America's Bubble Economy

0:00Ladies and gentlemen, the stock market like Elizabeth Taylor in the Wall Street Journal is always the same yet always different. Every great cycle is like every other great cycle and yet every one is unique. I stand before you this morning as the world's leading authority – Lou did mention this in his very generous introduction – the world's leading authority in where stock prices are not going. They go up, I say down. One of these days we'll I'd like to talk today in the six hours that Lew has generously given me on the present-day speculative environment, what actually has brought it about, and in general, to try to shed some light on this, the greatest, lustiest, and most flummoxing moment in American financial history.

0:55I'd like also to review exactly how we got here and ask not least one question that on Wall Street never seems to be asked, namely what if any is the distinction between central banking as practiced by our Fed and central planning. If fixing the federal funds rate isn't price fixing, what might it be? And if, indeed, Alan Greenspan and company have discovered the precise rate to guarantee American financial prosperity, where did the Soviets go wrong? And how, if they have not done this, what accounts for this massive suspension of disbelief on the part of people who are almost worshipful of the Fed?

1:45In that context, I propose to talk about the parable of the World Wrestling Federation, which is going public. Any wrestling fans in the audience? All right, nobody's going to admit it. Okay. Now, to begin with, the speculative setting. You know, where to begin, I stand in awe, and one is profoundly humbled. If you're a practitioner in markets, every day brings a new humiliation, otherwise known as learning experience. People talk about a bubble, which to me connotes something feeble, insubstantial or flimsy, but it's hardly flimsy that since the beginning of 1998, the market value of the six biggest and most popular technology stocks has tripled, taking them up to 1.65 trillion, which as Jake LaMotte used to say, is a lot of money even when you say it fast.

2:37The increase in the valuation of these six, that is this 1.65 trillion, is greater than the entire US stock market capitalization as recently as 1982, at the beginning of the great Reagan bull market. In fact, since 1995, which is not so very long ago, the market capitalization of these same six stocks, Microsoft, Intel, Dell, Cisco, Lucent, the market capitalization of these same six has gone six-fold or something, maybe more than that. On one day recently, that is the 3rd of September, there was a bullish employment report released by the government.

3:25On this one day, these six appreciated in market terms by 63 billion, which was 10 billion more than the entire market cap of the 10 biggest tech stocks in 1990. So to recapitulate, on one day, September 3rd, There was a greater increment of market value added to 6 than existed for 10 in 1990. So when people talk about a levitation or a bubble, they really don't exaggerate. These things have never been seen before. A bull market of this order, a speculation, this mass of credit structure, quite this extended, I'll get into that later, has never before been seen. This is all new. It is an elemental force, and to be on the wrong side of it, as I say, is quite humbling.

4:13And I stand before you with many more questions and answers. Why? What has caused this? If we understand that, perhaps we can think more clearly about the future. It seems to me that the one evergreen answer offered to that question is that technology has delivered us into a new age. Cyclicality is no longer a feature of markets. We have reached a kind of permanent high plateau of prosperity. Stability is no longer this kind of will of the wisp. It is upon us. and its stability with a difference, that is, nothing at all stable about the national wealth that forever accretes.

5:05The Internet is a wonderful institution. Is it any more wonderful than electricity that preceded it? Thinking about technology, I have thought a bit about an invention without which the Mises Institute would not have been below the Mason-Dixon line. When Willis Haviland Carrier was awarded patent number 808897 for an apparatus for treating air, this is 1906, little did he imagine of the consequences of what we would call air conditioning. And air conditioning, when you think about it, is a great parable of technology. has delivered innumerable benefits. It has made life from Bombay to Baltimore tolerable.

5:55It has infinitely expanded the wealth of the United States. It has changed migration patterns in the United States. It has delivered up to civilization Orlando and Las Vegas. It has It has given us the 12-month congressional session. Where would the institution of American statism have been without the air conditioner? There are debits and credits for every single technology. The Internet has facilitated the dissemination of American nuclear secrets around the world. It has given us, Lew Rockwell, not once a day, not twice a day, but many times a day. So what is the net of technological advance? It isn't just debt, it's not just credit, but there is a net, there's a net effect of technology.

