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August 12, 2007 by Gary North, Ph.D.
Stock markets have risen rapidly in Asian nations (not counting Japan) over the last fifteen years, matching the spread of free market ideas and practices there. So have Asia's real estate markets. There is no question that over the last fifteen years, there has been an historically unprecedented expansion of property rights in China and India. Discounting for price inflation, what about the U.S. stock market? If we take the Dow Jones Industrial Average as the benchmark, it was about 1,000 at its peak in early February, 1966. It is about 14,000 today. According to the Inflation Calculator of the Bureau of Labor Statistics, the dollar bought 6.5 times as much in 1966, so dividing 14 by 6.5 gives us about 2,150. So, it took 41 years for the DJIA to double in real terms. That's about 1.9% per year. There were dividends, of course, but these were taxed as regular income. Dividends after 1982 fell to about 2% or less. If the investor was in a DJIA index fund, he paid management fees: maybe 2% per annum. (There were very few no-load index funds in 1966.) If he invested $1,000 in February, 1966, and sells for $14,000 today, he will be taxed 20% on his $13,000 increase. So, he will take away $10,400 in after-tax profits. Divide this by 6.5. We get $1,600. Over 41 years, that's a return on investment of 1.15% per annum. In other words, the stock market investor after taxes and fees has just about nothing to show for his 41 years of doing without the use of his money. This is not the story which the "buy and hold" cheerleaders for the American stock market tell today's investor. Lyndon Johnson's Great Society gave us war, Medicare, and a vast expansion of Federal power over the economy. Economic liberty contracted. The performance of the stock market has reflected this contraction of economic liberty. There was economic growth, but it was not spectacular after 1973, when real wages grew stagnant for two decades. The stock market did not outperform general economic growth. After taxes, it did not match economic growth. In this report, I compare the differences between 1974 and today in terms of two things: the idea of economic liberty and the institutional reality of economic liberty. If we believe that stocks do well when economic liberty increases, we had better make an estimate of the "market for liberty." In this way, we can get some idea of the case for the American stock market. To assess the validity of my thesis that stock market performance is closely related to the market for economic liberty, let us compare the market for economic liberty in 1974 vs. today. I am saying that the stock market has performed poorly. So, I am also saying that the market for economic liberty has performed poorly. Is my conclusion correct? Money and Government Debt Since 1974 I think back to when I began publishing Remnant Review. That was in May, 1974. It was a period of enormous confusion in international currency markets: the end of an era. It was the beginning of international currency instability. This provided the first visible warning that the Bretton Woods monetary arrangement of the post-War world was about to come apart at the seams. The funding of the American welfare State got its wake-up call in this period. That system was Keynesian to the core. Keynesian economic theory got its wake-up call in this period. On Sunday, August 15, 1971, Nixon unilaterally revoked the convertability of the dollar into gold at $35/oz, a legal right possessed by foreign governments and central banks. This convertibility had been the central institutional guarantee of the Bretton Woods plan. "Hold dollar-denominated debt instruments instead of gold. They are as good as gold." This, in turn, had been the underlying promise of the Genoa Conference of 1922, where the world's central banks substituted pounds sterling or dollars for gold. It was fractional reserve banking for central banks. "We'll pay you interest; plus, you can get your gold back at any time on demand." Fractional reserve banking is built on a lie. There will eventually be a bank run in which the promising banks will suspend payment. The post-1922 system was called the gold exchange standard -- a fake gold standard. Great Britain went back to the gold standard in 1925, but at the pre-war price, as if there had been no wartime inflation. This was Churchill's decision, as Chancellor of the Exchequer. It caused a deflation in Britain and then depression. Great Britain went off the gold standard in 1931. In short, it reneged. Fractional reserve banks always renege. The United States reneged to its people in 1933 when Roosevelt outlawed the ownership of gold bullion by Americans. That was a herald of things to come in 1971. Officially, the dollar's exchange rate on August 16, 1971, was allowed to float temporarily. In December, 1971, there was an attempt by the International Monetary Fund to re-fix exchange rates: a 2.25% band in which currencies were allowed to fluctuate. This policy failed. Confidence in fixed rates was gone. In February, 1973, floating rates became official policy of the IMF. In 1974, it was still illegal for Americans to own gold bullion. That would not end until January 1, 1975. On October 17, 1973, during the Yom Kapur war (Oct. 5-26), the Arab oil states imposed an embargo on oil sales to countries supporting the State of Israel. Oil prices went from $3 a barrel to $12 by early 1974. The academic economists had no clue as to what was about to happen. Consider the 1972 prediction by M. A. Adelman, an academic economist