The Fictions of a Free Market
What is delightful about James Galbraith's The Predator State is that he says things that are, at once, outrageous-- and completely true. Because he shows so little concern for what one "can" and one "cannot" say in a polite capitalist society, one might call him an idealist. But Galbraith is not tilting at windmills; he is simply toppling the conventional wisdom of the past 28 years.
Begin with "the market." When you come down to it, Galbraith explains, "the market" is a fiction. In theory, "it is the broker, the means of detached and dispassionate interaction between parties with opposed interests. . . . Buyers want a low price, sellers wants a high price. The market works out the price that exactly balances these desires, a price that is fair because it is the market price." Even liberals believe in this mythy "market"--a higher intelligence that hovers over transactions ensuring that, as long as you let "the market" work its magic, everything will work out for the best
But Galbraith points out that when you try to define the word "market" you find that it is merely a negative. It refers to the "context of any transaction so long as that transaction is not directly dictated by the state. The word has no content of its own because it is defined simply, and by reasons of politics, by what it is not. The market is the nonstate and thus it can do everything the state can do but with none of the procedures or rules or limitations. . . . it is a disembodied decision-maker--a Maxwell's Demon--who somehow, and without effort, balances and reflects the preferences of everyone participating in economic decisions. . . . It can be these things precisely because it is nothing at all."
Yet who dares to say there is no wizard behind the curtain? "Can anyone in modern American politics . . . deny [the market's] existence, or even its relevance?" Galbraith asks. "To do so would be political suicide--precisely like denying the existence of God." The best that a liberal economist can do is to "hedge and qualify, at the margins." One can say that the market "may be imperfect, that under certain conditions it may fail."
Meanwhile, take a look at the last quarter-century of this country's economic history, and you have to acknowledge that Reality offers what Galbraith calls "an overwhelming critique of the very concept of the market."
Supposedly, the consumer stands at the very center of the market, and supply responds to his demands. With, of course, certain exceptions. Such as Detroit, where, for some reason, the consumer's plea for affordable, safe automobiles has fallen on stone-deaf ears. Or the pharmaceutical industry which, for reasons of its own, persists in turning out newer, better allergy medications when what we would really like, please, is something that might delay the onset of Alzheimer's. But Alzheimer's research is expensive. Moreover, there is a saying in the drug industry: "a pill that cures is good; a pill that you take every day is better."
To be fair, consumers embraced the mammoth, exorbitantly expensive, gas-guzzling cars that 'the market," in its wisdom, offered us--even after we learned that sometimes these cumbersome vehicles tip over.. Maybe we didn't "demand" the SUV, but when Detroit told us that this is the vehicle we needed to feel safe, affluent, and well--above it all--we lined up. And we keep on buying the allergy medications, paying more for them each year (even though medical research shows that half of all Americans who take these pills do not suffer from allergies.)
Supposedly, consumers hold sway over the market because they are savvy shoppers. They refuse to overpay. They always wait until competitors come in and drive prices down. They insist on quality--and results. They learn from the past, and remember what they learned. In short, as Galbraith puts, it market enthusiasts believe that "economic man is a machine to whom whimsy and evolution are unknown."
But "in practice," Galbraith observes, "man is inconsistent; changeable; sometimes, though not consistently, irrational; his judgment biased and distorted and influenced by his peers."
The bull market of the 1990s proved just how irrational humans can be. Ignoring every sign that the market was over-priced--from spiraling price-earnings ratios to a Fed chairman talking about "irrational exuberance"-- investors piled on, buying companies that, in some cases, didn't even have a product. Thenm when technology stocks began to dive, many individual investors kept on buying, like gamblers who believe that if they just stay long enough in the casino, their luck will turn.
At the height of the frenzy, supposedly sober journalists talked about how stratospheric stock prices represented "the collective judgment of millions of people around the world." The New York Times' Thomas Friedman celebrated the democratization of the financial world: "One dollar, one vote." The market, Friedman declared, had "turned the whole world into a parliamentary system . . . [whose citizens] vote every hour, of every day, through their mutual funds, their pension funds, their brokers and more and more, from their own basements via the Internet."
