Why the Stock Market is so Good when the Economy is so Bad

Posted by PITHOCRATES - March 31st, 2014

Economics 101

No One is going to get Rich by Buying and Selling only one Share of Stock

It takes money to make money.  I’m sure we all heard that before.  If you want to ‘flip’ a house you need money for a down payment to get a mortgage first.  If you want to start a business you need to save up some money first.  Or borrow it from a family member.  And if you want to get rich by playing the stock market you need money.  A lot of money.  Because you only make money by selling stocks.  And before you can sell them you have to buy them.

Stock prices may go up and down a lot.  But over a period of time the average stock price may only increase a little bit.  So if you bought one share of stock at, say, $35 and sold it later at, say, $37.50 that’s a gain of 7.14%.  Which is pretty impressive.  Just try to earn that with a savings account at a bank.  Of course, you only made a whopping $2.50.  So no one is going to get rich by buying and selling only one share of stock.

However, if you bought 10,000 shares of a stock at $35/share and then sold it later at $37.50 that’s a whole other story.  Your initial stock purchase will cost you $350,000.  And that stock will sell for $375,000 at $37.50/share.  Giving you a gain of $25,000.  Let’s say you make 6 buys and sells in a year like this with the same money.  You buy some stock, hold it a month or so and then sell it.  Then you use that money to buy some more stock, hold it for a month or so and then sell it.  Assuming you replicate the same 7.14% stock gain through all of these transactions the total gain will come to $150,000.  And if you used no more than your original investment of $350,000 during that year that $350,000 will have given you a return on investment of 42.9%.  This is why the rich get richer.  Because they have the money to make money.  Of course, if stock prices move the other way investors can have losses as big as these gains.

Rich Investors benefit most from the Fed’s Quantitative Easing that gives us Near-Zero Interest Rates

Rich investors can make an even higher return on investment by borrowing from a brokerage house.  He or she can open a margin account.  Deposit something of value in it (money, stocks, option, etc.) and use that value as collateral.  This isn’t exactly how it works but it will serve as an illustration.  In our example an investor could open a margin account with a value of $175,000.  So instead of spending $350,000 the investor can borrow $175,000 from the broker and add it to his or her $175,000.  Bringing the total stock investment to $350,000.  Earning that $25,000 by risking half of the previous amount.  Bringing the return on investment to 116.7%.  But these big returns come with even bigger risks.  For if your stock loses value it can make your losses as big as those gains.

Some investors borrow money entirely to make money.  Such as carry trades.  Where an investor will borrow a currency from a low-interest rate country to invest in the currency of a higher-interest rate country.  For example, they could borrow a foreign currency at a near zero interest rate (like the Japanese yen).  Convert that money into U.S. dollars.  And then use that money to buy an American treasury bond paying, say, 2%.  So they basically borrow money for free to invest.  Making a return on investment without using any of his or her money.  However, these carry trades can be very risky.  For if the yen gains value against the U.S. dollar the investor will have to pay back more yen than they borrowed.  Wiping out any gain they made.  Perhaps even turning that gain into a loss.  And a small swing in the exchange rate can create a huge loss.

So there is big money to make in the stock market.  Making money with money.  And investors can make even more money when they borrow money.  Making money with other people’s money.  Something rich investors like doing.  Something rich investors can do because they are rich.  For having money means you don’t have to use your money to make money.  Because having money gives you collateral.  The ability to use other people’s money.  At very attractive interest rates.  In fact, it’s these rich investors that benefit most from the Fed’s quantitative easing that is giving us near-zero interest rates.

People on Wall Street are having the Time of their Lives during the Obama Administration

We are in the worst economic recovery since that following the Great Depression.  Yet the stock market is doing very well.  Investors are making a lot of money.  At a time when businesses are not hiring.  The labor force participation rate has fallen to levels not seen since the Seventies.  People can’t find full-time jobs.  Some are working a part-time job because that’s all they can find.  Some are working 2 part-time jobs.  Or more.  Others have just given up trying to find a full-time job.  People the Bureau of Labor Statistics (BLS) no longer counts when calculating the unemployment rate.

This is the only reason why the unemployment rate has fallen.  If you add the number of people who have left the labor force since President Obama took office to the number the BLS reports as unemployed it would bring the unemployment rate up to 13.7% ((10,459,000 + 10,854,000)/155,724,000) at the end of February.  So the economy is still horrible.  No secret to those struggling in it.  And the median family who has seen their income fall.  So why is the stock market doing so well when businesses are not?  When profitable businesses operations typically drive the stock market?  For when businesses do well they grow and hire more people.  But businesses aren’t growing and hiring more people.  So if it’s not profitable businesses operations raising stock prices what is?  Just how are the rich getting richer when the economy as a whole is stuck in the worst economic recovery since that following the Great Depression?

Because of near zero interest rates.  The Fed has lowered interest rates to near zero to purportedly stimulate the economy.  Which it hasn’t.  When they could lower interest rates no more they started their quantitative easing.  Printing money to buy bonds on the open market.  Flooding the economy with cheap money.  But people aren’t borrowing it.  Because the employment picture is so poor that they just aren’t spending money.  Either because they don’t have a job.  Only have a part time job.  Or are terrified they may lose their job.  And if they do lose their job the last thing they want when unemployed is a lot of debt they can’t service.  And then there’s Obamacare.  Forcing people to buy costly insurance.  Leaving them less to spend on other things.  And increasing the cost of doing business.  Another reason not to hire people.

So the economy is going nowhere.  And because of the bad economy businesses have no intentions of spending or expanding.  So they don’t need any of that cheap money.  So where is it going?  Wall Street.  The only people who are borrowing and spending money.  They’re taking that super cheap money and they’re using it to buy and sell stocks.  They’re buying and selling like never before.  Making huge profits.  Thanks to other people’s money.  This is what is raising stock prices.  Not profitable businesses operations.  But investors bidding up stock prices with borrowed money.  The people on Wall Street are having the time of their lives during the Obama administration.  Because the Obama administration’s policies favor the rich on Wall Street.  Whose only worry these days is if the Fed stops printing money.  Which will raise interest rates.  And end the drunken orgy on Wall Street.  Which is why whenever it appears the Fed will taper (i.e., print less money each month) their quantitative easing because the economy is ‘showing signs of improvement’ investors panic and start selling.  In a rush to lock in their earnings before the stock prices they inflated come crashing down to reality.  For without that ‘free’ money from the Fed the orgy of buying will come to an end.  And no one wants to be the one holding on to those inflated stocks when the bubble bursts.  When there will be no more buyers.  At least, when there will be no more buyers willing to buy at those inflated stock prices.  Which is why investors today hate good economic news.  For there is nothing worse for an investor in the Obama economy than a good economy.

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The Dow Jones Industrial Average and the Labor Force Participation Rate from Ronald Reagan to Barack Obama

Posted by PITHOCRATES - February 10th, 2014

Economics 101

(Originally published May 21st, 2013)

The DJIA and the Labor Force Participation Rate tell us how both Wall Street and Main Street are Doing

Rich people don’t need jobs.  They can make money with money.  Investing in the stock market.  When you see the Dow Jones Industrial Average (DJIA) increasing you know rich people are getting richer.  Whereas the middle class, the working people, aren’t getting rich.  But they may be building a retirement nest egg.  Which is good.  So they benefit, too, from a rising DJIA.  But that’s for later.  What they need now is a job.  Unlike rich people.  The middle class typically lives from paycheck to paycheck.  So more important to them is a growing job market.  Not so much a growing stock market.  For the middle class needs a day job to be able to invest in the stock market.  Whereas rich people don’t.  For a rich person’s money works enough for the both of them.

