Stupid Money and Market Bubbles
by Gwydion M. Williams
Money is a crude way of running a complex society. Its big merit is that cash ties work when all else is falling apart. If the money keeps flowing, you will go on making goods for those you do not know, stay dependent for food, water and transport on people you’ve never met. When there are no agreed moral standards, the asocial exchange of cash can keep things ticking over.
This does not mean it’s a perfect system, or even a very good system. Money has no meaning without a fairly complex society where people will make more good than they need personally, in the hope of selling them. And only in the 20th century did money lose its link with gold and become token money, backed by the trustfulness or otherwise of the state that issued it. The value of the dollar rests on the US state guaranteeing that dollars can buy US goods and services. In the case of roubles, there was little to buy and inflation reduced their value, whereas West Germany chose to give a fictitious value to East Germany’s currency as the price of a peaceful takeover. That’s how ‘real’ money is.
Money cannot exist in a social vacuum. But it can exist for a time in a moral vacuum, with people working a system they do not like or trust.
From the late 1940s to the mid-1960s, the West had an agreed morality, what we now call 1950s morality. It featured low crime and an acceptance of tax-and-spend plus nationalisation: Keynesianism was a semi-capitalist system. But white males held almost all the power, there was no acceptance of sex before marriage, a whole host of social attitudes were different. The future was for everyone to be benevolently turned into clones of a bland Mid-Atlantic middle-class culture.
The old morality was successfully undermined in the 1960s and 1970s. The hope of the protestors was to replace it with a new and more humane moral order. This may well be the long result, the biggest changes in family life since the neolithic will take time to work through. It’s been less than half a century, not a long time in the history of civilisations. But the chance of creating a new morality in the 1970s was there, and it was missed. Workers wanted control over their own lives, and more collectivism through Workers Control was one way this could be done. When this was rejected, workers took another way, more freedom as individual consumers.
Thatcher and Reagan in the 1980s chose to undermine the social and economic underpinnings of Keynesianism, rather than seriously try to re-impose the old moral order. Mrs Thatcher—who had lacked the flexibility and imagination to be a successful industrial chemist and whose career flourished only after she secured a rich husband—was and is a believer in the New Right talk of returning to old-style morality. But greed was the thing that the critical ‘swing voters’ went for.
In terms of GNP growth, Britain and the USA have done no better than they did under Keynesianism. In the USA, where the New Right were believed, middle-income Americans have simply been swindled out of the increase in wealth they should have had. The whole benefit has gone to the richest 10%, and especially a stratum of some three million millionaires. The US Supreme Court helped with this process, by finding that legal limits on the amounts candidates could spend was an infringement of Sacred American Freedom. It doesn’t mean you can buy an election, bad candidates have spent a fortune and flopped. But it does mean that the political system is much more biased towards the rich than it is in the UK.
‘Deregulation’ was the watchword of the 1980s and 1990s. Take out the silly bureaucracy and let the ‘wealth creators’ get on with it. They created wealth, indeed. But it was fools gold, invented wealth, accountancy tricks by people who couldn’t run a complex business venture any better than other trained and clever rivals. Everyone wanted to be the best, but those who were actually only so-so kept going by cooking the books.
That’s the rule for places like Enron and WorldCom, where there was an intent to create wealth by superior management skills, and where the fraud may have begun in the hope it would all be fine in the end. Forked-tongue accountancy comes naturally enough in a culture that praises clever and successful cheats—look how long Jeffrey Archer lasted!
There is worse than Enron, stuff that was never intended to be honest. In America, the life savings of middle-income fools has been ‘lifted’ by rich crooks who talked the market up. It is hopefully not so bad in this country, but private pensions are a useful source of ‘stupid money’.
‘Stupid money’ is not a term you will find mentioned in the standard accounts. But if ‘smart money’ does better than the market average, this can only be at the expense of those who do worse, maybe losing everything. If ‘smart money’ gets out in time, someone else has been left with worthless paper.
