Warren Buffett is Right: Dow One Million is Not Ridiculous

Warren Buffett recently suggested that we could see the Dow Jones Industrial Average hit the one million mark within the next 100 years.  He says it is not a ridiculous forecast at all if you do the math.

According to this article from USA Today, the Dow would only have to go up by 3.87% per year for the next 100 years to hit the 1,000,000 mark.  This is quite doable, given that the index has gained an average of 5.73% per year over the last century.

The Dow is currently trading well above the 20,000 mark.  It would only have to go up by a multiple of a little under 50 times its current value.  While a 50 times return on an investment is huge, it isn’t huge when you use the compounding effect over a 100-year period of time.

Therefore, unfortunately, Buffett is right.  I say “unfortunately” for a reason.

In fact, I will one up Buffett and say that Dow one million is possible within the next 30 years.  And it is all possible for one reason: the central bank’s ability to create money out of thin air.

When we talk of Dow one million, we are talking about it in nominal terms.  We are not talking about the real inflation-adjusted value.

The primary reason the market goes up is because of monetary inflation.  They are not necessarily directly correlated in the short run, but the broad stock market will tend to move somewhat in correlation with the money supply over the longer run.

When I say or write this, it puzzles most people.  This is because we are accustomed to the world we live in.  When you have experienced inflation your entire life, you can’t imagine a world without inflation.

In a true free market without significant monetary inflation, a broad index of stocks would not likely go significantly higher, at least in terms of capital gains.  The main idea of becoming a shareholder (owning a piece of a company) is to share in the profits.  This is typically expressed in the form of dividends, at least when the government’s tax and regulatory schemes are not distorting this process.  When a company has greater dividends, or when investors believe that dividends will likely be higher in the future, then the share price will typically rise in response.

But on net, you wouldn’t see the significant capital gains in the broad market that we see today, even when accounting for the busts.  In a free market with relatively stable money, investors would buy shares to benefit from the dividends and the possibility of capital gains.  But someone buying an index fund probably wouldn’t be counting on the capital gains.  However, with increased technology and production, coupled with relatively stable money, the purchasing power of their money would likely increase.

There are many problems that the Federal Reserve and other central banks present.  Monetary inflation redistributes wealth.  It manipulates and distorts interest rates.  It causes artificial booms and busts in the economy.  Overall, it misallocates resources and makes us poorer on net.

Inflation is especially problematic for those trying to plan for the future.  This can include entrepreneurs.  It can also include people looking towards retirement.

How are you supposed to plan for retirement if you have no idea what your money is going to be able to buy 10 or 20 years down the line?  At least when you are working, you can hope that your wages will keep up with price inflation, even if they do lag behind.

We should hope that we won’t see Dow one million, even if it is 100 years from now.  We especially wouldn’t want to see it in the next few decades.

I know that people often equate a booming stock market with good economic times.  But these times are often the misallocations.

It feels like good times when you are on a lavish vacation, and you really probably are having a good time.  But you are consuming resources and your bank account is going lower.  It is not sustainable, and your vacation will eventually come to an end.  So too, will the boom.

We should hope that the government and central bank adopt some kind of gold standard.  Better yet, the Federal Reserve Act should be repealed, and we should have a completely free market in money.  But barring this radical move towards liberty, we should at least hope that the Fed engages in minimal, if any, monetary inflation.  Our living standards would be far better off in the long run.

If the Fed took a tight money stance over a long period of time, with no indication that it would return to loose money, then stocks would suffer greatly, at least in nominal terms.  But we would actually be more prosperous, as more resources would be allocated in accordance with consumer demand.

Buffett believes people should buy and hold index funds.  He recommends almost the exact opposite of what he did to become rich.  Buffett says you should bet on the U.S. economy.  With his talk of the Dow hitting one million, he is not so much betting on the U.S. economy as he is betting on continued monetary inflation.

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