So the Dow Jones Industrial Average shows how well rich people are doing.   And how well the working class’ retirement nest eggs are growing for their retirement.  But it doesn’t really show how well the middle class is living.  For they need a job to pay their bills.  To put food on their tables.  And to raise their families.  So the DJIA doesn’t necessarily show how well the middle class is doing.  But there is an economic indicator that does.  The labor force participation rate.  Which shows the percentage of people who could be working that are working.  So if the labor force participation rate (LFPR) is increasing it means more people looking for a job can find a job.  Allowing more people to be able to pay their bills, put food on their tables and raise their families.

These two economic indicators (the DJIA and the LFPR) can give us an idea of how both Wall Street and Main Street are doing.  Ideally you’d want to see both increasing.  A rising DJIA shows businesses are growing.  Allowing Wall Street to profit from rising stock prices.  While those growing businesses create jobs for Main Street.   If we look at these economic indicators over time we can even see which ‘street’ an administration’s policies favor.   Interestingly, it’s not the one you would think based on the political rhetoric.

Wall Street grew 75% Richer under Clinton than it did under Reagan while Main Street grew 65% Poorer

Those going through our public schools and universities are taught that capitalism is unfair.  Corporations are evil.  And government is good.  The Democrats favor a growing welfare state.  Funded by a highly progressive tax code.  That taxes rich people at higher tax rates.  While Republicans favor a limited government.  A minimum of government spending and regulation.  And lower tax rates.  Therefore the Republicans are for rich people and evil corporations.  While the Democrats are for the working man.  Our schools and universities teach our kids this.  The mainstream media reinforces this view.  As does Hollywood, television and the music industry.  But one thing doesn’t.  The historical record (see Civilian Labor Force Participation Rate and Recessions 1950-Present and Dow Jones Industrial Average Index: Historical Data).

DJIA vs Labor Force Participation Rate - Reagan

The Democrats hated Ronald Reagan.  Because he believed in classical economics.  Which is what made this country great.  Before Keynesian economics came along in the early 20th Century.  And ushered in the era of Big Government.  Reagan reversed a lot of the damage the Keynesians caused.  He tamed inflation.  Cut taxes.  Reduced regulation.  And made a business-friendly environment.  Where the government intervened little into the private sector economy.  And during his 8 years in office we see that BOTH Wall Street (the Dow Jones Industrial Average) and Main Street (the labor force participation rate) did well.  Contrary to everything the left says.  The DJIA increased about 129%.  And the LFPR increased about 3.4%.  Indicating a huge increase of jobs for the working class.  Showing that it wasn’t only the rich doing well under Reaganomics.  The policies of his successor, though, changed that.  As Wall Street did better under Bill Clinton than Main Street.

DJIA vs Labor Force Participation Rate - Clinton

Despite the Democrats being for the working man and Bill Clinton’s numerous statements about going back to work to help the middle class (especially during his impeachment) Wall Street clearly did better than Main Street under Bill Clinton.  During his 8 years in office the LFPR increased 1.2%.  While the DJIA increased 226%.  Which means Wall Street grew 75% richer under Clinton than it did under Reagan.  While Main Street grew 65% poorer under Clinton than it did under Reagan.  Which means the gap between the rich and the middle class grew greater under Clinton than it did under Reagan.  Clearly showing that Reagan’s policies favored the Middle Class more than Clinton’s policies did.  And that Clinton’s policies favored Wall Street more than Regan’s did.  Which is the complete opposite of the Democrat narrative.  But it gets worse.

The Historical Record shows the Rich do Better under Democrats and the Middle Class does Better under Republicans

The great economy of the Nineties the Democrats love to talk about was nothing more than a bubble.  A bubble of irrational exuberance.  As investors borrowed boatloads of cheap money thanks to artificially low interest rates.  And poured it into dot-com companies that had nothing to sell.  After these dot-coms spent that start-up capital they had no revenue to replace it.  And went belly-up in droves.  Giving George W. Bush a nasty recession at the beginning of his presidency.  Compounded by the 9/11 terrorist attacks.

DJIA vs Labor Force Participation Rate - Bush

The LFPR fell throughout Bush’s first term as all those dot-com jobs went away in the dot-com crash.  Made worse by the 9/11 attacks.  As all the malinvestments of the Clinton presidency were wrung out of the economy things started to get better.  The LFPR leveled off and the DJIA began to rise.  But then the specter of Bill Clinton cast another pall over the Bush presidency.  Clinton’s Policy Statement on Discrimination in Lending forced lenders to lower their lending standards to qualify more of the unqualified.  Which they did under fear of the full force and fury of the federal government.  Using the subprime mortgage to put the unqualified into homes they couldn’t afford.  This policy also pressured Fannie Mae and Freddie Mac to buy these toxic subprime mortgages from these lenders.  Freeing them up to make more toxic loans.  This house of cards came crashing down at the end of the Bush presidency.  Which is why the DJIA fell 19.4%.  And the LFPR fell 2.1%.  Even though the economy tanked thanks to those artificially low interest rates that brought on the subprime mortgage crisis and Great Recession both Wall Street and Main Street took this rocky ride together.  They fell together in his first term.  Rose then fell together in his second term.  Something that didn’t happen in the Obama presidency.

DJIA vs Labor Force Participation Rate - Obama

During the Obama presidency Wall Street has done better over time.  Just as Main Street has done worse over time.  This despite hearing nothing about how President Obama cares for the middle class.  When it is clear he doesn’t.  As his policies have clearly benefited rich people.  Wall Street.  While Main Street suffers the worst economic recovery since that following the Great Depression.  So far during his presidency the LFPR has fallen 3.7%.  While the DJIA has risen by 86%.  Creating one of the largest gaps between the rich and the middle class.  This despite President Obama being the champion of the middle class.  Which he isn’t.  In fact, one should always be suspect about anyone claiming to be the champion of the middle class.  As the middle class always suffers more than the rich when these people come to power.  Just look at Venezuela under Hugo Chaves.  Where the rich got richer.  And the middle class today can’t find any toilet paper to buy.  This is what the historical record tells us.  The rich do better under Democrats.  And the middle class does better under Republicans.  Despite what our schools and universities teach our kids.  Or what they say in movies and television.

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The Dow Jones Industrial Average and the Labor Force Participation Rate from Ronald Reagan to Barack Obama

Posted by PITHOCRATES - May 21st, 2013

History 101

The DJIA and the Labor Force Participation Rate tell us how both Wall Street and Main Street are Doing

Rich people don’t need jobs.  They can make money with money.  Investing in the stock market.  When you see the Dow Jones Industrial Average (DJIA) increasing you know rich people are getting richer.  Whereas the middle class, the working people, aren’t getting rich.  But they may be building a retirement nest egg.  Which is good.  So they benefit, too, from a rising DJIA.  But that’s for later.  What they need now is a job.  Unlike rich people.  The middle class typically lives from paycheck to paycheck.  So more important to them is a growing job market.  Not so much a growing stock market.  For the middle class needs a day job to be able to invest in the stock market.  Whereas rich people don’t.  For a rich person’s money works enough for the both of them.

