Jewish World Review May 1, 2000 /26 Nissan, 5760
Both myths derive from the fallacy of believing that what is true of the parts of a whole must also be true of the whole. In the case of financial markets, the fallacy is to believe that just because individuals frequently make mistakes in judgment, misestimate value and fall prey to bouts of euphoria and depression, markets do also.
For three years now, Fed Chairman Alan Greenspan has been warning that "irrational exuberance" on the part of individual investors is causing the stock market to "overprice" equities and create a "market bubble." Not surprisingly, two weeks ago when NASDAQ stock prices plummeted, a chorus of commentators agreed the bubble had burst.
Jude Wanniski, supply-side guru and president of Polyconomics Inc. - who along with Nobel Prize-winning economist Robert Mundell and Art Laffer (of "Laffer Curve" fame) helped lay the groundwork for supply-side economics with his thesis that the Wall Street crash of 1929 was caused by the market's correct judgment that the Smoot-Hawley Tariff Act would become law - advised his Wall Street clients and me as early as March 30 that the NASDAQ sell-off was tied to the April 15 tax deadline, when individual investors would be forced to sell to meet their income-tax liabilities.
After the crash of Friday, April 14, he told us the market would bounce back after the date was behind us: "I would jump in on Monday. The pattern should follow 1999's, when the bottom was hit on April 16 and jumped from there when mass selling pressure was removed."
He was right. In the two trading days after the April 15 date, NASDAQ had its two biggest gains in its history. Jude told me he was willing to risk his bold market call because it is so important that policy-makers resist arguments about market bubbles. When economists cannot explain in their own analytical models why markets crash, or climb, they ask us to believe it is because of the irrationality of the people in the markets, not the flaws in their models.
Wanniski originally laid out his brief for market efficiency in his 1978 book, "The Way the World Works," which National Review last year listed as one of the 100 most influential nonfiction books of the 20th century. It was here that he documented the link between the tariff act and the 1929 crash, which would lead to the Great Depression and World War II. To this day, demand-side academic economists still insist 1929 was merely a speculative bubble. In a client letter he shared with me last week, Wanniski cites Aristotle to demonstrate his point: "As Aristotle observed 2,500 years ago, there is one constant, which is the superior wisdom of the organic mass of people to that of the individuals who comprise it. The opinion of every individual who is in the market or thinking of getting out or getting in is of importance, as illogical or as irrational as they may seem to others.
"The market is rational and efficient in assessing risks and opportunities, based on the information available to it. If this were not true, the market could not set prices on goods and services through the law of supply and demand, nor on the underlying shares of corporations producing them. Capital could not be allocated effectively by the market, which would mean that market capitalism could not compete against wise men who could do it more effectively in government planning boards. It was the belief that the 1929 crash was such a 'bubble' that led to the New Deal government planners."
Does all of this mean the stock market is out of the woods? Hardly. As Laffer points out, there are four "prosperity killers" that could still bring the expansion to an abrupt end if policy-makers make a mistake: monetary, tax, regulatory or trade policies that block economic growth and global commerce.
Given a Congress and president insistent on retiring debt and refusing to cut tax rates, a Fed determined to slow economic growth, a Justice Department fanatical to penalize corporate success at Microsoft under the guise of "trust-busting" and a bipartisan faction in search of a trade war with China, all four prosperity killers are live threats to the stock market and our prosperity.
The continued belief in mythological "market bubbles" and "demand-push inflationary spirals" does more to threaten our prosperity than any amount of euphoria and exuberance that individual investors might exhibit. For after all, when private investors exhibit exuberance, irrational or otherwise, they are playing with their own money.
But when government "wise men" display their hubris in believing they can improve on market
outcomes by manipulating incentives and rewards from work, saving and investment, they are
playing with our money, our property and our country's future. I'm with Wanniski on this one.
Markets know better than government "wise men" the way the world
© 2000, Copley News Service