• Political Erosion: First Confidence Fades, Then Faith

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    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
    speed bump.

    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
    in 1990.


    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
    about then.


    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.

    In considering
    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

    In recent
    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.

    Why did
    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
    the lessons.”

    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
    could sell.

    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.

    13, 2002

    North is the author of Mises
    on Money
    . Visit http://www.freebooks.com.
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