Dow 20,000. Why Not Dow 100,000?

The Dow finally hit the 20,000 mark.  It seemed as inevitable as an anti-Trump story hitting the nightly news.

The Dow is only 30 stocks, and 20,000 is only a nice round number.  Maybe it is psychologically significant, but I think it is more significant as a symbol of our economy.

As I speculated recently, we may be in something of a mini-boom right now.  It is a mild boom for certain sectors of the economy.  Unfortunately, this does not include most of middle-class America.

And even for those in middle-class America who do seem to be doing ok, some of it may be an illusion.  It may be a rug under their feet that is about to be pulled.

I think stock prices are highly misleading as economic indicators.  There is no question that they are relevant.  It is no coincident that stock prices tumbled in the fall of 2008 with the fall of the economy.

But the economy was set to fall anyway.  There was a bubble economy that had been set by many years of monetary inflation and low interest rates, courtesy of the Fed.  This happened under Greenspan, before Bernanke took office.  The short time Bernanke was in office prior to the financial crisis, the Fed had actually tightened monetary policy.  Then the inevitable bust came.

Stocks are not an indication of the health of the economy.  If they are at all, it is the exact opposite of what we are told.  A booming stock market often means that there is a great deal of malinvestment (misallocated resources) taking place.  While the times may feel good for some, much of it is an illusion.

Imagine a world without any monetary inflation.  It doesn’t matter if it is a highly disciplined central bank that doesn’t print money, or if it is some kind of commodity that can’t increase.  In such a world, rising stock prices would not be the norm.  Individual stocks would go up and down as usual based on company profitability and potential future profitability.  But stock indexes would likely be relatively stable.

People would still own stocks for the possibility of capital gains, but the primary reason would be dividends from the profits.  It is confusing in today’s world where supposedly profitable companies pay little or no dividends.  What is the point of owning an investment if it never pays out a dividend?  Much of the capital gains are a result of easy money and speculation, and little to do with future dividends.

Of course, in a world with no monetary inflation, your purchasing power would increase as productivity increases.  Even if your stocks did not increase in price, your purchasing power would still be increasing if the prices stayed the same.

Japan in an interesting example of where the stock market (the Nikkei) hit its all-time high in 1989.  After a major crash, it has done very little since that time.  It has been a horrible investment.  It is only with the recent monetary inflation that stocks have done ok there (but still down about 50% from its all-time nominal high nearly 3 decades ago).

Japan had a relatively tight monetary policy throughout the 1990s and 2000s.  But the economy still struggled due to high government spending.  It is unique because the government spent massive amounts of money and accumulated great amounts of debt, but did not finance it through central bank inflation until only recently.  For some reason, the Japanese people felt some kind of patriotic duty to buy their government’s debt at low interest rates.

In most cases, a tight monetary policy is good for an economy because it limits government spending.  It may not seem like a booming time, but it is key in avoiding the busts.  It is better to grow consistently rather than having these booms and busts that distort production and make us poorer than we otherwise would have been.

Dow 20,000 is no victory.  If anything, it should serve as a warning sign.  We could have Dow 100,000 if the Fed really wanted it that way.  They could start up QE4 and start buying up assets at a rate of $100 billion per month or more.  If they are more aggressive than QE3, then they could keep this party going for quite a bit longer.

Of course, this would be highly destructive in the long run.  It would only serve to misallocate more resources and divert investment away from consumer goods that would be most in demand if left to the free market.

Nobody should hope for Dow 100,000.  It would be a sign of great monetary inflation and a massive drain on capital investment that is in accordance with consumer demand.  Dow 20,000 is bad enough.

We should hope for a tight monetary policy and a reduction in government spending.  This is the key ingredient for more savings and capital investment.  This is the key to greater productivity that is in accordance with consumer demand.  This is the way we increase our living standards sustainably.

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