The Smashing of Dreams Is Not Over

Day by day, the dreams of hundreds of millions of people around the world are being smashed. It is a terrible thing to see from the sidelines. It is far worse to be a participant.

The dreams of easy retirement are disappearing. So are the dreams of automatic wealth. Americans, more than any other people, bought into the dream of automatic wealth. “Just buy a larger home with 5% down and wait. You will get rich.” The dream of leveraged money trapped homeowners. It also trapped hedge fund investors.

This dream has yet to play itself out in a wave of bankruptcies. It will. Hedge funds, leveraged 30 to 1, have few reserves apart from stocks in their portfolios. When the stock market falls, they receive margin calls. They must sell more stocks. This depresses the stock market, which triggers more margin calls.

Getting rich looked easy when stocks were rising. Going bankrupt looks easy now. Leverage is a two-way street.

The sellers of dreams are still in business. “Buy stocks and hold.” “Don’t sell in a panic.” “This market will rebound.” “The decline in the American stock market since March 2000 is an aberration.” “We’re bullish on America.” “The government’s bailouts will work.” “The market is approaching a bottom.”

Those who were seduced by the dream want to believe these reassurances. There is a market for these reassurances. But, week by week, the audience is shrinking. So is their capital.

Recovery is a dream based on fiat money. Prices will go back up, say the cheerleaders. Yes, they will. When the Federal Reserve System pumps in new money at over 300% per annum, which it did from late August to late October (adjusted monetary base), eventually prices will rise. But few people will be made richer.

Here is the three-step religion of recovery: monetary inflation, increased Federal spending, and regulation. Congress promises to implement this program until the dream revives. Congress promises monetary inflation without price inflation, Federal spending without the crowding out of capital to fund business, and regulation without bureaucracy.

This program will not work. It cannot work. We need the opposite program: monetary stability, Federal surpluses, and reduced bureaucracy. We will not get this program . . . ever.

The dream was always naïve. The Reagan revolution was based on monetary inflation after the weekend of August 13, 1982, when the FED’s tight-money policy, which began in the fall of 1979 under Carter, was self-consciously reversed in the wake of the Mexican bank crisis. The Reagan revolution was also based on massive Federal deficits, beginning in 1983. While bureaucracy’s grasping hand did decline under Reagan, as evidenced by the reduction of pages in the “Federal Register” from 60,000 a year to under 40,000 a year in his first term, it started back up in his second term. It has continued to rise to its present 70,000 a year.

The dream of easy wealth through easy money and debt has accelerated in every American generation since the end of World War II. We have now come to a new phase. Money will be far easier as the Federal Reserve inflates, but profits through debt will become more elusive.

Meanwhile, those few Americans who have pension funds dream of the return of the boom of 1982 to 2000.


Last Friday, the Dow Jones Industrial Average fell over 300 points. This was considered a good day. It had been down over 600 points in the first hour.

Volatility is constant. The experts do not know whether this market is ready to soar or not.

My guess: it’s not.

Alan Abelson, who has been writing a wry weekly column for Barron’s for over 30 years, cited the work of John Harris. Harris says that in the years since 1928, whenever a Presidential election is accompanied by a bear stock market, the market continued down to year’s end after the election in four out of four cases: 1932, 1948, 1952, and 2000. The average loss on the S&P 500 was 5.9%, but on average the low was 10%.

Past is not necessarily prologue, but it surely is attention-catching.


The experts say that the traditional sign of a bear market climax is a panic sell-off of shares. This is called exhaustion. Exhaustion can produce a bottom. It also creates a sucker’s rally.

In October 2002 the S&P 500 bottomed at 777. That was one of the strangest oddities in stock market history. On Friday the 13th, August 1982, the Dow bottomed at 777.

The S&P 500 arrived at 777 in a most intriguing way. It closed below 800 in mid-2002. Then it soared back to about 950. Then it fell back to 777. Then it soared again to about 950. Then it fell back below 800. Only in the first quarter of 2003 did it begin its long trek back up. It peaked in late October 2007. Then the rout began.

The bulls are waiting for the final sell-off. They tell people to stay in this market, yet they also predict a final sell-off.

It seems to me that it is better to sell your shares — all of them — and short the market. This way, you profit from the final sell-off. But the analysts never mention this strategy, let alone recommend it.

