The Stock Market Bubble

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As time goes
by, memories fade. Most people are unaware of the origins of many
of our present day practices. For instance it seems that the original
purpose of the limited liability company has long been forgotten.

Once, long
ago, an individual with a good idea but little money needed funds
to develop his idea and sell it to the public. In order to raise
the funds he sold “shares” in the venture to others. In this way
capital was raised and the word “capitalism” came into being. If
the project proved successful, the resulting profits would be “shared”
among the “shareholders."

As the years
went by, things became increasingly formalized. In time, a market
for the shares developed. A shareholder might need the money immediately
and not want to wait for a future payout. A buyer may perceive greater
prospects for the future than the present shareholder and thus look
upon the purchase of the shares as a “good investment." But the
value of the share transaction was still usually based on the expected
size of the dividend or dividends to be paid out down the road.

Today all this
has largely been forgotten. Over time sales increased. Formalized
markets were established. The bundling of stocks into mutual funds
and the many other modern methods of “getting into the market” obscured
the original purpose of “buying shares." Few are those nowadays
who buy shares for the dividends they will pay, indeed many if not
most companies today pay no dividend at all.

If no dividend
is to be paid, why would one buy shares in a particular enterprise?
Because one expects that the share price itself will rise. In the
real estate market this was known as “the greater fool theory."
As long as demand for houses kept increasing, prices would keep
rising and it would usually be possible to find someone who would
pay a higher price for the property in question.

And why should
demand keep increasing? Well, in truth, it wouldn’t, or at least
would only keep going to a certain point. It will keep increasing
as long as there are people with money available to get in on the
action, or if the amount of money in circulation keeps increasing.
And in recent years, of course, the money itself has not needed
to be available. Your credit is good! Buy now, pay later! Banks
magically create all the money you need so you can borrow, borrow,
borrow and live the good life now.

The time comes,
however, when even with endless credit, more and more people are
unable to meet their obligations by paying off even the smallest
installment on their loans. We are all familiar with the bursting
of the housing bubble. As it became evident that too many loans
were bad, and that saturation point had been reached when it came
to new buyers, so lenders pulled in their horns, bad debts were
written off, and the dominoes began to fall. The whole edifice was
built, not on real money, but on debt – promises to pay. But promises
can be broken, and will be broken if the one who made the promise
either never had the ability to pay in the first place, or sees
that his house is worth less than he owes. He will walk away and
the bank will be left holding the bag.

It appears
to me that what we are now witnessing is the bursting of a stock
market bubble. Unreasonable expectations, based on little more than
hope and hype, with no consideration of eventual dividend payments,
pushed stocks to unreasonably high levels. We are now witnessing
share prices falling to more normal levels. Of course we continue
to hear such bromides as “the market always comes back." This is
true of course. The only problem is that after the 1929 crash, for
example, it took 27 years for the market to come back to where it
had been. Some of us don’t have that long to wait. And this time
the mess is so massive that it could even take more than 27 years
before 2007 prices are seen again.

The unbelievable
arrogance of the Treasury Secretary et al. who actually think
that their actions will “restore confidence” etc. boggles the mind.
The market is made up of billions of individual decisions and will
continue to be so. Many of these decisions are based on expectations
arising from government pronouncements. However there is such deep
distrust of governments today, and with the internet and cellphones
immediately giving the lie to most official statements, it is doubtful
that officialdom can have much effect on the eventual outcome of
this market meltdown. Their only hope is that the public may understand
even less of what is going on than they do.

My advice?
Protect yourself with gold, then sit back and enjoy the ride.

October
17, 2008

Bill
Trench [send him mail]
is a writer and cogitator who enjoys watching and commenting on
the passing show.

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