The metaphor fueled faith in "the wisdom of the market." Who could question prices set by millions of voters? According to the received wisdom, in 1999 AOL was worth 305 times its previous earnings, while IBM was fairly valued at 28 times earnings, because more people had voted for AOL.
If investors actually picked stocks while seated in sealed voting booths, one voter might be able to correct for another's mistakes. But people who buy stocks are social creatures, and be they pros or fledgling 401(k) investors, they are influenced en masse, by the spirit of the times.
In short, they talk to each other. Galbraith explains: "modern behavioral economics has begun . . . to show that the actual behavior of presumptively competent people" does not "correspond to the predictions of rationalist theory." Whether they are picking stocks or deciding to buy a car, "ordinary, intelligent people appear consistently unwilling, or unable, to calculate the consequences of their decisions in a manner predicted by the view that they are responding purely to the market. Instead, they act as social beings, concerned about their standing with their peers, about the fairness of the deal they are being offered, and other matters quite irrelevant to the utility of the object or money on offer."
There goes another piece of conventional wisdom : "The wisdom of crowds," it turns out, is just a catchy title for a book.
For, as every Wall Street veteran knows, in our competitive free markets, stocks, (and other products) are not "bought" they are "sold."
"In the real world," Galbraith writes, "the autonomous individual is not the active agent who matters most. . . Advertising is propaganda . . . and markets are controlled by large organizations that have the capacity to decide what will be produced (i.e. SUVs); "the capacity to adjust the presentation of such products to what research and experience indicate the public will actually buy" (i.e. allergy medications) and "the capacity to influence the public's buying preferences through advertising."
But what about the consumer's "freedom" in a free market--our freedom to say "yes" or "no"? Galbraith explains that we are "free to choose only among a menu of items set out for sale." Large corporations with "substantial political power" have control over "the design of products . . . the pricing and the distribution" and "the planned obsolescence" of those products. Galbraith explains: "The freedom to shop is, for the rest of us, an incident to this freedom."
Finally, of course, our freedom to shop is constrained by how wealthy we are. Whenever anyone, liberal or conservative, talks about the importance of Choice in a free market, and how Americans like to be able to Choose from a menu--beware. This is especially true if they are talking about something important, such as health care or education.
Too often, "choice" means that we are "free to choose"--in fact forced to choose--what we can afford. When it comes to health-care "menu" is code for a tiered system If you are middle-class, even if you are upper-middle-class, you may find that reformers who promise "universal coverage" are, in fact, offering an array of "choices to fit every pocketbook." And unless you happen to be perched on the top step of a five-step economic ladder, you may well discover that the only insurance policy that fits your purse really shouldn't be called "insurance." Either the co-pays and deductibles are so high that you can't afford to use it--or when you do use it, you'll be told that the treatment you most need isn't "covered." So-called "Swiss cheese" policies are filled wiht holes that open, like trap doors, when you most need protection.
As for education, Galbraith notes "he concept of a freedom to shop has been extended insidiously . . . into the realm of careers where it plays even greater havoc with the normal use of words. In a 'free' capitalist society with private schools and universities free to admit whom they please and charge what the market will bear, the freedom to choose one's profession becomes, in part, the freedom to become what one can afford to become."
Does Galbraith have a solution? Yes. The rule of law. This is why we have government--to pass laws and regulations, and to enforce them, with an eye to the public good. The predator state is a state of anarchy where lobbyists have persuaded Congress that they own government.
But all of the campaign contributions in the world will not help a legislator if his constituency has decided that he doesn't deserve to remain in office. Lobbyists don't yet own our government. Voters still have power. They just need to remember what the world was like before 1980. It wasn't perfect. But it wasn't ruled by predators, either..
.
Don't take for granted that the vote counting is fair everywhere. The predators are out to rig our elections, too, and we'd better not forget it.
-- ARG
August 11, 2008 5:13 PM | Reply | Permalink
ARG--
I realize you're right.
But I do believe that they can rig an electoin by only so much--by 1 percent, 2 percent--but not, I believe, by 6 percent or 8 percent. Not yet. It would be too obvious.
We need really good grass roots organizing around certain issues--like Medicare, galvanizing seniors to take out the legislators who are putting for-profit health care lobbyists ahead of seniors.