Money means nothing except as a measure of the total goods and services for sale using that currency. Print more—or create more using accountancy tricks—and you are floating a falsehood. Either the money is real, in which case you get inflation, too much money chasing too few goods. Or the money supply remains constant, and someone else suddenly finds that they have lost money, the shares they bought for £10,000 are now worth only £5000 and the extra £5000 potential spending has gone elsewhere.
Smart money depends on ‘stupid money’ to balance the books. Obviously no one starts investing with the intention of being ‘stupid money’, just as no one goes betting or gambling with the intention of enriching the bookies and casino owners. But that’s the way it works out.
The majority of investors were convinced that they would be included among the elite group. Obviously a promise like that cannot be met. But there are a lot of stupid short-sighted people out there, and they may soon go back to blaming the government.
We are told now that the Telecoms bubble has been ten times bigger than the dot.com bubble. It was the same error, the theorists of McLunatic globalisation overselling a real trend. Computers are important, the internet is spreading fast and Telecoms are part of it. But with vast numbers of clever people well aware that these are growth areas, the rather-clever will inevitably lose out to smarter or luckier rivals. This is how the whole wealth of Marconi was frittered away, by an ‘imaginative’ program of buying up Telecoms companies that were seriously overvalued.
At the time of writing (26th June [2002]), shares are still 25% overvalued, by the standard measure. And that’s assuming honest accountancy, which is just what’s been lacking. The figures this evening are Dow Jones 8264, London’s FTSE 4016, Nasdaq 1262 and the Euro worth 1.0128 dollars. If shares are really still overvalued, we may expect figures of maybe 6200, 3000 and 950 to be reached over the next few months. I do not have stocks myself, except a tiny holding in the former Building Society still called Alliance & Leicester. But I do have to worry about what my pension fund might be doing. And holders of endowment mortgages and share-related insurance have a whole lot more to be worrying about. Not to mention the ordinary Enron employees who suddenly found that they had lost their jobs, their savings and their pensions.
Shares have a value based on earnings, that’s real and mostly reliable—though not if you stuck loyally with GEC when it ‘reinvented’ itself as Marconi. Then there’s speculation based on a genuine belief in future earnings. That was the logic behind the dot.com bubble – anyone who bought Microsoft or one of the other winners at the right time would have done splendidly, and Microsoft remains sound. But the same rules apply as in the USA’s various gold-rushes—most of the money is made by people selling things to the fortune hunters, and most of the rest goes to enthusiasts who were there already.
In Alaska, six times as much was spent by newly-arrived prospectors as their was gold taken out. And almost all of it was wasted, with the main wealth going to the ‘sourdoughs’ who had been there for years from a simple desire to live that way. Bill Gates, Steve Jobs and the rest were ‘sourdoughs’ in the world of software and personal computers, they basically just liked it in the same way others enthuse over model railways or recreating battles in the English Civil War. They had no idea they were going to grow rich that way, they just made intelligent use of the chances that came their way.
Remember the Goldrush Rule. If you can find an ‘opportunity’ on the business pages of a national newspaper, almost everyone likely to invest also knows. You could be lucky, just as you can be lucky betting on horses or at a casino. But it’s a ‘sucker bet’, and you should also wonder if some smart operator might have bribed or flattered financial journalists to ‘talk up’ a share which they can they sell for an undeservedly high price. For that’s the third way to grow rich, ‘bubble selling’. You know the price is too high, but figure it will go higher and you can get out in time. And this also is why ‘shareholder power’ will not work—is not in fact a cure for problems that have got worse and worse as ‘shareholder power’ has been advancing.
Consider the following scenario. Mr Worldly Wiseman, multi-millionaire with a fortune honestly made from Bunyan Enterprises, buys into Enron in the sincere belief that it’s a great business. He asks questions of its senior management, as is his right, and soon realises all is not well. He maybe reports malpractice by senior managers to the top bosses and finds them curiously uninterested. It slowly dawns on him that this is not a great business, but in fact a disaster waiting to happen.
What does he do? Take action to try to correct it? This would mean a big fight and a risk of huge losses through a share collapse which he might then be blamed for. Some people would speak out for truth regardless—there are moral and ethical people even in today’s climate of business sleaze. And yet his own self-interest lies in quietly selling off his holding, and then advising his friends to do the same.