So the Dow Jones Industrial Average shows how well rich people are doing.   And how well the working class’ retirement nest eggs are growing for their retirement.  But it doesn’t really show how well the middle class is living.  For they need a job to pay their bills.  To put food on their tables.  And to raise their families.  So the DJIA doesn’t necessarily show how well the middle class is doing.  But there is an economic indicator that does.  The labor force participation rate.  Which shows the percentage of people who could be working that are working.  So if the labor force participation rate (LFPR) is increasing it means more people looking for a job can find a job.  Allowing more people to be able to pay their bills, put food on their tables and raise their families.

These two economic indicators (the DJIA and the LFPR) can give us an idea of how both Wall Street and Main Street are doing.  Ideally you’d want to see both increasing.  A rising DJIA shows businesses are growing.  Allowing Wall Street to profit from rising stock prices.  While those growing businesses create jobs for Main Street.   If we look at these economic indicators over time we can even see which ‘street’ an administration’s policies favor.   Interestingly, it’s not the one you would think based on the political rhetoric.

Wall Street grew 75% Richer under Clinton than it did under Reagan while Main Street grew 65% Poorer

Those going through our public schools and universities are taught that capitalism is unfair.  Corporations are evil.  And government is good.  The Democrats favor a growing welfare state.  Funded by a highly progressive tax code.  That taxes rich people at higher tax rates.  While Republicans favor a limited government.  A minimum of government spending and regulation.  And lower tax rates.  Therefore the Republicans are for rich people and evil corporations.  While the Democrats are for the working man.  Our schools and universities teach our kids this.  The mainstream media reinforces this view.  As does Hollywood, television and the music industry.  But one thing doesn’t.  The historical record (see Civilian Labor Force Participation Rate and Recessions 1950-Present and Dow Jones Industrial Average Index: Historical Data).

DJIA vs Labor Force Participation Rate - Reagan

The Democrats hated Ronald Reagan.  Because he believed in classical economics.  Which is what made this country great.  Before Keynesian economics came along in the early 20th Century.  And ushered in the era of Big Government.  Reagan reversed a lot of the damage the Keynesians caused.  He tamed inflation.  Cut taxes.  Reduced regulation.  And made a business-friendly environment.  Where the government intervened little into the private sector economy.  And during his 8 years in office we see that BOTH Wall Street (the Dow Jones Industrial Average) and Main Street (the labor force participation rate) did well.  Contrary to everything the left says.  The DJIA increased about 129%.  And the LFPR increased about 3.4%.  Indicating a huge increase of jobs for the working class.  Showing that it wasn’t only the rich doing well under Reaganomics.  The policies of his successor, though, changed that.  As Wall Street did better under Bill Clinton than Main Street.

DJIA vs Labor Force Participation Rate - Clinton

Despite the Democrats being for the working man and Bill Clinton’s numerous statements about going back to work to help the middle class (especially during his impeachment) Wall Street clearly did better than Main Street under Bill Clinton.  During his 8 years in office the LFPR increased 1.2%.  While the DJIA increased 226%.  Which means Wall Street grew 75% richer under Clinton than it did under Reagan.  While Main Street grew 65% poorer under Clinton than it did under Reagan.  Which means the gap between the rich and the middle class grew greater under Clinton than it did under Reagan.  Clearly showing that Reagan’s policies favored the Middle Class more than Clinton’s policies did.  And that Clinton’s policies favored Wall Street more than Regan’s did.  Which is the complete opposite of the Democrat narrative.  But it gets worse.

The Historical Record shows the Rich do Better under Democrats and the Middle Class does Better under Republicans

The great economy of the Nineties the Democrats love to talk about was nothing more than a bubble.  A bubble of irrational exuberance.  As investors borrowed boatloads of cheap money thanks to artificially low interest rates.  And poured it into dot-com companies that had nothing to sell.  After these dot-coms spent that start-up capital they had no revenue to replace it.  And went belly-up in droves.  Giving George W. Bush a nasty recession at the beginning of his presidency.  Compounded by the 9/11 terrorist attacks.

DJIA vs Labor Force Participation Rate - Bush

The LFPR fell throughout Bush’s first term as all those dot-com jobs went away in the dot-com crash.  Made worse by the 9/11 attacks.  As all the malinvestments of the Clinton presidency were wrung out of the economy things started to get better.  The LFPR leveled off and the DJIA began to rise.  But then the specter of Bill Clinton cast another pall over the Bush presidency.  Clinton’s Policy Statement on Discrimination in Lending forced lenders to lower their lending standards to qualify more of the unqualified.  Which they did under fear of the full force and fury of the federal government.  Using the subprime mortgage to put the unqualified into homes they couldn’t afford.  This policy also pressured Fannie Mae and Freddie Mac to buy these toxic subprime mortgages from these lenders.  Freeing them up to make more toxic loans.  This house of cards came crashing down at the end of the Bush presidency.  Which is why the DJIA fell 19.4%.  And the LFPR fell 2.1%.  Even though the economy tanked thanks to those artificially low interest rates that brought on the subprime mortgage crisis and Great Recession both Wall Street and Main Street took this rocky ride together.  They fell together in his first term.  Rose then fell together in his second term.  Something that didn’t happen in the Obama presidency.

DJIA vs Labor Force Participation Rate - Obama

During the Obama presidency Wall Street has done better over time.  Just as Main Street has done worse over time.  This despite hearing nothing about how President Obama cares for the middle class.  When it is clear he doesn’t.  As his policies have clearly benefited rich people.  Wall Street.  While Main Street suffers the worst economic recovery since that following the Great Depression.  So far during his presidency the LFPR has fallen 3.7%.  While the DJIA has risen by 86%.  Creating one of the largest gaps between the rich and the middle class.  This despite President Obama being the champion of the middle class.  Which he isn’t.  In fact, one should always be suspect about anyone claiming to be the champion of the middle class.  As the middle class always suffers more than the rich when these people come to power.  Just look at Venezuela under Hugo Chaves.  Where the rich got richer.  And the middle class today can’t find any toilet paper to buy.  This is what the historical record tells us.  The rich do better under Democrats.  And the middle class does better under Republicans.  Despite what our schools and universities teach our kids.  Or what they say in movies and television.

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Dow Jones Industrial Average

Posted by PITHOCRATES - May 6th, 2013

Economics 101

The Dow 30 is a Selection of Companies that gives an Idea of how the Economy is Doing as a Whole

The stock market rallied on Friday thanks to what investors viewed as a favorable jobs report.  Sending the Dow Jones Industrial Average into new territory.  Above 15,000.  But it couldn’t hold on to close above 15,000.  Instead, closing at 14,974.  Close but no cigar.  It even fell a little on Monday.  Reaching only 14,968.89 at the close of trading.

No doubt many wonder 14,968.89 of what?  Is it dollars?  After all, they call it the Dow Jones Industrial Average (i.e., the Dow).  And most know it has something to do with the stock prices of some group of companies.  Thirty, to be exact.  The Dow 30.  A selection of companies that gives an idea of how the economy is doing as a whole.  By looking at stock prices from all sectors of the economy.  So is the average price of these 30 stocks $14,968.89?  Well, let’s take a look at those 30 stocks and their closing prices at the end of trading today.

Bow Jones 30 Stocks and Closing Prices 5-6-2013

Hmmm.  Looks like IBM is the most expensive stock in the group at $202.78.  But an average can’t be higher than the highest price.  It has to be somewhere in the middle of the pack.  In this case the average is $64.97.  So the Dow certainly isn’t the average stock price of these 30 companies.   Is it the sum of these stock prices?  Well, if we add all of the stock prices in the above table we get $1,949.19.  That’s closer to 14,968.89 than 64.97.  But it sure isn’t 14,968.89.  So what exactly is this number?