Do you remember the "grey panthers"? In the 1970s, they were the over-65 version of the Black Panthers. And if they targeted a legislator, he would have a hard time holding onto his seat.
August 11, 2008 6:23 PM | Reply | Permalink
The bull market of the 1990s proved just how irrational humans can be. Ignoring every sign that the market was over-priced--from spiraling price-earnings ratios to a Fed chairman talking about "irrational exuberance"-- investors piled on, buying companies that, in some cases, didn't even have a product.
That was largely because we do not have a free market in money, but rather have worthless paper imposed upon us as "legal tender" by the government. This allows the government to manipulate credit, and to give loans far in excess of what has actually been saved aside.
Most speculative booms are the direct result of the government's meddling with the money supply.
August 11, 2008 6:46 PM | Reply | Permalink
With, of course, certain exceptions. Such as Detroit, where, for some reason, the consumer's plea for affordable, safe automobiles has fallen on stone-deaf ears.
Yes, if only there were some way that we could buy cars from places other than Detroit. If only there were such a thing as foreign imports and if only people could buy affordable, efficient automobiles from them if Detroit won't listen to them...
The fact of the matter is that cheap gas prevented Americans from caring about getting more efficient cars. That is likely to change very quickly, even absent government intervention.
August 11, 2008 6:51 PM | Reply | Permalink
Glavester--
You are right: consumers could buy more fuel-efficent foreign cars. But advertising is very powerful. What we need in the U.S. is appropriate govt' regulation could set standards for American cars--in terms of gas consumption and safety. (For Galbraith "standards" are an important issue.)
Yes--cheap gas meant that many Americans didn't care about efficent cars. This is why we need govt to oversee the public good and set standards for certain products. This is why we have seat belts, standards for toy safety, etc.
As for the bull market, certainly "easy money"
and the ability to borrow and buy "on margin" at low cost contributed to the frenzy.
But the average individual investor wasn't borrowing to buy stocks. He was simply responding to the advertising for the bull market (in the financial media and in the mainstream media.) And he was responding to what his neighbor said about how much he had made.
August 11, 2008 7:48 PM | Reply | Permalink
Just how much did the "average individual investor" lose in the "bull market of the 1990s"? or even that part of it following Greenspan's irrational exuberance comment (the "bubble" of 12/1996 -- 3/2000)?
And I'm not talking about the loss of phantom wealth "earned" by virtue of other people bidding up the prices of stock the average investor already owned. No; I'm talking about money they put into the market and lost when they sold.
I'm betting you -- and Dean Baker and the rest of the "Ooh, ooh; the dotcom bubble was terrible" crowd -- have no idea what the number is. And if you have no idea, then, it's time to stop pulling this red herring out of your bag of polemical tricks every time the conversation turns to the claimed failure of markets.
August 11, 2008 8:17 PM | Reply | Permalink
red herring, meet straw man: does the phrase "average individual investor" appear anywhere in the post?
August 12, 2008 8:32 AM | Reply | Permalink
oh never mind. you were replying to her response. my fault.
August 12, 2008 8:33 AM | Reply | Permalink
Yes--cheap gas meant that many Americans didn't care about efficent cars. This is why we need govt to oversee the public good and set standards for certain products. This is why we have seat belts, standards for toy safety, etc.
Okay, then stop this B.S. about how in "Detroit, where, for some reason, the consumer's plea for affordable, safe automobiles has fallen on stone-deaf ears." You are not saying that the "market" did not deliver to consumers what they want, but that the consumers did not want the things you think they should want.
But the average individual investor wasn't borrowing to buy stocks. He was simply responding to the advertising for the bull market (in the financial media and in the mainstream media.) And he was responding to what his neighbor said about how much he had made.
But "easy money" affects every single credit market, not just the stock buyers. And moreover, so what if the average investor was not borrowing to buy stocks? Those who were were driving up the price, affecting everyone else.
Like it or not govermments have always meddled with the money supply, no matter what the coin of the realm was made of, paper money is no worse in this respcet than anything else.
Yes, it is, because the government can print as much of it as it wants. The paper money (or electronic money) supply can be tripled, quadrupled, dekupled in a week. You can't do that with gold.
