, for one month — January — the FED increased
its purchases sharply. After that, stability. From mid-February
until April 13, the
adjusted monetary base remained flat
: 0.1% annual rate of increase.

has had a dramatic effect on the monetary statistic known as MZM
— money of zero maturity. Since late November, it is down by
0.3%. Since
early February, it is down by 2.5% annually. Since late June, it
is up by 0.8% annually.

result of this policy change has been obvious in the federal funds
market. The St. Louis FED has a handy chart that compares the expected
rate of interest as registered in the financial futures market with
the announced targeted rate. You
can see the rise.
The futures rate exceeds the targeted rate
when announced. The interest rate experts believed that Greenspan
was telling the truth about rising rates.


stock market has recently been falling, in spurts, or whatever the
opposite of a spurt is.
Gaps. (Gasps.)

was still rising through early March. The fund managers, who cannot
easily liquidate, were still optimistic. That optimism has disappeared.

investor in the financial futures market operates with a tiny margin.
He must liquidate when the market moves against him. If he doesn’t,
his position will be sold out from under him by his brokerage house.

contrast, the stock market fund manager can grit his teeth and hope
that he will not be hit with a flood of "sell" orders
from his fund’s investors. His problem is that if he does get hit
with sell orders, and his peers are also being hit, there will not
be ready buyers for the corporate shares he must sell in order to
redeem with cash the fund’s shares. The stock market can drop rapidly.

are now seeing headlines regarding fear about the stock market.
The Dow has dipped below its 200-day moving average, which for some
investors is an indication of further weakness. I am not a chartist,
and so I regard this indicator as important mainly as an early warning
indicator of a shift from optimism to caution. We have not yet seen
real pessimism. We have not yet seen fear.

a look at the S&P 500 chart for the last decade. It
is now at the same level where it was in mid-1998.

almost seven years, the S&P 500 has returned zero capital gains.
It has paid minuscule dividends — under 2%. Most dividends are consumed
by fund management fees.

are millions of investors out there who honestly believed in 1998
that the stock market would pay 20% per annum indefinitely. Many
surveys taken in the late 1990s revealed this opinion. People believed
that the abnormal returns from 1992 to 1998 were part of a new era.
This is what Federal Reserve-funded booms do to investors. They
lose their sense of history. "This time, it’s different."

was not just common investors who believed this. In October, 1999,
Harry Dent’s book appeared: The
Roaring 2000s: Building the Wealth and Lifestyle You Desire in the
Greatest Boom in History
. The following March, three months
after the Dow Jones Industrial Average peaked at 11,750 and two
weeks after the Nasdaq’s peak at 5040, Business
published an interview
with Dent

tells author Dent that the Dow will hit 40,000

Dow Jones industrial average’s bad behavior may give you cause
to doubt the durability of the great bull market. Don’t worry,
says Harry S. Dent Jr., the author, lecturer, and money manager.
The bull market is as vast and powerful as the baby boomer generation,
and the two are inextricable. The 80 million or so boomers — those
born between 1946 and 1964 — are hitting their peak earning, spending,
and investing years, and that’s what’s driving the economy’s incredible
performance and the stock market’s spectacular returns. His target
for the Dow is 40,000 — which he believes it will hit somewhere
around 2008.

that, watch out. As an economic force, the boomers will have peaked,
and there just aren’t enough Generation Xers to sustain the economic
and stock market boom. Even the revolutionary changes wrought
by the rapid growth of the Internet don’t change that. In Dent’s
view, the economy goes into a deflationary funk for another 10
or so years, until the boomers’ children — the 83 million "echo
baby boom" generation — reach their economic prime. Dent’s
warning: Make your money now, and secure it before the inevitable
bust that can take the Dow down to 10,000 again (chart, page 212).

a bummer if I ever heard one. Here we are, with the Dow at 10,000,
and it’s 2005. The clock is ticking. The Dow seems headed toward
7,000 rather than 40,000. But not in March, 2000.

as destiny? It’s a simple idea, really, and with it, Dent, a 46-year-old
boomer himself, has built quite an empire. His latest book, The
Roaring 2000s Investor, is fifth on the Business Week Best-Seller
List. His previous work, The Roaring 2000s, is ninth on the BW
paperback list. On the lecture circuit, Dent is a favorite of
brokerage firms and mutual-fund companies, which use him to fire
up their sales forces and investor groups. He recently upped his
lecture fee to $50,000. "I’m trying to cut down on the speaking
engagements," says Dent. "I was doing over 200 a year,
and that’s too much." He recently launched the Dent Advisory
Network, which licenses Dent materials and the right to give investment
seminars based on his work in particular territories.

sounded so easy. It sounded so good. It sounded like something worth
paying $50,000 to bring before clients in a one-hour lecture.

was a crock.


based it on demographics. The boomers are scheduled to begin retiring
in 2011, when the first contingent, born in 1946, turns 65. Then
why 2008? Because early retirement at age 62 is legal under Social

who took him seriously in 2000 has five years of evidence that he
did not know what he was talking about. Demographics was not destiny
after all.

that it really is. In fact, in economic life, there is hardly anything
more certain than demographics. It’s the "death" half
of "nothing is sure except death and taxes." The boomers
are going to see to it politically that as they approach death,
the workers are going to pay more taxes.

boom is off the rose. The Dow has gone down since the date of Dent’s
interview. Five years have passed by, and there is no boom in sight.

did not invest because of Dent. They invested because the FED expanded
the money supply, created a boom, and lured in the suckers who are
always ready to believe in a new era. But brokerage houses paid
Dent big money to come on stage and provide charts and stats to
reinforce the march of the lemmings. His message was clear: demographics
is destiny, and in 2008, destiny says the market will go back to
10,000 from 40,000.

Where will it go to if, in 2008, it begins its descent from 10,000?

feel sure that Harry Dent’s arguments are not bringing him $50,000
per speech today. The closer we get to 2008, the less market value
his thesis has for brokerage houses.


those of you who have not yet received your offer from Social Security
to retire early, let me tell you what that letter means. It means
that the clock is definitely ticking. It means that the likelihood
of your being able to retire in three years is nil unless you can
afford to retire today.

letter has not yet arrived in the mail boxes of the boomers. It
arrived in mine late last year. Not planning to retire, I found
it amusing. With my income level, the tax man would collect so much
of my promised early retirement windfall that anything left over
would barely pay my medical insurance and my life insurance premiums.
So, I ignored the offer. Besides, I like my work.

began planning my non-retirement over three decades ago, when I
started my newsletter, Remnant Review. I plan to open a day
care center this fall. I’m ready to branch out into a new career.
I figure I can earn 25% on the day care’s real estate alone, not
counting appreciation . . . in the middle of a boom area. (Note:
it will be located within jogging distance of mid-America’s shrine:

of millions of Americans my age or close to it have lived an illusion,
an illusion fostered by men like Harry Dent. They really did believe
that there was an escape hatch from both poverty and work. There
isn’t — not for at least 80% of Americans.

20, 2005

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

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