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Can The Stock Market Crash?
Of course the stock market can crash but
not for the reasons most often given. Investors, traders and
speculators perform a valuable service. They bear risks that others
are unwilling or unable to assume. As long as the majority of the
market participants are directly involved in buying and selling
actual shares of stocks, the result is beneficial to a free
market economy. Without stock traders, the economy would collapse.
However, stock traders make up a
constantly shrinking fraction of securities volume. Most volume is
related to options and futures and is divorced from any beneficial
economic role. Tons of money is devoted only to generating noise in
the stock market. The derivatives industry has already caused one
crash, 1987. Derivatives transactions have two goals, avoiding risk
and milking the market for more than it is worth. Both efforts make
the equities market less efficient and vulnerable to failure.
Misunderstanding Liquidity
What does it mean
when one pundit or another makes reference to the global liquidity
glut? I am not sure they know. Are there actually bundles of cash
sitting around in shoe boxes because there is no place to put the
money? No, 100% of the world's money is already invested or
designated for some immediate use. Think of liquidity as being
like air going in or out of a balloon. Saying that there is a glut
of liquidity in the world is like saying there is too much air in a
balloon. What is important is whether there is air going into the
balloon or air going out of the balloon.
The world's money
supply only causes high stock prices if it is growing . A glut of
liquidity is more of a danger to stock prices than anything else. If
the world really has more money in circulation than is productive,
credit will either shrink or the excess funds will eventually be
spent on consumption, causing an inflationary spiral. In either
case, stock prices will be adversely affected. Credit can contract
rapidly for more reasons than a mind can keep track of at one time.
A credit contraction can cause a crash. The stock market would drop
considerably if the rate of monetary growth only slowed
significantly. If a lot of money has been placed in stocks just
because funds dropped out of the sky, prices could drop quickly if
the situation changes.
Humphrey-Hawkins Full Employment Act
Free market is a term that is
used to describe the U.S. and other economies. The U.S.
economy is actually more of a planned economy. The
Humphrey-Hawkins Full Employment Act of 1978, forever
changed the federal government's role in the economy.
The federal government is now, by law, charged with
pursuing "maximum employment, production, and purchasing
power" through cooperation with private enterprise.
Under the act, the president is required to set
numerical goals for the economy. The Federal Reserve is
required to coordinate monetary policy with the
President's economic policy. The result of the law has
been to provide justification for political agendas and
to weaken the free market characteristics of the
economy. Only the parts of the law that serve political
needs are enforced.
Humphrey-Hawkins also
requires the government to balance the budget and avoid
trade deficits. Once political goals dominate economic
decisions, all solutions tend to become temporary.
Planned economies fail. Economic failure can cause a
stock market crash.
Only Good Forecasts
Government reports are like
commercials. If information might cause the public to
exercise caution it is "wisely" withheld. Part of
the Federal Reserve's role is to attune public
sentiment. Recessions are not forecast by government
economists partly because to do so would be admitting
personal ineptitude. In the minds of elitist
intellectuals, people are statues with highly
predictable behavior. But, behavior does change. On a
collective level, human beings monitor and adjust.
Eventually, the public learns to anticipate federal
actions and incorporate expected policies into their
personal economic models. Objective economic analysis is
very rare. Even private organizations have agendas that
are furthered best by adhering to a positive bias.
Stock market crashes are
surprises by nature. Investors are not privileged to
objective information. Yes, the stock market could
crash.
Inflation
Commodity prices cannot easily
contribute to published price indexes because they aren't directly
counted.
I
Higher nterest rates are popularly viewed as evidence of Federal
Reserve's restrictive monetary policy. Higher interest rates are not
possible unless financial institutions have pricing power. If
interest rates increase while there has been no slowing in the
growth of monetary aggregates, then the increases are inflationary.
A sudden surge in inflation numbers could cause a crash. Stock
prices are already highly valued. Inflation lowers P.E. ratios by
bringing stock prices down. Inflation lowers the present value of
future earnings.
This week, for the first time, I heard public mention of the fact
that consumers are now financing consumption with margin loans on
stocks. Hedge funds have been leveraged to the hilt for a long time.
Any decline in stock prices could accelerate easily because holders
of stocks are so vulnerable. The stock market has increasingly
become a lagging indicator. It no longer anticipates news but reacts
instead, as news comes out. Yes, the stock market could crash. All
it would take would be a surprise.
James Quillian |