Moreover, the real issue is that the government can force us to accept dollars (they're called "legal tender laws"). If people were freer to use alternative currencies (if they desired) and to refuse payment in dollars ifthey so choose, then the government could only manipulate the money supply so far before people would stop using the government's money.
In any case, blaming the stock market bubble or our low savings rate on "the market," rather than on government inteventions, is completely wrong.
August 12, 2008 8:23 PM | Reply | Permalink
I thought that "The Wisdom of Crowds" was excellent, and Mr. Surowiecki went on at length about the forces that subvert the effect (as you say, of social pressures, or herd mentality). I didn't find anything in it which contradicts what you have to say here (with which I largely agree), and suggest that you read the book, or, if you have already, refrain from mischaracterizing it.
August 11, 2008 8:27 PM | Reply | Permalink
Re: Or the pharmaceutical industry which, for reasons of its own, persists in turning out newer, better allergy medications when what we would really like, please, is something that might delay the onset of Alzheimer's.
You seem to assume that such a drug already exists, and that the Rx industry is failing to market it. This is tin-foil hat land.
Re: Moreover, there is a saying in the drug industry: "a pill that cures is good; a pill that you take every day is better."
I suspect an Alzheimers drug would need to be taken every day, much as HIV meds, and the newer cancer drugs (google Glevec for an example) do. Alzheimers is a common disease and worthwhile drugs for it would find a wide and profitable market. You'd have a better point if you posted about the lack of drugs and research for rare conditions.
Re: Most speculative booms are the direct result of the government's meddling with the money supply.
Like it or not govermments have always meddled with the money supply, no matter what the coin of the realm was made of, paper money is no worse in this respcet than anything else. The real issue here is that anything we ascribe monetary value to-- from paper money to precious metals to shells to wampam-- is a public fiction. That value exists only because we (all of us) believe it does. And because belief is ultimately subjective the value of meony is always free to fluctuate-- or be manipulated.
August 11, 2008 8:50 PM | Reply | Permalink
Ellen--
Thanks for your comment.
Here are some facts regarding what happened to the individual investor:
By 2002 100 million investors had lost $5 trillion--or 30 pecent of the wealth they had
accummulated in the stock market--just since the spring of 2000. These were almsot all people who "bought high" and "sold low,"
The Vanguard mutual fund company's reseach shows that 70 percnent of 401-k invesors lost 70 percent of their savings during the three years ending Dec. 31 , 2002 ---with 45 percent losing more than one-fifth.
Those who how could least afford it lost the most. The vast majority of middle-income investors came to the market AFTER 1995 lost more than they invested. (You'll find foonote to reputable studies on this in my book Bull!)
August 11, 2008 9:25 PM | Reply | Permalink
Kindly note that I excluded the silly Vanguard type "study" in my initial question -- and not only because it suffers from starting/ending date bias.
I asked specifically not what portion of their virtual wealth, a " paper wealth" which was created by others bidding up the prices of stocks these "average investors" already held, they lost but what part of their actual cash investments* they lost.
As I said -- and can now say once more -- you don't have the slightest idea of the amounts in question.
* We might wish to know, as well, what percentage of their total assets these cash investments in the stock market comprised.
August 11, 2008 9:59 PM | Reply | Permalink
i guess i don't understand your pre-occupation with making an arbitrary distinction between 'average' investors and 'others'. nor do i see the relevance of insisting on hard figures for actual cash losses. the virtual wealth vs actual cash investments tangent ('red herring') - though a fair point when discussing specific figures - doesn't seem to me to undermine the fundamental argument(s).
August 12, 2008 9:01 AM | Reply | Permalink
Results of a quick Google search; sorry for its length:
The top 1 percent of families hold half of all non-home wealth.
The middle class’s major assets are their home, liquid assets like checking and savings accounts, CDs and money market funds, and pension accounts. For the average family, these assets make up 84 percent of their total wealth.
The richest 10 percent of families own about 85 percent of all outstanding stocks. They own about 85 percent of all financial securities, 90 percent of all business assets. These financial assets and business equity are even more concentrated than total wealth. Edward Wolff 5/03/2003 Top Heavy: The Increasing Inequality of Wealth in America and What Can Be Done About It
If I spent longer, I'd find a link showing this ownership bulge is hugely skewed toward the upper 1/10 of 1%. And I'd find it's gotten worse in the past 5 years.
