THE WORLD OF MONEY

Has the market broken the laws of economics?

JAMES GRANT

BNew York esides unconditionally opposing Rus- sian corruption and world poverty, the gov- erning bodies of the International Monetary Fund and World Bank took the occasion of last month's annual get-together in Wash- ington, DC, to lift an eyebrow at the incred- ible run of American prosperity. Contrary to Wall Street's favourite self-aggrandising theory, they said, the United States is not embarked on a New Era of wealth and hap- piness, but rather is the beneficiary of 'a series of fortuitous but temporary events'.

Few, of course, are so fortunate as the tax-advantaged employees of these amply staffed world bodies, but that is by the by. Just this once, the IMF may have hit the nail on the head. The United States invest- ing public is indeed more lucky than smart.

Never before has the American stock market been so richly valued as it is today, and never before have so many speculators played it from the comfort of their own homes. Not once in history has an unbacked paper currency enjoyed such worldwide prestige as the United States dollar does, and continues to do — notwithstanding its recent curious weakness against the yen — a currency that offers an interest rate of only a little more than zero. And on no pre- vious occasion has a country run up such a titanic debt with its foreign creditors as America has been granted the privilege of doing in this fat and happy decade.

The principal explanation given for this break from all that is traditionally under- stood about the laws of economics is that technology has led us into paradise. It is not just the stock market that is in uncharted territory. Human ingenuity has also broken free. Financial history, like history, has ended, according to the people who ride in the limousines.

In some departments of human activity, there are, indeed, epochs in which prece- dent does not apply, or is not meant to. But always, in finance, these supposed new eras are cut short by the kind of behaviour they elicit. Extravagant valuations coax forth a boom, duly followed by a bust. Thus, before long, the valuations become less extrava- gant. Only recall Japan a decade ago.

A glimpse into the pre-millennial Ameri- can financial mindset is afforded by a much- praised new book, Dow 36,000, by James K. Glassman and Kevin A. Hassett. The num- ber in the title represents the authors' best estimate of where the Dow Jones Industrial Average should be quoted at this very moment. For reference, it is more than three times higher than the current excessive level. The Glassman-Hassett argument, in brief, is that shares are safer than government bonds because, over time, the profits of enterprise grow, whereas the government's contractual interest payments do not. As shares excel unconditionally, the authors advise, they should be purchased fearlessly.

It is a characteristic weakness of the New Era theory that the authors give scant attention to the effect that such a sudden accretion of stock-market wealth would have on American life. I, for one, can imag- ine many improvements. For instance, because people who own equities in their retirement accounts could afford to stop working, they would. The size of the labour force would suddenly collapse, thereby affording every remaining commuter a seat on the rush-hour subway. Then, too, a stock market triply more absurd than the one we already have would undoubtedly entice vast new .share issuance. Enterprising business- school students would stop going to class in order to devote themselves to the work of starting up companies for the very purpose of capitalising them.

Possibly, the visiting G7 personages had occasion to glance at an arresting full-page newspaper advertisement that also tells vol- umes about the current American financial psyche. In it, a hard young beauty is saying, 'I don't want to just beat the market. I want to wrestle its scrawny little body to the ground and make it beg for mercy.' The sponsor is an online brokerage firm, Arneri- trade, the slogan of which is 'Believe in your- self.' But it wasn't self-doubt that caused people now the age of the parents of this formidable-looking woman to lose their shirts in the relentless bear market of 1968-74. It was the miscalculations of cen- tral bankers and of other human beings too numerous to mention. Sometimes, in the material realm, life works out badly.

It is said that the microchip has rendered obsolete the previously immutable laws of supply and demand. In an information- intensive economy, as opposed to an indus- trial one, the argument goes, there will be no 'business cycle'. There should be no inflation. Fewer and fewer people will do more and more work. But the conse- quences of technological upheaval are com- plex and unpredictable. Innovation makes the world a more productive place, but also, in ways rarely anticipated, a less pro- ductive one. Thus, on the plus side, the Internet has unimaginably expanded the accessible store of human knowledge. On the minus side, it has brought personal e- mail and computer solitaire within the reach of every white-collar employee. It has facilitated the universal dissemination of American nuclear secrets.

Possibly, the Internet is an epochal invention. But is it any more liberating than air-conditioning, which changed American migration patterns, opened up Las Vegas to family entertainment, and immeasurably increased human comfort from Bombay to Baltimore (not to mention in the Washing- ton offices of the IMF itself)? Who could enjoy a life of digital interactivity with mas- cara melting down her face?

In about 1933, Carrier Corp., then as now the leading American producer of air-condi- tioners, was forced to suspend production of its prototype residential room-cooling unit. There were no sales. Yes, a New Era enthusiast might say, but that was the Depression. Yes, I would reply, but air- con- ditioning did not forestall the Depression (Fortune magazine called air-conditioning 'a prime public disappointment of the 1930s'). Innovation neither assures economic growth nOr guarantees against economic shrinkage.

Looking for a great investment? Try his- tory. It's overdue for a rebound. And don't forget gold. Sometimes even the best cen- tral bankers and most far-seeing interna- tional bureaucrats fall into error.

James Grant is the editor of Grant's Interest Rate Observer, www.grantspub.com

ktS" Christopher Fildes is away.