Detour on Easy Street

Because 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 fishing.

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, random-walk theory 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 socialism.

Academic 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.

Random-walk 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 market.

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?”

Academic 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:

Unlike 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 roulette.

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.

Investing 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.

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

Because 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 market.

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.

Then 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.


Investing 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 rigged.

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 here.


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.

Smithers 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. (The Anti-Capitalistic Mentality, Van Nostrand, 1956, pp. 88, 89).

Take a look at the Table 1 in the following series of tables. They 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%.

“Net 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.

Americans 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:

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

May 31, 2004

Gary North [send him mail] is the author of Mises on Money. Visit For a free subscription to Gary North’s newsletter on gold, click here.

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