6:47More than that, the bowls, the super bowls, the unconditional bowls on equities and on the internet and revolution have told us that in effect the progress is seamless, not cyclical. Is that so? If you look at the revolution in air condition, what you find is that it didn't work. In 1930, it didn't work commercially. In 1933, Carrier had to suspend production of its then revolutionary room air conditioner because no one was buying them. Ah, you will say that was a depression. Well, yes, I say it was a depression, but note that innovation did not forestall the depression. So those who would contend that a new age has been delivered by technology are arguing without facts.

7:35Electricity, coming into commercial application a hundred, say, years ago, produced, theoretically, doubled or tripled the workday, which I guess is a good thing. Was that not productivity? Of course it was. The automobile, and so forth and so on. All these things have immensely enriched human life, in Life, but they have not delivered us from what we know on Wall Street as ups and downs, to speak technically. So I submit to you that technology alone can't explain stock market valuations and stock market speculation that is literally unprecedented, I think, in all markets and in all countries.

8:21Perhaps Japan accepted ten years ago. So what then might explain this, and technology explains it in part, this is indeed an age of miracles. Life is ever so much easier than it had been only a generation ago, but that alone cannot explain what could be called, I think, fairly a bubble. Well there is another, a much more pedestrian observation we made about American financial Markets and the American Financial Prosperity, and that is that Wall Street has found a benefactor in the federal government. Federal subsidy of credit expansion is a very, very important element in this unique moment in American finance. The Federal Reserve system is institutionally as a bank and you can't examine its balance sheet, they publish it weekly, unaudited.

9:20Burt Ely, who will see to that one of these days. But if you add up the assets in the Fed and do a year-over-year check of its growth, the Fed has expanded its footings, its balance sheet, by almost 10 percent. Well, is the economy growing at 10 percent? Why is the Fed expanding its assets? Why is the Fed delivering this stimulus to an economy that shouldn't need it, right? I mean, this is a new age. So the Federal Reserve system is an author or a co-author of the financial underpinning to this Great Speculation. Then, too, there are the so-called government-sponsored enterprises, the handmaidens of the Fed, outfits that do a very brisk financial business that are beloved on Wall Street because they are what is known in the trade as a great account, but which also must be included on any list of financial benefactors to the American speculator.

10:13To pick one of the biggest, Fannie Mae, the Federal National Mortgage Association, Fannie The Fannie Mae expanded its balance sheet in the 12 months ending June 30th by about 25%. Its mortgage portfolio is up by about 40%. The Fannie Mae is not creating credit, but it's facilitating the creation of credit by other institutions. Ditto the home loan banking system, ditto Freddie Mac, which has just hired our former leader Newt Gingrich as a consultant. So, one important observation about our prosperity is that it is subsidized in part. Credit is expanding briskly, money supply is expanding briskly. The broadest measure of money supply, M3, has been growing by upwards of 9.5% or so over the past couple of years.

11:03So yes, there is, in fact, a great miracle being wrought in the business of production. But there is also terrific fuel being poured into the engine of speculation. And every great bull market has a proximate cause. It has a reason. I mean, people didn't imagine that the automobile did great things in the American economy in the 20s. People don't imagine now that the microchip has done wondrous things for the economy in the 90s. But there is more to it than innovation. I promised you at the start the parable of the World Wrestling Federation, and to tie this into the actions of our Federal Reserve Board.

11:55Thanks to the Internet, you can go online and do key word searches, and I suggest you might try the following experiment right in your own homes, as we've done at Grant's. Ask the computer, who knows so much, ask him, her, to find, to match the words, Greenspan and God. And as the bookend to this exercise, ask the same omniscient thing to match for gold and Nazi. Again, you will not come up empty-handed. The market collectively, individuals en masse have credited a Federal bureaucracy with powers of intuition, of knowledge and of foreknowledge that are unique in the history of the public sector.