specializing in oil, that OPEC would be unable to maintain high prices, and that the price of oil was about to enter an era of long-term price decline. (The World Petroleum Market, Johns Hopkins University Press, 1972.) This prediction matched Milton Friedman's prediction that if the dollar were ever floated, the "system of floating exchange rates would eliminate the balance-of-payments problem. . . ." (Newsweek May 15, 1967). I look around me today and find that the Federal government still extracts a quarter of the output of American citizens. It regulates the economy with greater intensity and zeal in many fields. There are some exceptions. Airlines and transportation have experienced falling prices and vastly increased volume because, under Carter, there was de-regulation in these fields. Because the Federal Communications Commission does not regulate satellite radio or the Internet, there is a new world of information available to us. The U.S. Postal Service charges ever more money to mail a letter or a package, but email and on-line bill payment have dramatically cut into USPS revenues. FedEx and UPS have taken away the government's one-time monopoly in packages. So, where the government has receded or has never run the show (Internet), productivity is up dramatically. Then there are the currency markets: floating rates. But where the government still regulates, we are in worse shape than in 1974. The level of Federal debt relentlessly climbs upward. This fiscal year, the on-budget debt will rise by over $200 billion. The economy is still growing, so revenues have increased enough to slowly cut rate of increase, despite an Iraq war bill of $450 billion so far and seemingly endless. The off-budget debt now approaches $70 trillion. The next prescription drug bill, which Bush is expected to sign, will hike this by several trillion more. Nothing is done to deal with this statistically inevitable disaster. The public trusts the government, and says nothing. The government just keeps passing more Medicare-related legislation. Despite Ronald Reagan, despite talk radio, and despite the Internet, the spread of government power has not been reversed. It has been challenged intellectually, which is positive, but the last major round of government-slashing came under Carter: the Civil Aeronautics Board, the Interstate Commerce Commission (which went out of operation in 1995, under Clinton), and a few other price floor agencies. By 1974, I had been in the conservative movement for almost two decades. I came into the conservative movement in 1956. The impetus was a speech by Fred Schwarz, an Australian physician who spent his career arguing against Communism. He was a very effective speaker and teacher. His little books on Communism remain among the best introductions to the topic ever published. He aimed them at the common man, not scholars. Yet his understanding of Marxism-Leninism was equal to any scholar I ever came across in my own studies of Marxism. I came across a lot of them. I wrote my first book on this topic: Marx's Religion of Revolution (1968). Since 1956, I have seen a lot of conservative people and organizations come and go. I have seen some victories, though not many. I have seen many failures. But this is normal in life. Most ventures fail. Capitalism's great benefit is that it links responsibility with outcomes. It imposes the costs of failure mainly on individual entrepreneurs, who would have benefited greatly, had the ventures succeeded. Capitalism transfers to consumers -- people with money -- the veto power over unsuccessful ventures. Communism failed because of its own internal contradictions. Reagan did stand up to Gorbachev, but the reality of the USSR's disintegration was becoming clear by the late 1980's. When the USSR went under in 1991, it owed the West about $60 billion, which it could not pay. Today, due to revenues from oil and natural gas, the Russian government has foreign exchange reserves of $406 billion -- third behind Japan and China. That is up by $150 billion in eleven months. Eleven months! Got that? China and Russia are second and third. The United States was over $2.5 trillion in the hole at year-end, 2006, according to the Bureau of Economic Analysis. The United States is the biggest debtor on earth. No other nation comes close. This has taken place since 1985. Americans have experienced the expansion of debt on a scale undreamed of in human history. There is no thought given as to how these debts will be repaid by the government. Private debt ratchets upward along with private assets. Monthly debt service payments as a percentage of disposable income for the Average household in 2007 is a little above 19%. It was slightly below 16% in 1980. This figure has risen, but not spectacularly. Consumers do pay attention to their monthly income and outflow. But government debt ratchets upward. The best site that covers this expansion is M. W. Hodges' Grandfather Economic Report. Here are five charts that tell the story.
This process is relentless. Americans get political rhetoric to the contrary, but the reality is seen in these graphs. The government is tireless in its expansion. There are a few victories, but in terms of its rate of growth vs. the private sector's rate of growth, it's no contest.
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We
would expect the world's stock markets to rise as
liberty spreads. If men expect to be allowed to
retain the fruits of their production, they ought
to invest more money in the markets for ownership,
which the equity markets are.
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