Now, I'm not interested in the upper 10% or 1% or 1/10 of 1% and Maggie Mahar ("100 million investors had lost $5 trillion") and Dean Baker claim not to be, either.
And notice this -- the lower 90% paid for the "bubble" for years in the form of FRB mandated lower interest rates on the assets they do own -- their "CDs and money market funds" -- and paid for better than a year getting less than 1% interest.
But, according to Maggie and Dean, the 90% should have paid; they were involved, too -- it's only fair 'cause they were just too emotional and too dumb. Looking at the figures -- making Maggie and Dean come up with the real figures -- puts the lie to the charge.
When they repeat their urban legend over and over again Maggie and Dean become cheerleaders and enablers of one more unfair transfer of wealth from the middle class to the rich and super rich.
August 12, 2008 9:54 AM | Reply | Permalink
Stock mutual fund investments are a good guide to what the "average individual investor is doing.
What I've done below is to show the total value of stock funds in billions throughout the period starting at the oldest ICI archive. To those figures I've applied the broad market price changes (S&P 500) to show what would be expected if fund investors did nothing.
Jan 1998 Stock Funds $2,395.1
1/30/1998 $980.28(S&P 500 INDEX)
Jan 1999 Stock Funds $3,083.81
1/29/1999 1279.64(S&P 500 INDEX) Up 30.5% Expected $3126.5
Jan 2000 Stock Funds $3,949.41
1/31/2000 1394.36(S&P 500 INDEX) Up 9% Expected $3360.3
Jan 2001 Stock Funds $4092.81
1/31/2001 1366.01(S&P 500 INDEX) Down 2% Expected $3869.1
Jan 2002 Stock Funds $3372.31
1/31/2002 1130.2(S&P 500 INDEX) Down 17.3% Expected $3386.3
Jan 2003 Stock Funds $2597.41
1/31/2003 855.70(S&P 500 INDEX) Down 24.3% Expected $2553.2
As I see it the average investor put very little in the market and lost as of Jan 2003 a few hundred billion if that much -- and recovered that loss within the next year ($3,804.7 -- up $1,250 billion as of Jan 2004).
Note: My apologies if the formating turns out to be a disaster.
August 11, 2008 10:59 PM | Reply | Permalink
Jan 2004 Stock Funds 3,804.7
1/30/2004 1131.13(S&P 500 INDEX) Up 30.1%
Expected $3378.8
August 11, 2008 11:23 PM | Reply | Permalink
I'd like to see an answer to Ellen's specific question which I understand is directed at specific statement which she challenges.
Personally I'm more interested in abstract question of what happens over time to the investor with the median 401K. My guess is she made less than if she purchased T bills.
Two reason:one practical,one having to do with what I'll call market fundamentals.
Practically I think the median 401K investor has his market gains, if any, destroyed by transaction costs.
Fundamentally securities are rationally priced. To the extent the investor earns a premium over investing in a risk free government bonds , he does so because she is taking a greater risk, and over time the bad investments,combined with those transaction costs, will sufficiently offset the good ones so his return will be the same as in a no risk, no transaction cost T bill.
In part because of liquidity.
Unlike the models she doesn't leave her money in the market permanently but withdraws it for whatever reason and that happens at market bottoms as well as tops.
I hear about studies demonstrating that equities outperform debt but have more confidence in the efficient market than in those studies.
There is no free lunch
August 12, 2008 8:03 AM | Reply | Permalink
If you want to see what a well-managed fund has done over a long period of time look up the CREF fund of TIAA-CREF (teacher's insurance) at tiaa-cref.org.
It was the first 401K-type fund and has been in existence since 1952. There are no "transaction costs" in the traditional sense since it is not really a publicly available fund. It does charge a management fee of 0.56%.
Over the life of the fund it has averaged a return of 10%. Five and ten year returns are highly influenced by the latest downturn which just goes to show that those investing for retirement shouldn't try to time the market.
A typical return for a decent fund over time should be about 8%, but if you take out the money when you retire you are subject to a great deal of point-in-time risk. CREF avoids this by using "shares" and converting your money into a variable annuity.