A Company wants a Rising Stock Price and a High Trading Volume

The Dow Jones Industrial Average (DJIA) dates back to 1896.  Then it included 12 industrial stocks.  American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, U.S. Leather preferred and U.S. Rubber.  (General Electric has been a part of the DJIA for all its 117-year history except for the periods September 1898 – April 1899 and April 1901 – November 1907.)  And the DJIA was just that.  The average price of these 12 stocks.

To simplify this let’s look at three fictitious companies and their stock prices.  ABC at $300/share.  XYZ at $200/share.  And 123 at $100/share.  If you add these three stock prices together you get $600.  And if you divide this number by three you get the average stock price ($200).  This is how they calculated the first DJIA.  Only with those 12 stocks.  Which gave a good idea about the market.  If companies were doing well their stock prices went up.  Raising the average price.  Telling us the economy was doing well.  Doing this today, though, would give you a distorted view of the economy.  Why?  Because of stock splits (as well as the changing of companies in the Dow 30).

When a company has growing sales and growing profitability the value of the company increases.  Which the stock price reflects.  As people bid up the price of the stock.  Because everyone wants to buy it.  So the laws of supply and demand raise the price.  But a higher price will reduce the number of shares an investor can buy.  Which will reduce the trading volume.  Showing a falling interest in the stock.  Which may cause the stock price to fall.  Something a company doesn’t want.  What they want is a rising stock price AND a high trading volume.  Two seemingly contradictory things.  Which is where the stock split comes in.  Which works like this.  If there are 1 million shares outstanding at $300/share that’s a market capitalization of $300 billion (1 million shares X $300/share).  To increase the trading volume the company may announce a 2-1 stock split.  That is, they will cut the stock price in half and double the shares outstanding.  So after the stock split there’s a market capitalization of $300 billion (2 million shares X $150/share).  The value of the company is the same BEFORE and AFTER the stock split.  But the stock price is lower which encourages investors to buy and sell more of the stock.  Thus increasing the trading volume.  While the stock price can continue to rise.  Thus meeting those two contradictory objectives.

They divide the New Sum of the Closing Stock Prices for the Dow 30 by the Current Divisor to get the DJIA

The DJIA shows the relative strength of the economy.  As companies grow more valuable their stock prices rise.  If they rise a lot the company may announce a stock split.  Anyone holding stock at the time of the stock split will be very happy.  As the number of their shares may double.  Triple.  Even quadruple.  And even though the market capitalization remains the same before and after the stock split the split itself is a sign of a strong and growing company.  Which tends to drive the stock price—and the market capitalization—higher.  So stock splits are good things.  Which is why they had to change the way they calculated the DJIA.  For the average of stock prices after a split will fall even though the economy as a whole is getting stronger.  As we can see with our three sample companies.

Adjusting Index after Stock Split

This is the problem of using a straight average of stock prices.  It would show a weakening market when it was, in fact, growing stronger.  So they had to add a little math.  To make the market capitalization before and after the stock split the same.  And they do this with a divisor.  They divide the sum of stock prices after the split by the sum of stock prices before the split (450/600=0.75).  So if we divide the sum of stock prices after the split by 0.75 the ‘DJIA’ equals 600.  Just what it was before the stock split.  Which makes the market capitalization before and after the split the same.  As it should be between the close of one day’s trading and the beginning of the following day’s trading.  As there are more and more stock splits this divisor gets smaller.  As the sum of stock prices gets smaller with each stock split.  Which makes the divisor grow smaller with each stock split.  And as we divide the sum of closing stock prices in the Dow 30 by a divisor that is continually getting smaller the resultant ‘DJIA’ gets larger.  As we can see here.

Adjusting Index after Stock Split 2

These companies are doing exceptionally well.  So well that they all announced stock splits.  ABC and XYZ quadrupled the number of shares outstanding and divided their stock price by 4.  123 tripled their outstanding shares while dividing their stock price by 3.  The average stock price fell by 73%.  If this was reported as the ‘DJIA’ it would probably cause a stock market crash.  Which is why the DJIA is no longer an average of stock prices.  Because an average of stock prices does not show the true economic picture.  But adding a divisor into the mix does.  And every time there are stock splits (or new companies replace old companies in the Dow 30) they calculate a new divisor.  They divide the new sum by the old sum of stock prices.  Then multiply this number by the old divisor to get the new divisor.  Which they divide into the new sum of closing stock prices in the Dow 30 to arrive at the DJIA at the close of each trading day.

At the close of trading today the DJIA was 14,968.89.  While the sum total of the closing stock prices for the companies in the Dow 30 was $1,949.19.  If we divide 1,949.19 by 14,968.89 we get 0.130216081.  This is the divisor.  Which they publish every day.  Showing any revisions in the divisor whenever there is a stock split or a change in the companies in the Dow 30.  And every day at the close of trading they divide the new sum of the closing stock prices for those companies in the Dow 30 by the current divisor to get the DJIA.  And today they divided 1,949.19 by the current divisor to get 14,968.89.  The Dow Jones Industrial Average at the end of today’s trading.

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The Rich are doing well in the Stock Market while the rest of us Suffer in a Jobless Recovery

Posted by PITHOCRATES - April 7th, 2013

Week in Review

The stock market is doing well.  Thanks to the Federal Reserve’s flooding the economy with new money.  Which rich people are borrowing to get even richer in the stock market.  But all this monetary stimulus is not creating real economic activity.  Like Keynesian economics says it’s supposed to.  For the Keynesians believe the only thing needed to create economic activity is cheap money.  And government spending.  Which the government is doing.  Running record trillion dollar deficits.  But there is no new economic activity.  They are not creating new, good-paying jobs.  No, it’s quite the contrary.  Some of the most anti-business policies has frozen job creation.  With Obamacare doing much of that freezing.

The problem is that governments embrace Keynesian economics to expand the government.  Not the economy.  They hope the economy will follow.  But if it doesn’t, that’s okay.  For they are more interested in taxing, borrowing, printing and spending.  Because you can get a lot of people to vote for you when you do.  And when stimulus spending fails, why, it just gives them an excuse to pass more stimulus spending legislation.

But businesses aren’t stupid.  They know that when the government expands the money supply they will depreciate the dollar.  So they’re not borrowing any of that cheap money.  Because they know inflation will soon follow.  Raising prices.  And bringing on another recession.  Or keeping us in a perpetual recession.  At most you get a surge of consumer spending.  But that’s it.  Retailers may draw down inventories at wholesalers.  But the wholesalers aren’t increasing their orders with manufacturers.  And the manufacturers aren’t increasing their orders with their raw material suppliers.  So there is no job creation above the retail level.  And very little at the retail level.  So while rich people are taking advantage of the Federal Reserve’s quantitative easing to get rich in the stock market, the rest of us are just seeing flat and stagnant economic growth of a jobless recovery (see Demand for space in U.S. strip malls still weak in first quarter by Ilaina Jonas posted 4/4/2013 on Reuters).

With retail sales struggling to recover and muted demand for space, new construction for neighborhood strip centers remained near record low levels during the quarter, according to the report by real estate research firm Reis Inc…

The data adds to recent evidence that without a stronger labor recovery, the rebound of the U.S. economy continues at a glacial pace, rather than gaining momentum.

