Tuesday, November 4, 2008

Austrian Critique of a Big Shot Economist

Jeremy Siegel has opined that folks should be buying stock, and that they might possibly make 20% or more within the year if they buy today:
I believe that stock prices are now so extraordinarily cheap that I would be very surprised that if an investor who bought a diversified portfolio today did not make at least 20% or more on his investment in the next twelve months.
Jeremy Siegel is a bigshot financial guy. Very bigshot. He's a very smart man who knows a lot more about economics than I do. He also seems like a very nice guy. But I think he is wrong. Let's look at his arguments.
The case for equities at these levels is compelling. The last time we have seen prices this low was more than 30 years ago, when the US economy was in far worse shape than today... Except for the tech-laden Nasdaq, the US markets are selling at 10 to 11 times 2008 estimated earnings while European markets, save Switzerland, are selling between 7 and 9 times earnings. Asian stocks are also very cheap, as the Japanese Nikkei Index is selling at 11.4 times earnings, not much different than stocks in Hong Kong, Australia, and Singapore. The Chinese market, which had been selling at over 50 times earnings last year is now selling at a far more modest 15 times earnings...
He goes on to argue that "bears" will say that there are still a lot of bad earnings reports to look forward to, implying that PE's are still too high to consider buying at this point, and that if a few companies in the index go bankrupt, so what? They constitute a very small fraction of an index. The basic argument is "Numbers, numbers, blah, blah... stocks prices are historically low and the economy is not really all that bad." Not really all that bad?
Although the financial stocks are more stressed today, the economy was in much worse shape then. Inflation hit 14.8% in the early 1980s and interest rates on perfectly safe, long-term government securities soared to 15.9%. It is little wonder that nobody wanted stocks when you could pocket nearly 16% per year by just investing in treasury bonds.
We've already seen what I think about interest rates. The globe is positively glutted with treasuries, and more are piling up each minute as the bailout continues and tax revenues fall. "Experts" are predicting near trillion dollar deficits this year and next. The dollar is now strengthening, but stacking a few trillion on the debt and printing a few hundred billion more should put a dent in that little trend over the next couple of years. Of course, one can never underestimate the lengths that Japan and China will go to to suppress their currencies and keep their artificial markets for electronic goodies here in the States "profitable." Still, the situation is absolutely staggering. Who's going to purchase these volumes of debt, denominated in falling dollars, at anything close to present interest rates? You'd have to be just plain stupid. "Pocket 16% per year?" On what planet? Reality check: with inflation at 14.8% (read the previous sentence), you're "pocketing about 1.2%" and paying ~35% income tax for the privelege of having the government steal your savings at a slightly lower rate. Let's just get it straight what's really going on, sil vous plais. Bonds were not a steal by any means. (Although if you held them until the rates fell the following ~2 yrs, you probably made a pretty penny on the trade! But you were just an idiot if you bought them for the interest...) Back to my assault on the numbers: one of the basic tenet's of Austrian economic theory is that "economics isn't math." Dr. Siegel, wonderful financial expert that he is, is pretty good with numbers, but probably doesn't know all that much about concrete. You see, when the "numbers" change, his computer gets updated automatically. He can cut and paste in his spreadsheet programs to help make predictions, run cool algorithms to manipulate the numbers on a whim, and look at all sorts of trends and graphs. Concrete doesn't do these things. You can't unpour it. You can't move it around easily. Most economist types don't spend a lot of time with the "concrete" side of economics. They spend their time looking at graphs and numbers. They are like military generals who have never been in the trenches, for whom armies are little plastic flags on a map: easily ordered about and moved on a whim. Crossing the English channel? No problem! You just move the little flag like so... Dr. Siegel can talk about his numbers but the facts are the facts: America is full of strip malls, shopping centers, and row after endless row of suburban McMansions that never should have been. Wealth was not destroyed when the prices of these assets fell, it was destroyed when perfectly good raw materials and human labor were expended on these ill-advised and ill-conceived, so-called "investments." The falling of the price was simply a realization of what had actually been the case all along. They are still with us, the material is spent, the labor gone. Refinery capacity is insanely low; the energy infrastructure as a whole is nowhere near where it ought to be. The housing bubble ate up valuable resources which should have been applied elsewhere. Shuffling numbers can not change this, any more than moving a flag on a map can capture Berlin. For Austrians, economics is not about numbers. It is not really even about money. Economics is about stuff, of which money is but one, if special, example. Numbers change quickly, stuff does not. Especially stuff like refineries, or giant sports stadiums that look like a bird's nest. When stuff is misallocated and wasted, there is a price to pay. That price is lost productivity and time. These investment imbalances will take time to work out. The actual practice of Austrian theory is really actually quite simple. One simply:
  • watches for the opening of the money spigot
  • predicts bedlam
  • endures criticism for being a "barbarous fool" and a "relic" while waiting for "it" to hit the fan
  • watches while real losses due to the squandering of resources and foolish investments pile up due to the economic fantasy of unsustainably easy money
  • frolics in the inevitable financial bloodbath
Recessions are not "numbers problems." They are real problems, made of concrete and steel in the real world that no amount of creative accounting can straighten out. Fixing them requires sledgehammers, sweat, and time. It will take far more than 12 months for the present screw-ups to be liquidated and the resources re-deployed to more rational ventures. Presently, the AMB indicates that the FED is printing away, yet asset prices continue to fall. People are still trying to pay the old bills in the new reality, and the government is still trying to help. Fat chance. Truth be told, a wave or two of bankruptcy would be more helpful to the economy. So long as we stay mired in the present mess, we cannot move on to better things. Like setting up the next one. If you really want to buy stocks, you will probably have your chance at much lower prices in the not too distant future. In my, humble, non-expert, self-educated, Austrian opinion, of course.

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