Wall Street doesn't offer funds like this, there isn't enough profit to be made. TIAA is non-profit.
August 12, 2008 9:27 AM | Reply | Permalink
"Choice" is always presented as our saving grace, our saving throw (for the nerds out there), our panacea for maintaining the American Myth. Sure we have a choice in matters, but so has everyone throughout history - it's just a matter of whether the choices present constitute anything reasonable.
E.g., when invaded, a tribe has the choice of fleeing or fighting, but either option may include death - it's just a matter of when. When oppressed by a tyrannical government, a citizen has the choice of speaking out and being targeted, or staying quiet and being targeted - again, either option may lead to death.
We "free Americans", as market participants, do in fact have a choice, as is constantly noted by Conservatives: we can choose to sell our souls and buy everything we're sold, buy into all the BS we're told, and live like we're "supposed to", like everybody else who believes that the keys to a good life are a fancy car, an obedient spouse, a few kids, credit card debt for useless items, and a wide-screen tv with 80+ sports channels, hoping all the while no one in the family ever gets sick.
Or we can choose to fight this massive lie of the "American Dream", and grow steadily alone, bankrupt and insane - but they're correct, it IS OUR CHOICE.
I could well have become a "successful" millionaire, a "mover and shaker", but as every Supply-Sider will remind me - this was my choice. I chose to keep my soul, as it were.
August 12, 2008 12:45 PM | Reply | Permalink
Flavius, rdf, JonF311, JHM Ellen
Thanks for your comments.
Flavius --
You're right, many 401k investors would have done better if they had bought and held Treasuries. In fact, if a buy-and-hold investor began buying 30-year Treasuries in 1980-and kept on buying and holding Treasuries rather than stocks--by March 2003 he would have made just as much money as the person who invested in stocks for those 22 years--with a lot less aggravation.
And chances are the stock investor would have made less, because when markets crash (in 1987, in 2001, etc.) people tend to sell--at a low. And when markets are peaking, they tend to buy more.
This part of the "behavioral economics" that Galbraith is talking about. People who buy Trasuries to hold until they mature do not do a lot of trading
This is also why Wall Street wasn't advertising Treasuries in the 1980s and 1990s. It was pushing stocks because Wall Street makes a lot of money when investors buy and sell stocks and mutual funds. The tranaction fees are huge.
By contrast, you can buy Treasuries directly from the Government at Treasury.Direct--with no fees.
Again, this is what Galbraith is talking about. Although investors seemed to have a huge menu of choices in the 1980s and 1990s, and were "free" to invest where they chose, the truth is that they were influenced by all of the hype from Wall Street, on television, and in the financial media, telling them that "real men buy stocks." They also were influenced by talking to each other: your neighbor tells you how his mutual fund made 22 percent last year and gives you the name of it. You buy it.
Jon 311-- regarding drug-makers. OF course if the drug industry had a pill for Alzheimers they would market it. The point is that they don't put as much money into trying to solve the hard reserach problems as they do into creating "me-too" drugs (which costs very little) and then marketing and distributing then.
Overall the pharmaceutical industry spends twice as much on marketing and advertising as it spends on research.
A "pill you take every day" refers to pills that healthy people take for a lifetime. Drugmakers are not as interested in developing drugs for people who are going to die of their disease in two to seven years.
That is why, until recently, they were not that interested in cancer drugs. The pool of potential patients suffering from any particular type of cancer is too small, and they die too soon. But as the WSJ reported a couple of years ago, Big Pharma finally figured out that even though the volume of sales for cancer drugs is small, There is Virtually No Limit to How Much You Can Charge Per Medication. So they've begun developing and selling $100,000 cancer drugs.
JHM-- I have read Surowiecki's book-- and I often read his column in the New YOrker (which, I think is often better than the book.)
He takes his title from a book by Charles Mackay: "Extraordinary Popular Delusions and the Madness of Crowds"--an excellent history of mass delusions ranging from witch hungs to financial bubbles.
Because of that the title of Surowieki's book seems to be suggesting that Mackay is wrong, and that herds are wise. As you say Suowieki goes to lengths to explain this is not what he means (He or more likely his publisher picked the title to sell the book). In fact, his "crowds" are wise only under very particular circumstances. A wise crowd needs diversity, the members need to be indpendent from each other, etc.