Despite the fact that exhaustion has not happened, the analysts also assure us that the stock market is still fundamentally sound — Herbert Hoover’s famous phrase from 1930 to 1932. There is bad economic news on all fronts, but somehow the stock market is sound. Yet the economy is in recession — something the analysts have denied until recent weeks. The stock market’s bottom is supposed to send a message: the economy is going to recover in six months. Or nine months. Yet the experts are now talking about a recession that lasts longer than the traditional 11 months. Then why should the stock market be close to the bottom?


The economy is slowly sagging. This has not been like a fall off a cliff. It has been more like a stroll down a hill. The overleveraged behemoths of finance have taken huge hits, as have the taxpayers, but the economy is not showing signs of anything remotely catastrophic.

There seems to be a disconnect between the stock markets of the world and the world economy. The Hang Seng index of Hong Kong is down by two-thirds over the last year. Yet the Chinese economy, while slowing, still seems to be growing above 7%. These are government-supplied figures. We should not take them too seriously. But the trend is still positive.

Are the Asian stock markets not forecasting really bad news to come in 2009? This is what bullish analysts ought to argue. We are told that the Hang Seng index is selling off because profit projections had been wildly optimistic a year ago. Maybe so, but the question remains: Why?

The answer is the Austrian theory of the trade cycle. The economic boom is created by rising monetary inflation. The bust occurs when the rate of monetary expansion slows. The Chinese central bank is slowing the rate of monetary inflation. It had pumped in money (M1) at a rate of close to 20% per annum for several years. Year to year in September, M1 rose at less than 10%.

In June of 2007, I predicted what I thought was going to happen in China.

The bubble in China resembles the bubble 1995—2000 NASDAQ in the United States. The Chinese stock market is trading at a price/earnings ratio above 50. Some stocks are trading at 80. In a speech on June 12, Alan Greenspan commented, “Some of these price-earnings ratios are discounting Nirvana.” But let us not forget that the NASDAQ reached a p/e ratio of more than 200 in December, 1999.

In late January, I wrote this:

At some point, China’s central bank will be successful in slowing price inflation. The economic boom requires ever-larger percentage increases of the money supply. By merely following the policies of the previous year, the central bank will produce a recession. If the central bank is serious about slowing inflation through interest rate increases, it will see its goal achieved. Price inflation will in fact slow. The cause of the slowdown will be a recession in China.

What could trigger this? A recession in the United States could. Falling demand for the goods produced by China’s export sector will produce bankruptcies in China. They will order no more goods and services. These effects will ripple through the Chinese economy. In the absence of the recessionary efforts of central bank policy, these ripples could be contained by growth in the other sectors. But a reduction of Chinese economic growth is already in the pipeline. The central bank’s policy of letting interest rates rise is sufficient to create a domestic recession.

China is now where I thought it would be. China is cutting jobs in the export sector. The government is intervening to save jobs — the standard approach of governments all over the world.

In short, the recession is spreading fast. The crash in Asian stock markets is not a random event.

We have not had a crash in American stocks comparable to the fall in Asian stocks, but the trend is relentless. The stock market does not reverse for long. Optimism is fading. But it still remains. The average pension fund investor has not called the fund to tell it to stop buying stocks. He does not have to tell the fund to sell — just stop buying.

Because companies match investments in 401(k) programs, investors stay in. They are told endlessly that American stocks will return to their tradition of producing 7% per annum returns, despite the fact that the Dow is down sharply from its peak in 2000 of 11,700, even without the 22% loss to price inflation. The bulk of retirement investors still believe the mantra, despite the evidence.

The falling economy will push down profits. This will push down the denominator of the price/earnings ratio. Prices will fall.

The stock market has obviously reversed its momentum. It heads lower, week by week. The public cannot seem to come to grips with what I have been predicting ever since last November: the end of the boom in stocks and the coming of a long recession.


I think the market will get exhaustion. There will be a sharp move downward. But I also expect to see a repeat of 2002 and 2003: spiked upward moves followed by spikes downward.

When will this happen? I don’t know. The market is grinding away investors’ optimism. This psychology has not yet moved to real pessimism — when investors abandon the constant slogan, “Don’t sell in a panic.”

They should have sold calmly a year ago.

October 29, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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