“Until the economy begins to create more and better jobs, retail sales will remain listless, demand will remain at low levels, and the vacancy compression will be slow and tedious,” Reis economist Ryan Severino said…

Since the United States began to drag itself out of recession, the national vacancy for neighborhood strip centers is just half a point below the 1990 all-time high of 11.1 percent that was also reached in 2011. Vacancies remain well above their 2005 low of 6.7 percent.

The unemployment rate fell in March from 7.7% to 7.6% with the economy adding only 88,000 jobs.  Horrible economic numbers.  And an unemployment rate that is meaningless.  For 496,000 people disappeared from the civilian labor force in March.  Which is the only reason why the unemployment rate fell.  They didn’t count these 496,000 people who don’t have a job as unemployed.

The economy is horrible.  It is far more horrible than the official government numbers tell us.  And it’s not going to get better anytime soon.  Not with these anti-business policies freezing hiring and hindering new job creation.  Especially Obamacare.  Whose onslaught of new taxes will snuff out whatever life is left in this anemic recovery.

But the Keynesians play with the economic data.  Telling us, as they have been telling us the past 4 years, that we’ve turned the corner.  But the only improvement in the unemployment rate is due to people disappearing from the civilian labor force.  Since Obama became president there has been a permanent decline in the labor force participation rate.  Because President Obama is a Keynesian.  And cares more about the power these horrible policies give him than the economy.

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Wall Street is Doing Well because the Fed’s Inflationary Policies keep Raising Prices

Posted by PITHOCRATES - March 9th, 2013

Week in Review

Investors like rising stock prices.  They don’t like falling stock prices.  Which is why Wall Street likes inflation.  And fear deflation.  Even though the economy is still sluggish with more and more people dropping out of the labor market (which is why the unemployment rate fell) investors are bullish.  Because of the Federal Reserve and all of their quantitative easing.

The more the Fed increases the money supply the more inflation there will be.  Investors like that.  Because inflation increases prices.  Such as the prices of their stocks.  As well as gasoline and groceries.  Making the current economic times odd.  For the stock market recently reached a record high.  Even though the labor participation rate (see THE EMPLOYMENT SITUATION —FEBRUARY 2013, page 4) continues to fall.  It is now at 63.5%.  Which means 89,304,000 people are not in the labor force.  A record high.  But you wouldn’t know this by looking at the official unemployment rate.  Or the stock market (see Stocks And Inflation: The End Of An (Abnormal) Affair? by James Picerno posted 3/69/2013 on Seeking Alpha).

The positive correlation between the market’s inflation forecast and the stock prices appears a bit looser these days, but it’s premature to declare that the link has been broken…

Normally, rising/high inflation doesn’t inspire the bulls. But the last several years have been less than normal in terms of the macro backdrop. The crowd has remained worried about disinflation/deflation, which means that signs of higher inflation in the future have soothed anxious traders…

And why not?  For when have inflationary policies ever caused an asset bubble? That burst into a long and painful recession?  Except the housing bubble that brought about the 1990-91 recession.  The dot-com bubble that brought about the 2000-01 recession.  And that other housing bubble that brought about the 2007-09 recession.  AKA The Great Recession.  So there is no worry that these record highs in stock prices aren’t just another bubble.  Just waiting to burst.  Bringing on another deflationary recession.  I mean, what are the odds of that happening again?

Actually, the chances are pretty good that 2013 will have a very painful recession.  Because we don’t have any real economic growth.  These gains in the stock market aren’t because businesses are expanding and hiring.  Not with a falling labor participation rate.  No.  For all intents and purposes we are still in the 2007-09 recession.  Only we should probably call it the 2007-(end date to be determined) recession.  Because the president’s economic policies haven’t helped the economy yet.  And probably never will.

There’s no reason to believe that the fifth year will be any better than the previous four years.  In fact, it will probably be worse.  In fact one would almost get the impression that he is not trying to help the economy.  But, instead, trying to destroy the Republican Party.  So he can win the House of Representatives back in 2014.  So he can pass even more anti-business policies.  To transform the country into something it was never before.  Less prosperous than communist China.

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Bill Gates, Microsoft, Dot-Com Companies, Dot-Com Bubble, Green Energy and Green Energy Companies

Posted by PITHOCRATES - December 18th, 2012

History 101

Investors poured Money into Dot-Com IPOs to get in on the Ground Floor of the next BIG Thing

Cash is king.  It is the lifeblood of a business.  The most serious business issues are discussed in blood metaphors.  When a company’s operations are losing money the company is ‘in the red’.  When the company’s losses are so great that there is a high probability of bankruptcy business analysts may say the company is ‘bleeding (or hemorrhaging) red ink all over their balance sheet’.  Indicating the death of the business is imminent.  For if the company is bleeding too much cash it simply won’t have the cash to pay its people, its vendors, its taxes, etc.  And it will cease to be.  Like any living organism that loses too much blood.

Healthy cash flows in a business are so important that analysts, investors, bankers, etc., will review one particular financial statement, the statement of cash flows, for an immediate assessment of a business’ health.  This statement shows the three sources of cash a business has.  Operating activities, investing activities and financing activities.  A successful business can generate all the cash they need from their operating activities.  To get there, though, they need startup capital.  Which comes from their financing activities.  The companies that are preparing for a surge in growth will look for venture capital.  And the inevitable initial public offering (i.e., going public).  For many companies the IPO is the measure of success.  Because going public is what makes these entrepreneurs millionaires.  And billionaires.

In the Eighties one such entrepreneur that became a billionaire is Bill Gates.  Mr. Microsoft himself.  Who made a fortune.  And is now working to give it away.  Just like Andrew Carnegie.  And John D. Rockefeller.  This geek made so much money with his software company that he made a lot of people wealthy who were smart enough to buy Microsoft stock early.  How these stockholders loved Bill Gates.  And every investor since has been waiting for the next Bill Gates to come along.  So they can get in on the ground floor of the next BIG thing.  And they thought they found him.  Rather, they thought they found a whole bunch of him.  Pouring their money into IPO after IPO.  Just waiting for the nascent dot-com companies to take off and soar into the stratosphere of profits.  For the Internet had arrived.  Few knew what it did.  But everyone knew it was the next BIG thing.

The Dot-Coms survived on Venture Capital and the Proceeds from their IPOs as they had no Sales Revenue

And these dot-coms took their money and spent it.  They hired programmers like there was no tomorrow.  They built office buildings.  Cities even offered lucrative incentives to attract these dot-coms to tech corridors they were building in their cities.  And splurged on infrastructure to support them.  The dot-coms bought advertising.  They spent a fortune to develop their brand identity.  Making them common place names in the new high-tech economy.  There was only one thing they didn’t do.  Develop something they could actually sell.

Those on the Left keep talking about how great the Clinton economy was in the Nineties.  Despite higher marginal tax rates than we have now.  These people who don’t even like Wall Street say the stock market did better under Clinton.  Apparently getting rich in the stock market was okay in the Nineties.  Today it only attracts occupy movements to protest the evil that stock profits now are.  But there was one subtle difference between the economy in the Nineties and the boom of the Eighties.  Most of the Nineties was a bubble.  A dot-com bubble.  It wasn’t real.  It was all paper profits that sent stock prices of companies that had nothing to sell soaring.  As all those stockholders sat and waited for these companies to sell the next BIG thing.  Taking them on a whirlwind ride to riches that never came.  Because once that startup capital petered out so did these dot-coms.  Leaving George W. Bush to deal with the resulting Clinton recession.