12:58Alan Greenspan was once a fellow in a business suit trying to make a living by telling the future, and he didn't fill many rooms. He was a good economist, but he was an ordinary guy who got up in the morning and went to work. How did it happen that Alan Greenspan became omniscient? Can anyone pinpoint the moment? Was there a federal program in which you participated? Was there adult education? What caused this? How is it that federal employees meeting in committee can set the one interest rate ostensibly that brings us unchecked and no longer cyclical financial progress and 20% per year compounded rates of return in the stock market?

13:43Well, it's absurd when you talk about it, isn't it? It simply doesn't make sense. And I think that I could ask any political, any audience with any politics to imagine the implausibility. This is not merely a libertarian or Austrian perception. It simply doesn't make sense. The suspension of disbelief is one of the secret engines of American Speculative Prosperity. When Stone Cold Steve Austin meets the executioner and there is a double flying dropkick laid on him or somebody breaks a chair over Stone Cold and says, we don't think that somebody is going to the hospital really, do we?

14:38World Wrestling Fans, of whom there are millions in this country, suspend disbelief willingly for the pleasure of the entertainment. Now we find in the pending public offering of the World Wrestling Federation, the perfect parable of the Federal Reserve, Dow 11,000, and this moment in finance. A little like day trading or speculation by the public, the World Wrestling Federation has come from nowhere into ubiquity. Financial results of the past five years show revenues on average in the first three years of $85 million per year. Last year there were $250 million. World Wrestling lost money in two of the three years, 95 and 97, this first three years work period.

15:26It made $30 million or so last year. The Enderwright has proposed to capitalize this company at 150 times the average of the What do they mean by this? They mean to say that wrestling is no longer cyclical. They mean to tell us that it will continue as it has been for the past 12 months. They mean us to overlook the fact that wrestling, like so many other entertainments, has had its moments in the sunshine, its moments in the shade. Roddy Roddy Piper was not a centimillionaire on the strength of his performance. And presumably this issue will blow out the door like so many have because people are willingly suspending their disbelief.

16:14Now, I'm going to stop in a moment and I'd love to take a question or two if you have any. Again, I stand before you not as a dogmatic savant about markets. about markets. If you are in the business, you are necessarily humble. It's not something you have acquired on Sunday mornings. It is a very humbling business, this Wall Street business. But I do, so to contend is, I guess you will hear others contend that the market is wrong and that one's self is right is a very, very big and bold claim, especially in view of some of our track records, but that is in fact my conviction, and let me try to, in winding up, let me try to strike an Austrian theoretical note in the context of the present day market, in the present day bubble. One of the hot new books out in the stock market, and there are a myriad of them, is something called Dow 36,000. Two very smart people have written it, one is a James Glassman, nice guy, I know, he's

17:22The American Enterprise Institute, and they contend that the stock market has systematically been undervalued by Americans who have not seen that the risks of owning equities over a 20-year holding period are in fact paradoxically lower than the risks of owning government securities. It is their assertion that stocks ought to be three times higher on aggregate than they are now. And then they propose that any moment, a tripling of the market will begin. Now it seems to me that many arguments can be arrayed against this. In fact, we tried to do that in the issue of grants I think you have back there. But I think the central and most interesting fallacy from the point of an Austrian analysis is that these fellows don't see the market as something that, they don't see market action and market valuation as having consequences apart from a theoretical marker of one's own wealth.

18:22They don't see that if stocks were tripled, then people's behavior would change and that the architecture of the economy, as it were, would be corrupted. The easiest way, to me, of imagining what would happen, if they were right, is to say what would happen if real estate values tripled tomorrow? Well, people would build, right? They'd build and then build and then overbuild. There would be a massive credit expansion to finance the construction of real estate, now triple in value. Landlords, however, would have to fight to keep their tenants, right? Because the population of tenants wouldn't triple. So rents would come down, landlords would cut rents, profit margins would shrink, and at the end of this bubble, the real estate business would be worse off than it had been before values tripled. In other words, the change in the value of an asset class generates changes in the way people capitalize themselves and capitalize their businesses Businesses and the structure that the economy takes. It becomes much more capital intensive

19:29if you mark up the value of capital. And I will leave it to people much more knowledgeable about the theory of this than I to elaborate on that as the days go on. There is no quarreling with the result of the financial environment in which we are are privileged to live. It has been merely stupendous. But as the French say, the practice is fine, but what about the theory? So with that, I got a few minutes. I'd love to take a question or two. Yes, sir? The question is on this confection called the euro, the pan-european fiat currency.

