Making secure investments is important
Like arrows in the hands of a warrior
Merely a few years ago the Dow Jones Industrial Average (a measure of the New York stock market) broke its incredible record of 4,000. Champagne and ink were poured in gallons. Today it dances around 10,700.
Are stock prices for real? Are they just a bubble, inflated by optimism and/or greed? Are they fundamental prices, reflecting the real prospects of American firms? My answer to this question is another question: are the real prospects of American firms 250 percent - 300 percent of what they were six years ago? Is the American economy nearly three times as productive today as it was in 1994?
Some people argue that the market is "efficient" by which they mean that prices capture so much information that they reflect reality. If people value oranges, apples or IBM at this price, that must be the fundamental price, determined by preferences and technology. Then the price of a stock reflects its real value, the value of all the present and future profits of the firm put together.
Those who believe this say that all the downsizing, reengineering, etc., of the early 1990s is paying off today, plus the reforms of the Reagan era. Just for the sake of the argument, let's grant that cutting jobs improved efficiency by getting rid of the fat, and that the Gipper's policies were really good for the economy. Still, there is a simple number: 300 percent? Can somebody say that the economy has improved by that much in this decade?
Doomsayers are nearly always right in the long run but nearly always wrong in the short run. Because of their repeated failures, people ignore the doomsayer. "Economists have predicted nine recessions out of the last six," goes the saying. People will believe that a "new economy" has arrived, and the financial situation is not a bubble but the new structural reality.
People have short memories — that is a fact. We forget that stock booms have happened before, fueled by euphoria about an unstoppable market, and followed by stock crashes. So we speculate in stocks — after a while, the market crashes.
What explains the stock boom? Over the last few years, people have being putting their money in the stock market. Demand has risen, and so have prices. The more prices rose, the more people came to the market, so prices rose more. There is no doubt that companies are more efficient and that the economy has been doing very well. But because investors not only look at future profits but also at how fast are prices rising today, more and more people looked at the same improved corporate and economic data and at stock prices and invested in the bull market — eventually, the market lost touch with reality.
What is the stock market? It is supposed to be the place where companies (real companies, which make milk and nails) raise funds to produce milk and nails. But the enormous majority of transactions in the stock market do not go to the real firms but just are just transfers of pieces of paper among investors. Obviously, a very "thick" market (where a lot of transactions happen) makes it easy for firms to issue new stock, because any buyer knows he can dump the firm in about 60 seconds. But since nearly every transaction on Wall Street is not directed to the specific purpose for which it exists (raising funds for real firms), it is very easy for Wall Street to go flying high in the sky.
A good economic system is busy producing and distributing the material necessities for the people in it. In a good economic arrangement, the owners of a firm are deeply involved in its management, because they have their heart into that company, its products, its workers, its customers. It is a personal society, not an impersonal one — people are important, with names and background.
In an impersonal society, ownership of a firm can last 30 minutes. These owners are ready to dump the stock, the market, and the economy, at the least sign of trouble. If the stock market is so high, it is mostly because demand for stocks has risen, their fundamental value is not connected to their price: Do not be surprised if you see the market drop whenever declining investor optimism causes demand to fall.
The market will crash, sooner or later. When it does, all of Greenspan's careful management and all the balanced budgets will not save investors from some serious poverty.
My advice to all of those who want to provide for their future: Find a very, very secure investment, maybe U.S. Treasuries or a very prudent company. Do not put your money in the Wall Street Casino. If you must gamble, go to a real casino. At least there you know the probabilities.
Gabriel Xavier Martinez is a graduate student in economics. He apologizes to all economic historians for all the gross inaccuracies in this article. But alas! He is an economist and simplifies heroically for the sake of exposition.
The views expressed in this column are those of the author and not necessarily those of The Observer.
All Viewpoint Stories for Wednesday, November 10, 1999