A review of their statement of cash flows for all of these failed dot-coms would show the same thing.  They would show tremendous flows of cash.  But it all flowed from their financing activities to their operating activities.  Which was nothing but a black hole for that startup capital.  All of these companies survived on venture capital and the proceeds from their IPOs.  They paid all their programmers, bought their buildings, paid for advertising and developed their brand with money from investors.  A healthy business eventually has to replace that startup capital with money from their operating activities.  Businesses that don’t fail.  Because even the most diehard of investors will stop investing in a company that can’t do anything but bleed red ink all over their balance sheet.

Instead of Investors taking the Loss on Green Energy Investments it’s the American Taxpayer taking the Loss

Bill Clinton had his dot-coms.  While President Obama has his green energy companies.  Which are similar to the dot-coms but with one major difference.  Instead of investors pouring money into these companies for a whirlwind ride to riches they’re sitting out the green energy industry.  Because it is a bad investment.  There will be no Microsoft in green energy.  Because it is a horrible business model.  The cost to harness the free energy out of wind and solar is just prohibitive.  The amount of infrastructure required is so costly that there can never be a return on investment.  Like there can be for a coal-fired power plant.  Which is something investors will invest their money in.

Green energy cannot compete in the marketplace unless the government subsidizes it with tax dollars.  Green industries cannot even build a factory.  While they have some private investors it is never enough.  Most green investors typically support these companies with a token investment.  But the real investors who expect a return on investment look at a green energy prospectus and say, “Thank you but no.  It is a horrible investment.”  And the people who want to build these plants know they’re horrible investments as they want to risk other people’s money.  Not theirs.  Which leaves but one source for startup capital.  A source that is so inept about business that they will pour money into a horrible investment.  The government.

The Energy Department invested heavily into these bad investments.  And a lot of them ended the same.  Just like the dot-coms.  The cash on their statement of cash flows went from financing activity to operating activities.  Another black hole for investment capital.  They spent that startup capital on plants and buildings.  Hired people.  And paid themselves very well.  But eventually they ran through that startup capital.  And were unable to get any more.  And with their operating activities unable to generate cash like in a healthy business many of the green energy companies went the way of the dot-coms.  Only instead of investors taking the loss it’s the American taxpayer taking the loss.  As it is their money that is bleeding out in red ink all over these green energy balance sheets.

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FT127: “Obamacare is a lot like the Smoot-Hawley Tariff in terms of scaring the bejesus out of businesses.” -Old Pithy

Posted by PITHOCRATES - July 20th, 2012

Fundamental Truth

The Roaring Twenties gave us Automobiles, Electric Power, Radio, Movies, Telephones and Air travel

In 1921 there were 9 million automobile registrations.  That jumped to 23 million by 1929.  An increase of 156%.  That’s a lot more cars on the roads.  In the Roaring Twenties we made cars out of steel, paint and glass.  Inside we fitted them with lumber, cotton and leather.  We put rubber tires on them.  And filled their fuel tanks with gasoline.  So this surge in car ownership created a surge in all of these industries.  Extraction of raw materials.  Factories and manufacturing plants to build the equipment to extract those raw materials.  As well as the machinery to build these automobile components.  And the moving assembly lines in assembly plants to assemble these automobiles.  The plants, warehouses and automobile dealers created a surge in the construction industry.  And all the industries that fed the construction industry.  Including the housing industry to house all these gainfully employed workers.

And this was just the auto industry.  Which wasn’t the only industry that was booming during the Roaring Twenties.  Thanks to the hands-off government policies of the administrations of Warren G. Harding and Calvin Coolidge businesses introduced us to the modern world.  Electric power came into its own.  By 1929 about 80% of all installed horsepower was electrical.  And it entered our homes.  Electric lighting and electric appliances.  Vacuum cleaners.  Washing machines.  Refrigerators.  All of this required even more raw material extraction from the ground.  More manufacturing equipment and plants.  More wholesale and retail construction.  And more housing to house all of these workers earning a healthy paycheck.

And there was more.  The Roaring Twenties gave us broadcast radio in our electric-powered homes.  Free entertainment, sports broadcasts and news.  Paid for by the new industry of advertising.  Competing with radio was another growing industry.  Motion pictures.  That by the end of the Roaring Twenties were talkies.  And speaking of talking there was a lot of that on the new telephone.  In our homes.  Interconnecting all of these industries was ship, rail and truck transportation.  Even air travel took off during the Twenties.  More raw material extraction.  More equipment.  More manufacturing.  More construction.  And jobs.  More and more jobs.  The hands-off government policies of the Harding and Coolidge administrations created the great Bull Market of the Twenties.  Explosive economic activity.  Real economic growth.  Creating low-cost consumer goods to modernize America.  Increase her productivity.  Making her the dominant economic power in the world.  The Europeans were so worried about America’s economic prowess that they met in 1927 at the International Economic Conference in Geneva to discuss the American problem.  And how they were going to compete with the American economic juggernaut.  Because the free market capitalism of the New World was leaving the Old World in the dust.

Herbert Hoover was a Republican in Name Only that FDR once Admired but Calvin Coolidge Despised

This was real economic growth.  It was not speculation.  This wasn’t artificially low interest rates creating an asset bubble.  Working Americans bought homes and cars.  And furnishings.  Businesses produced these to meet that demand.  They had growing sales.  And growing profits.  Which increased their stock prices.  Investors wanted to own their stocks because these companies were making money.  And with the world modernizing these stock prices weren’t going anywhere but up in the foreseeable future.  Unless something changed the business environment.  Well, something did.

Despite the roaring economy Calvin Coolidge did not run for a second term.  Which was a pity.  For his successor, Herbert Hoover, was a Republican in name only.  He was a big time progressive.  Who wanted to use the power of government to make the world perfect.  A devout believer in the benevolence of Big Government.  He added about 2,000 bureaucrats to the Department of Commerce.  FDR at one time admired him (before he ran against him for president).  Coolidge despised him.  Under Hoover the federal government intruded into the private sector.  His economics were Keynesian.  He, too, worshipped at the altar of demand.  He believed high wages were the key to prosperity.  For people with more money buy more.  And all that buying created demand for businesses to meet.  Even during a recession he believed wages should not fall.  Despite the fact that’s what recessions do on the back side of the business cycle.  Lower prices and wages.  And lay off people.

By the Twenties American farmers were mechanizing their farms.  Allowing them to grow more food than ever before.  Agriculture prices fell.  At first this wasn’t a problem as there were export markets for their bumper crops.  Thanks to a war-devastated Europe.  But eventually the European soldiers returned to the farm.  And the Europeans didn’t need the American food anymore.  Even places tariffs on U.S. imports to their countries to help their farmers get back on their feet.  Add in a bad winter that killed livestock.  Some bad insect infestation in the summer.  Add all this together and you had the beginning of the great farm crisis.  Debt defaults.  Bank failures.  And the contraction of the money supply.  Which the Federal Reserve (the Fed) did not step in to compensate for by expanding the money supply.  Which was sort of their purpose for being in existence.  As there was less money to borrow business could longer borrow to continue their growth.  Because of the time factor in the stages of production to expand production required borrowing money.  To make matters worse the Fed was actually pulling more money out of circulation.  Because they looked at the rising stock prices and concluded that speculators were borrowing money to invest in the stock market.  Thus inflating stock prices.  But it wasn’t speculators running up those prices.  It was an economic boom that was running up those stock prices.  Until the government put a stop to that, at least.