In other words, under perfect circumstances the crowd is wise--and then it can estimate how many jelly-beans there are in a jar.
The book is largely anecdotal, and while fun, it doesn't have much to do with how people behave in markets--or how much or how little control the consumer has over the market--which is what Galbraith is talking about.
Ellen-- Turning to your many quetions about the bull market . . . .I'm sorry that this thread has become so focused on bull market, since this is not the subject of Galbraith's book--and I'd like to talk more about his book.
But you seem to be convinced that Dean and I Baker exaggerate the effect that b theubble--and the bursting of the bubble--had on the "average" individual investor.
So let me try to deal with that quickly: Yes, the wealthiest 1% and the wealthiest 10% do own (and did own) the lion's share of all U.S. stocks. But if you were a middle-class, middle-aged investor with $150,000 in your 401-k in 2000 and by 2002, your nest egg was worth only $75,000, that loss of $75,000 would have an enormous impact on your life. It really doesn't matter that the $150,000 that you originally had, and the $75,000 that you lost, are just a tiny, tiny fraction of the total wealth in the U.S. stock market.
Wealth is always relative. To middle-class people, $25,000 can be very important.
As to how much of the $150,000 was money that the investor put in and how much was capital gains . . . In many ways, this doesn't matter. He thought he had $150,000 and that influenced his behavior, making him feel more comfortable about refinancing his home and taking equity out etc. Economists call this "the wealth effect." (See below)
Moreover, what we know is that nvestors were not just sitting by passively and watching the price of stocks rise. Over the course of 2000, individual investors poured $260 billion into U.S. equity funds--up from $150 billion in 1998. (By and large they were buying on dips, thinking the market had bottomed) In other words, as the market became riskier, they invested more. The behavioral economics that Galbraith is talking about shows that this is what most people tend to do.
This was hard-earned money that they could ill afford to lose. In 2002, the 401-k accounts of households in the 47-64--yearold age gropu averaged only $69,000. In order to have $20,000 a year to live on when they retired (the average company pension) these folks needed to have $200,000 by age 50. They didn't. They were in trouble and many knew it.
And Ellen, no one said that they were "too emotional" or "dumb." Those are your words. If you read my book (Bull!) or the many articles I wrote at Barron's about the individual investor in the 1990s, I explained, again and again, that individuals were buying stocks because they felt they Must. They had no choice.
Their wages were not rising. Interest rates were low. They knew they wouldn't have enough to retire on unless they somehow took advantage of the bull market. And everyone, from Merril Lynch to Peter Lynch was telling them that if you just
buy stocks and hold for the long run, you'll make money.
As we speak, we see this isn't true.
Everything has to do with those "beginning and "ending" points that you find "silly." I don't know how much experience you have as an investor, but as Warren Buffet has demonstrated again and again, success is all about beginning points and ending points--knowing when to get in, when to hold and when to fold.
For example, if you began investing in the S&P in 1983, and got out in 1999, you averaged 12.1% a year in capital gains alone. (If you reinvestd dividends you made 15.7%.) But it was very hard, psychologically, to get out in 1999. The only people who did were insiders who knew that corporate earnings were being artifically inflated.
Generally speaking, if you get in when the market is high, you will lose money. This is what happened to people who got into the market in 1967 and tried the "buy and hold" strategy through the 1970s. They lost 3.8% a year, year after year. Even if they reinvested dividends they made only 2/10 of a percent a year.
Finally, and this is the important point: by the time the bubble burst, more than half of all Americans owned stocks. And while the total value of their portfolio may have been small, these losses felt enormous.
. Indeed, many with $200,000 or $300,000 in their 401-k had felt wealthy--and because of that they piled up debt on their credit cards. Many re-financed their homes, taking equity out of their home to go on a vacation--or to invest more in the stock market.
August 12, 2008 1:38 PM | Reply | Permalink
There you go again -- as someone once said.
Without the bubble your average individual investors would have had $75,00 in their 401(k)s. Now, by virtue of artificially inflated gains due to the bubble, they have $150,000. When the bubble bursts their artificial, unearned gains evaporate and they find themselves back with what they would have had without the bubble.