Most of the New Right ‘solutions’ founder on the difference between grand abstractions like ‘shareholder interest’ and the specific interest of particular individuals who own shares. Mr Worldly Wiseman can only be a smart-money success if he finds corresponding ‘stupid money’ in the share market that will sell too cheap or else buy too dear. Bubbles and frauds are a nice opportunity, especially if he personally took no part in them and cannot be blamed.
Outside of economics textbooks, markets are not self-correcting. The destruction of fish stocks has been blamed on the lack of definite ownership. But what about the increasing blight over the centuries of the lands round the Mediterranean, every scrap of which has always had an owner, mostly a peasant farmer? History and archaeology tell us that these lands were once wooded and fertile, but gradually got stripped and eroded. The best survivor has been state-dominated Egypt, though maybe just because of the geographical accident of the Nile bringing fresh soil as well as water.
Puffing up shares is bad for shareholders as a group. But they aren’t a group, they are a set of separate individuals, all of them trying to be ‘smart money’ at the expense of the rest. Any investor who notices a fraud or bubble has a strong incentive to let it happen and sell before the shares crash.
And that’s just with owner-investors. A fund manager has more options, the option to accept bribes and let it happen at expense of those he or she is supposed to be looking after, it would be hard to prove any wrongdoing.
Imagine the following scenario. Tom, Dick and Sally each manage 10 investment trusts.
Tom buys at a high price what Dick and Sally have bought cheap, say Internet Teddybear Picnics. Tom helps pump it up and on the face of it has lost, made a bad decision. Or rather his No.3 fund makes a loss. But meantime funds No.4 and 5 doing nicely, this is Dick and Sally working the same trick in spirit of reciprocity, giving him a nice profit on E-mail Doughnut Deliveries and Dali’s Floppy Mobile Phones. So he can advertise his successes on funds No.4 and 5 with their above-average returns, and hope the rest will be overlooked.
Market economics are called ‘rational’. But when you analyse this ‘rationality’, it is built about some very strange beliefs. Market ‘rationality would be better called the Law Of The Immaculate Consumer.
The key assumption—what they call rational and what I call the Law of the Immaculate Consumer—is that people in a free market will always act according to their own best interests. Economic models are built on the assumption that they do not panic, get greedy, follow fashion or make gross errors. If pressed, economists will admit that individual consumers do do such things. But a mass of human and imperfect consumers are assumed to spontaneously assemble themselves into an entity obeying the Law Of The Immaculate Consumer. All mathematical economics is built on this assumption.
The Law of the Immaculate Consumer would tell you that managers given bonus incentives to boost share prices will not engage in all sorts of flimflam to give those share an unreal price. Myself, I’d sooner believe in virgins having babies by Divine Grace. (I find it surprising that conventional Christians will accept that the creator of the universe might have arranged for a particular baby to have been born 2000 years ago, and yet balk at a little think like pregnancy without sex, which is already entirely possible just with human medical technology.)
Actual businessmen working in mundane world of commerce are sometimes devout Christians or Jews or Muslims or Hindus or Buddhists. They show no belief in the Law Of The Immaculate Consumer in their own work, though it is nice to cite it as a ‘general truth’ so that social regulation is not applied to them. It’s always true—except in my back yard!
Private business used to be dominated by a culture of ‘managerial excellence’. People would often work for the same company all their lives, more than two or three was unusual. The ambition was to be part of a great company and to produce a product you could be proud of.
The ‘shareholder revolution’ changed all that. How dare the managers think about workers or products or anything except return on capital? Economists like Hayek, as well as Ayn Rand who was Alan Greenspan’s guru, assured us that managers who followed the dictates of the market would do much better. Their reasoning was flawless—assuming that the Law Of The Immaculate Consumer to be true. But then why so many market bubbles?
Back in the 1960s, a stock market crisis was a problem for rich investors, not for ordinary people. But changes to pensions have meant that everyone now has a stake. Wealth siphoned off by ‘smart money’ will ultimately come from the impoverishment of pensioners who were counting on private pensions to keep them secure and comfortable. There’s a lot more I could say on this, but it really needs another article, hopefully next month.
Long Revolution 