Bad Government Policy didn’t Create the Roaring Twenties but Bad Government Policy ended Them

The Smoot-Hawley Tariff was close to becoming law in the fall of 1929.  It was moving through committees on its way to becoming law.  This tariff would raise the tax on all imports by about 30%.  The idea was to protect domestic supplies and manufacturers.  But even in 1929 it was a global economy.  A lot of imports entered the stages of production.  Which meant costs would be increasing throughout the stages of productions.  Greatly increasing the input costs of all those businesses enjoying those high stock prices.  Which would raise their prices (to cover those higher input costs).  Reducing their sales.  And slashing their profits.  Add this to the contracting money supply and it painted a very bleak picture for business.

With demand sure to fall due to a massive new tariff that was about to become law businesses cut back.  To get rid of what was about to become excess capacity.  For they were smart.  And understood what affected their businesses.  And you know who else were smart?  Investors.  Who looked at this tariff and saw a locomotive engineer about to slam on the brakes.  And if Congress passed this into law after 1928 Coolidge wasn’t going to be there to veto the law.  So they all came to the same conclusions.  The bull market was coming to an end.  And they wanted to sell their stock to lock in their stock gains.  Which caused the great sell-off of 1929.  And the stock market crash.  Starting the Great Depression.

People still debate the cause of the Great Depression.  A popular argument is that greedy investors caused it by speculating in the stock market.  Or that greedy businesses out-produced demand.  But the economics of the Roaring Twenties don’t support this.  This wasn’t people buying big houses because interest rates were low.  This was the electrification of America.  Cars.  Telephones.  Radio.  Movies.  Air travel.  This was broad and real economic growth.  Bad government policy didn’t create it.  But bad government policy ended them.  And it was the expectations of even worse government policies that yanked the rug out from underneath the economy.  By causing a business contraction and stock market sell-off.  Much like Obamacare is doing to businesses today.  Scaring the bejesus out of them.  For they have no idea what their future costs will be under Obamacare.  So they are doing their best to prepare for it.  By not expanding their businesses.  By not hiring anyone.  And sitting on their cash.  To prepare for the worst.  Much like businesses did in 1928.  Which explains why the Great Recession lingers on.

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FT122: “Japan’s Lost Decade helped the Clinton economy by reducing imports while the global slowdown does nothing for the Obama economy.” -Old Pithy

Posted by PITHOCRATES - June 15th, 2012

Fundamental Truth

The Japanese Government made Money Cheap and Plentiful to Borrow creating a Keynesian Dream but an Austrian Nightmare

Once upon a time Americans feared the Japanese.  Their awesome might.  And their relentless advances.  One by one the Japanese added new properties to their international portfolio.  They appeared unstoppable.  Throughout the Eighties everything was made in Japan.  Government partnered with business and formed Japan Inc.  And they dominated the world economy in the Eighties.  A U.S. Democrat nominee for president held up Japan Inc. as the model to follow.  For they had clearly shown how government can make the free market better.  Or so this candidate said.

But it didn’t last.  Why?  Because in the end the Japanese just interfered too much with market forces.  Businesses invested in each other.  Insulating themselves from the capital markets.  Allowing them to make bad investments to sustain bad business planning.  All facilitated with cheap credit.  Government made money cheap and plentiful to borrow.  And they borrowed.  A Keynesian dream.  But an Austrian nightmare.  Because they used that money to make even more bad investments (or ‘malinvestments’ in the vernacular of the Austrian school of economics).  Creating a real estate bubble.  And a stock market bubble.  Bubbles are never good, though.  Because they can’t last.  They must pop.  And when they do it isn’t pretty.

The U.S. just went through real estate bubble that peaked in 2006.  Money was so cheap to borrow that people were buying $300,000+ McMansions.  Anyone could walk in and get a no-documentation loan with nothing down.  People were buying houses and flipping them.  And people who couldn’t qualify for a mortgage could get a subprime mortgage.  Further pushing house prices higher.  Not because of real demand.  But because of this artificial tweaking of the free market by the government.  Making that money so cheap to borrow.  And when all that cheap credit caused inflation elsewhere in the economy the Fed finally tapped the brakes.  And increased interest rates.  Raising monthly payments on all those subprime mortgages.  Leading to a wave of defaults.  The subprime mortgage crisis.  And the Great Recession.

Japan’s Deflationary Spiral gave American Domestic Manufacturers a Huge Advantage

This is basically what happened in Japan during the Nineties.  The government had juiced the economy so much that they grew great big bubbles.  Ran up asset prices to incredible heights.  But then the bubble burst.  And those prices all fell.  They fell for so long and so far that Japan suffered a deflationary spiral.  Throughout the Nineties (and counting).  The Nineties were a painful economic time.  After a decade or so of inflation the market corrected that with a decade of recession.  And deflation.  A decade of economic activity the Japanese just lost.  The Lost Decade.  But it wasn’t all bad.

At least, in America.  There was still some Reaganomics in the American economy.  Producing real economic growth.  But there was also a bubble.  In the stock market.  The dot-com bubble.  The Internet was brand new and everybody was hoping to be in on the next big thing.  The next Microsoft.  Or the next Apple.  Also, unable (or unwilling) to learn from the mistakes of the Japanese real estate bubble the Clinton administration was making it very uncomfortable for banks to NOT approve mortgage applications for people who were unqualified.  Putting more people into houses who couldn’t afford them.

So while the Clinton administration was trying to change America (during the first 2 years they tried to nationalize health care against the will of the people) the economy did well.  For awhile.  Irrational exuberance was pushing the stock market to new heights as investors poured money into companies that didn’t have a dime of revenue yet.  And never would.  Clinton had to renege on his promise on the middle class tax cut because things were worse than he thought when he promised to make that middle class tax cut.  (Isn’t it always the way that when it comes to tax cuts some politicians can’t keep their promise because they were too stupid to know how bad things really were?)  Added into this mix was Japan’s Lost Decade.  Their deflationary spiral increased the value of the Yen.  And made their exports more expensive.  Giving the American domestic manufacturers a huge advantage.  The economy boomed during the Nineties.  For a mix of reasons.  They even projected a budget surplus thanks to the economic woe of the Japanese.  But then the dot-com bubble burst.  Giving Bill Clinton’s successor a nasty recession.

When a Recession ails you the Best Medicine has been and always will be Reaganomics

The Left always talks about fair trade.  And about the unfair practice of foreign manufacturers giving Americans inexpensive goods that they want to buy.  So their answer to make these unfair trade practices fair is to slap an import tariff on those inexpensive foreign goods.  To protect the domestic manufacturers.  For they believe it’s that simple.  And plug their ears and sing “la la la” when you discuss David Ricardo’s Comparative Advantage.  Ricardo says countries should specialize in the things they’re good at.  And import the things others are better at.  When everyone does this we use our resources most efficiently.  And the overall wealth in the international economy increases.  Making the world a better place.  And increases our standard of living.  But the rent-seekers disagree with this.  They want high tariffs.  And obstacles for foreign imports.  To protect the domestic businesses that can’t sell as inexpensively or at such high levels of quality.

Some would point to Japan’s Lost Decade as proof.  Where their deflationary spiral removed a lot of foreign competition to American manufacturing.  Allowing them to sell at higher prices and lower quality.  All the while protecting American jobs.  And, yes, Japan’s woes did help the American domestic manufacturers during the Nineties.  But it wasn’t because they could raise prices and lower quality in the face of low foreign competition.  It was because there was still enough Reaganomics in the country to produce some vibrant economic activity.  That encouraged entrepreneurs to take chances and bring new things to market.  Which is a huge difference from the current economic picture.