You want to prevent stock market bubbles, because stock prices become artificially inflated. But when you're making a point, you're happy to accept the benefits of the bubble in giving you an elevated valuation (Oh, the horrible losses!) from which to start your polemic.
You can't have it both ways.
August 12, 2008 2:56 PM | Reply | Permalink
Oh, and since "$200,000 or $300,000" in a retirement account will -- if you don't want to be pushing your goods around in a shopping cart in your old age -- generate $660 or $1000 a month*, how would you describe the character of investors who "felt" these sums made them "wealthy"?
* For the results of Monte Carlo simulations, try here.
August 12, 2008 3:08 PM | Reply | Permalink
rdf--
sorry forgot to respond in my last comment.
you're right about tiaa/cref.
August 12, 2008 1:45 PM | Reply | Permalink
"Free Market" is an oxymoron.
Thanks! What a great set of observations. We tend to get mired in tinkering with details - this piece of legislation, that policy, this technology - without stepping back and looking at the entire "forest" of the economic model. Maybe we're heading down the wrong path!
The notion of a "free market" is itself a Junior High economics class pipe-dream. The last thing any corporation wants is a free and open market. And the larger and more powerful a corporate entity becomes, the better positioned it is to rig the system through a variety of means: lobbying, contributions, bribes, special legislation, mergers, acquisitions, hostile takeovers, PR and disinformation campaigns, anti-competitive practices, threats and deals with suppliers, and the like.
August 12, 2008 3:19 PM | Reply | Permalink
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. Adam Smith
Your assertion -- otherwise known as an ancient commonplace -- that businesses don't want a "free and open market" is not an argument against free markets but an argument against the state which empowers those businesses -- usually by adopting laws which prevent the victims from asserting their rights and market power.
Figure out a way to prevent businessmen from capturing the state, and maybe, you'll get what you're actually looking for -- free markets.
August 12, 2008 9:25 PM | Reply | Permalink
The elites have convinced the public that Capitalism = Free markets.
That the "Economy" is Wall Street, instead of Main Street.
If we had an actual Free Market there would a lot of defunct enities out there now, not exhumed failures propped up by congress and the US treasury.
I guess they don't teach the Law of Diminishing Returns in business 101 any more, which actually is just common sense.
If consumers were creatures of common sense without ego,emotion, desire for gain and fear of lost they would all drive black Fords. Since they aren't and never will be the only alternative is government regulation of critical aspects of our economy.
August 12, 2008 4:45 PM | Reply | Permalink
Sign me up for the panthers. I have my T-shirt and am ready to rumble.
BURN CONGRESS TO THE GROUND AND START OVER.
August 12, 2008 4:54 PM | Reply | Permalink
ptsf, bmiller and calypso -
Thanks for your comments.
Ptsf: You're right "choice" is valuable only if there are some good choices that one can afford.
bmiller: Yes, corporations do not want to have to compete on a level playing field--and they don't want us to have the information needed to make good choices. That is why drug-makers and device-makers have long resisted the idea of unbiased researchers doing unbiased, head-to-head comparisons of new products and older products to see whether the new (and almost always more expensive) medical products are in fact better than products already on the market.
But very recently the chair of the Senate Finance Commitee and the chair of the Senate Budget committee co-sponsored legislation calling for "Comparative Effectiveness Research." I do think there is the possibilty of change in the air in Washington, with Congress pushing back
and beginning to regulate corporations.
Calypso-- Yes, we definitely need much more government regulation of critical aspects of our economy: energy, healthcare etc.
As for the panthers-- I would like to see the Grey Panthers come back--and fight for higher quality, lower cost Medicare.
August 12, 2008 5:55 PM | Reply | Permalink
Business is already very heavily regulated, to the point where it is beneficial for some to leave the US. Something you should keep in mind is that the global community is by default a free market. There is no overarching authority regulating the entire planet, just individual participants, sovereign nations. Cripple our competitive advantages and pretty soon we'll be learning Mandarin, rather than the Chinese learning English.
As to corporations and politics, there will always be money and influence involved. Our choice is whether that influence is from people that actually produce something useful or political apparatchiks who have absolutely no value to anyone other than loyalty to a particular politician.
Be careful what you wish for.
August 13, 2008 7:08 AM |