-- Posted Monday, 17 March 2008 | Digg This Article
| Source: GoldSeek.com
by Howard S. Katz
3-17-08
John Maynard Keynes argued that the stock market was moved by fear and greed. That is, he said that traders are irrational and that they swing back and forth between emotional extremes – “animal spirits” he called them.
I have often wondered why gold bugs, who reject Keynes’ theories of economics, are often willing to accept his theories about what moves markets.
Markets are primarily moved by paper money and easy credit – exactly the two forces which Keynes spent most of his life championing. They are only secondarily moved by the emotions of traders. Keynes was trying to blame others for his own failures. Let us take the dot com bubble of 1999 and its bursting as an example.
At first glance, this would seem to confirm Keynes’ fear/greed theory. Wasn’t the dot com bubble an example of greed at its worst? This is the conventional explanation.
But the people who give the conventional explanation did not call the top of the dot com bubble in early 2000. In January of that year, I instructed my subscribers to get out of stocks and to take a position in commodities. Correct predictions are one sign of a true theory.
Early in the 1990s, in a response to the “recession” of 1990-91, the Greenspan Fed undertook a program of massive easing. T-bills went from 10% in 1989 to 3% in 1993. The U.S. money supply rose by 15% in 1993. T-bond yields followed bill yields down, but the whole program was so massive that it took until ’98 for bond yields to hit their low point (at the LTCM crisis in October ’98).
At that time, I came to the conclusion that real T-bond yields were negative. This is a difficult point. One calculates real yields by taking the nominal yield and subtracting the rate at which prices are rising. However, most analysts make the mistake of subtracting the CPI. Even if it were accurate, The CPI looks backward. It tells the rate at which prices rose last year. The T-bond market needs to look forward and estimate the rate at which prices will rise over the next 30 years. I have found a method of calculating this number and came to the conclusion, in 1999, that real interest rates on bonds were below 0.
This meant, of course, a massive stampede out of bonds and into stocks. Who would buy a bond with a negative (real) interest rate? If bond yields were 0, then stock yields had to drop to 0 also. Since a P:E ratio is simply an (earnings) yield inverted, this computed (in theory) to a stock P:E of 11,700/0 = infinity.
How good this reasoning was is shown by the fact that 1999 saw a rush out of bonds and into stocks; by early 2000, the P:E on the DJI was up to 35:1, and there was an important group (the internet start-ups) which actually did have infinite P:Es.
But the point is not that the stock market was high. The point is that it was undervalued. It had a P:E of 35 when it should have had a P:E of infinity. The stock market went up in the late 1990s not because traders became optimistic or greedy. It went up because Greenspan (following Keynes) had eased. Traders actually realized that the Fed might change its policy and kept P:Es from going to their theoretical level.
Sure enough, the stock market was (rationally) anticipating the future. In mid-’99, Greenspan started to tighten, and this led to the bear market which began in early ’00. We did not have an irrational stock market which got too high. We had (and have) an irrational political system (based on paper money) which changed the real value of stocks (by changing bond yields). Traders acknowledged this, but they were also smart enough to predict its eventual end.
To my subscribers at the time, I said (about the internet bubble), “Play it, but don’t believe it.” As noted, I said goodbye to the internet stocks in Jan. 2000. So the stock market top of early 2000 was not caused by traders’ greed. It was caused by Alan Greenspan’s easing of the early 1990s. And since Greenspan was doing exactly what Keynes told him to do, the basic blame for the dot com bubble (and its bursting) belonged to Keynes, not to the emotions of the average trader.
In the current stock market (analogous to early ’95), we have a similar situation. The Fed has been engaged in a massive easing, and this easing will cause stocks to go up. The only trick is to judge the lag time between bonds and stocks.
Since last October there have been waves of pessimism with a new bearish news item hitting the market every few days. Right now Bear Sterns is on the ropes and is being bailed out by the Fed. But this will not make stocks go down. I stand by my previous prediction that the bottom came on March 10-11.
The purpose of the “recession” propaganda is to scare the blazes out of your average owner of stocks. In this way, he will put pressure on his Congressman to pressure the Fed to ease. (An independent central bank is another fantasy of our times.) It is working. The Fed is easing to beat the band. This week, both Al Abelson and Warren Buffet jumped on the “recession” bandwagon. Sorry Al and Warren, you forgot an important market principle, “Don’t fight the Fed.”
In the very long term, commodities are the most important of the financial markets. As they go up, the price increases are passed through to consumer goods. Right now, Bernanke is trying as hard as he can to ignore these consumer price increases. But in the long run this pressure will win out and force him to tighten.
But here in the short term, stocks are the most important of the financial markets. This is because the recession propaganda, which is aimed at stocks, is affecting the other markets. Large numbers of people believe the recession propaganda, and they draw the (Keynesian) conclusion that commodities will have to go down.
Remember, Keynes said that a recession was a lack of demand and inflation was too much demand. So how can there be a recession at a time (like the present) of roaring inflation? How can we have a lack of demand when prices are exploding and all over the world people are rioting for food? It seems to me that it is not stock markets which are irrational. It is Keynesians who are irrational.
At the One-handed Economist we take advantage of the animal spirits of the Keynesian traders. We buy when they are selling, we sell when they are buying, and we take their money. You are invited to visit our web site, www.thegoldbug.net, (no charge) which applies Austrian Theory economics to social problems of our time and to subscribe to the One-handed Economist ($300/year, see web site) which applies Austrian Theory economics to the individual problem of putting money in your pocket.
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-- Posted Monday, 17 March 2008 | Digg This Article | Source: GoldSeek.com