The Eurozone sovereign debt crisis has plunged Europe into a recessionary freefall.  Much like the Japanese suffered in the Nineties.  Yet the American domestic manufacturers aren’t benefiting from this huge decline in foreign competition.  Why?  Because the Obama administration has excised any remaining vestiges of Reaganomics out of the economy.  Everything the rent-seekers could ever hope for they have.  Only without tariffs.  And yet the Obama economy still lingers in recession.  Because irrational exuberance and barriers to free trade don’t create real economic growth.  And an administration hostile to capitalism doesn’t inspire entrepreneurs to take chances.  No.  What encourages them to take chances are low taxes.  And less costly and less punishing regulations.  For programs like Obamacare just scare businesses from hiring any new employees.  Because they have no idea the ultimate costs of those new employees. 

Now contrast that to the low taxation and relaxed regulatory climate of Reaganomics.  That produced solid economic growth.  And this growth was BEFORE Japan’s Lost Decade.  Which just goes to show you how solid that growth was.  And proved David Ricardo’s Comparative Advantage.  For both Japan and the United States did well during the Eighties.  Unlike Clinton’s economy in the Nineties that only did well because Japan did not.  But the good times only lasted until the irrational exuberance of the dot-com bubble brought on an American recession.  Which George W. Bush pulled us out of with a little Reaganomics.  Tax cuts.  Proving yet again that higher taxes and higher regulations don’t create economic activity. Tax cuts do.  And fewer regulations.  In other words, when a recession ails you the best medicine has been and always will be Reaganomics.

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The Great Depression

Posted by PITHOCRATES - December 20th, 2011

History 101

The  Roaring Twenties were a Time of Unprecedented Innovation and Manufacturing

The Roaring Twenties were good times.  Kicked off by the Warren Harding administration.  Thanks to one of the few honest guys in his administration besides Harding.  Andrew Mellon.  Secretary of the treasury extraordinaire.  Some say the best secretary of the treasury since our first.  Alexander Hamilton.  High praise indeed.

So what did Mellon do?  He did some research that showed rich people paid less in taxes the higher the tax rates were.  The higher the rate the less they invested in plant and equipment in America.  Instead they invested their money out of the country.  In other countries’ plant and equipment.  So Mellon was a tax-cutter.  And that was his advice to Harding.  And that’s what Harding did.  And Calvin Coolidge continued.  Kept taxes low.  And kept government out of the business of business.

And how business responded.  The 1920s were a time of unprecedented innovation and manufacturing.  Low taxes, little government spending and limited government produced record employment.  Record upward mobility.  And record per capita income.  Gains in the decade touched 37%.  How?  I’ll tell you how.

The auto industry was booming thanks to Henry Ford’s moving assembly line.  Everyone was driving who wanted to drive.  The car companies sold one car for every 5 people.  This production created a boom in other industries to feed this industry.  And cars did something else.  They gave people mobility.  And opportunity.  People left the farms in droves and drove to better jobs.  Which didn’t hurt the farmers in the least as mechanization on the farm put more land under cultivation with fewer people.  Housing and cities grew.  Radio debuted.  And radio advertising.  Motion pictures went from silent to talkies.  Telephones became more common.  New electric utilities brought electricity to homes.  And new electric appliances filled those homes.  Including radios.  New electric motors filled our factories, increasing productivity and slashing consumer prices.  More people than ever before flew.  An increase of nearly 1000%.  It’s nowhere near today’s number of flyers but it was a reflection of the new industrial dominance of the United States.  There was nothing we couldn’t do.  And Europe was taking notice.  And not liking what they saw.  And talked about a European union to compete against the Americans.

Businesses scaled back Production in Anticipation of the Smoot Hawley Tariff Act

So the spectacular economic growth of the Roaring Twenties was solid growth.  It wasn’t a bubble.  It was the real deal.  Thanks to capitalism.  And a government willing to leave the free market alone.  It was so dominating that the Europeans wanted to stop it anyway they could.  One way was protective tariffs on farm imports.

American farm exports boomed during World War I.  Because most of Europe’s farmers were busy fighting.  With the end of the war the Europeans went back to their farms.  Which reduced the need for American farm imports.  And the tariffs compounded that problem.  To make things worse, prices were already falling thanks to the mechanization of the American farm.  Producing bumper crops.  Which, of course, dropped farm prices.  Good for consumers.  But bad for farmers.  Especially with the Europeans shutting off their markets to the Americans.  Because they paid for a lot of that land and mechanization with borrowed money.  And this debt was getting harder and harder to service.  Throw in some weather and insect problems in some regions and it was just too much.   Some farms failed.  Then a lot.  And then the banks that loaned money to these farms began to fail.

We created the Federal Reserve to increase the money supply to keep pace with the growing economy.  By making money cheap to borrow for those businesses trying to expand to meet demand.  They weren’t exactly doing a stellar job, though, in keeping pace with this economic expansion.  And when the bank failures hit the money supply contracted.  Thanks to fractional reserve banking.  All that money the banks created simply disappeared as the banks failed.  Starving manufactures of money to maintain growth to meet demand.  Things were getting bad around 1928.  The Fed did not intervene to save these banks.  Worried that investors were the only ones borrowing money for speculation in the stock market, they shrunk the money supply further.  About a third by 1932.  Manufacturers had no choice but to cut production.

While businesses were dealing with a shrinking money supply they had something else to worry about.  Congress was moving the Smoot-Hawley Tariff Act through congressional committees in 1929 on its way to becoming law in 1930.  This act would add a 30% tax on most imports.  Meaning that the cost factories paid for raw materials would increase by up to 30%.  Of course, sales prices have to include all costs of production.  So sales prices would have to increase.  Higher prices mean fewer sales.  Because people just can’t afford to buy as much at higher prices.  Businesses knew that once the tariff was passed into law it would reduce sales.  So they took preemptive steps.  And scaled back production for the expected fall in sales.

It was Government Meddling that Turned a Recession in the Great Depression

This brings us to the stock market crash.  The Roaring Twenties produced huge stock market gains as industry exploded in America.  Things grew at an aggressive pace.  Stock prices soared.  Because the value of these manufacturers soared.  And investors saw nothing to indicate this growth was going to stop.  Until the contraction of the money supply.  And then the Smoot-Hawley Tariff Act.  Not only would these slow the growth, they would reverse it.  Leading to the great selloff.  The Great Crash.  And the Great Depression.

As feared the Europeans responded to the Smoot-Hawley Tariff Act.  They imposed tariffs on American imports.  Making things worse for American exports.  Then President Hoover increased farm prices by law to help farmers.  Which only reduced farm sales further.  Then the banking crisis followed.  And the Fed did nothing to help the banks.  Again.  When they did start helping banks in trouble they made public which banks were receiving this help.  Which, of course, caused further bank runs as people hurried to get their money out of these troubled banks.  Tax revenue plummeted.  So Hoover passed a new sales tax to raise more revenue.  Which only made things worse.

Hoover was a Republican.  But he was a Big Government progressive.  Just like his successor.  FDR.  And all of their Big Government Keynesian solutions only prolonged the Great Depression.  It was government meddling that turned a recession into the Great Depression.  And further government meddling that prolonged the Great Depression.  Much of FDR’s New Deal programs were just extensions of the Hoover programs.  And they failed just as much as they did under Hoover.  The Great Depression only ended thanks to Adolf Hitler who plunged Europe back into war.  Providing an urgency to stop their government meddling.  And to let business do what they do best.  Business.  And they did.  Building the arsenal that defeated Hitler.

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