20:17The United States dollar is the ivory soap of monetary brands. It has market share, it has everything that an advertising agency could want in a product the dollar possesses. It is virtually the monopoly money of the world. This has caused no end of irritation of people who don't live in the United States. If you remember back to the 60s and the 70s, the United States would rather high-handedly, periodically change the value of the dollar at the expense of the economies of continental Europe and Asia.

21:06So the impetus for the creation of a euro, this goes back to the snake and other monetary adventures in the 60s, the impetus for this was in good measure political. Europeans were tired of an an Imperial Dollar and wanted a bit of their own. Jacques Rouef, who was a very solid thinker about monetary matters, deplored in the 20s the Imperial British Pound and deplored in the 50s the Imperial American Dollar. And these pleadings were heard and Europe set to work to create a competitor currency. It wants to create a currency that will serve The Federal Reserve is a reserve unit for the world in competition with the dollar. Is the euro something that one should hold or would hold?

21:53I don't know. I have a blind spot in monetary matters. I should confess my own personal financial interests. I'm very bullish on small Japanese stocks because I think they're being given away, or have been given away. I'm very bullish on gold. The first idea is working. is hopeless. Gold is the dog of dogs. And if the bears think they're bearish on it and they're disgusted by it, they ought to talk to the bulls. I can't stand it anymore. But I buy it because I think that in a world of competitive evaluations, in a world of very insubstantial monetary systems, Goal will one day reclaim some measure of market share in this monetary marketplace.

22:43So I think that the euro is not the worst idea for Europe given the politics of the situation. I have absolutely no confidence that this band of bureaucrats in Europe will fix on the right quantity of money, the right credit arrangements, the right interest rate. I think they're doing things that are wrong that the Fed has done. It wasn't very well said. I think that they are making many of the same mistakes the Fed has made. But I think unless you see it in the context of political competition, you can't properly handicap the race. So I think that the Germans want a weak euro, the French, for reasons of prestige, want a strong euro. Everyone wants a euro that will compete with a dollar, and a part of me thinks that they ought to have that.

23:33This is the saddest story ever told. I'm trying to think of all the things that should have made gold go up and haven't. I'm thinking about the serial currency disaster of 1998. I'm thinking about the disestablishment of the Deutschmark, one of the few relative success stories in post-war fiat monetary annals. I'm thinking of the record and growing U.S. current account deficit.

24:19I'm thinking of stupendous institutionalized short positions by producers. I'm thinking about the stupid mispriced facilitation of that short selling by central banks through gold lending operations. None of this matters except to assure a new low in the bullion price. There is no market like a bear market. I own this stuff. I own mining shares. I will continue to own them. Some of the mining shares have done pretty well considering the gold price. The only thing I can say is that it acts miserably. It's not validating the bullish On the other hand, things often don't work, before they do work. In January of 1980, gold bullion spiked $850 an ounce. The United States was on the verge of a Weimar inflation.

25:07You could see it, you could read it in the marketplace. Well, nuts, it was not. You should have sold gold and bought bonds, right? Bonds were 9%. 9%. Well, bonds proceeded to go to 15% after they should have gone down in yield. That's what lends the poetry and the majesty and the mystery to what we do in Walter. It never works. It's always flummoxing. You never get it in a good night's sleep if you're invested. So, well, it's not exactly true. The weekends are okay. So, I'm a firm believer in the ultimate I think the federal response would matter if they wanted to make that decision.

26:18is aggressively easy, meaning it will aggressively chop the one thing it can chop, the federal funds rate. It has done so every time it has had the pretext, and it doesn't always work. The Bank of Japan cut rates now to their zero, and it was a very long, it's been 10 years in that market. Interest rates were sensibly zero in this country during the 30s. But to answer your question, I do believe the Fed will aggressively intervene to reduce interest rates and to facilitate a credit expansion in the face of a very dramatic fall in stock prices. One and all, I thank you. I thank you for your indulgence with my hurricane-induced time and exit. Thank you.