Source: George P. Brockway, "The End of Economic Man", p. 122-126, 1195.


Why a Bull Market Is a Disaster

If you have saved some money (since you have it, it is saved) and want to use it to get more, you can buy a factory (fixed capital), goods to sell (working capital), stock (claims on future profits), bonds (which will pay fees for the use of your money). You can put your money where your mouth is at Las Vegas or Atlantic City or in any of several state- run lotteries or racetracks. You can buy gold or a bundle of stocks or a bundle of mortgages or a carload of pork bellies (without having a clear idea of what a pork belly looks like or why anyone would want one). You can buy unimproved land or improved land, rare stamps or toy soldiers, a real Monet or lots of pseudo-Monets.

If you're a red-blooded American, you will expect prices to go up, whereupon you will sell your purchases and reap a capital gain. Or if you are of a more somber turn of mind, you can sell almost anything short and hope to make your gain as prices fall. Alternatively, still expecting prices to fall, you can do nothing with your money, boarding it (exercising liquidity preference) in anticipation of eventually buying something cheap.

With the possible exception of how you use the first two items in the first paragraph, you will have been speculating or gambling. In ordinary speech, speculation tends to be defined somewhere between gambling and enterprise on a scale of relative riskiness. But betting on dice (which everyone would classify as gambling) is liable to risks that may be closely anticipated, while launching a new product (the quintessential example of productive enterprise) is likely to be very risky indeed. In the publishing business, most new books lose money, though this is not the deliberate intent of either authors or publishers. If no one takes risks of the latter sort, nothing is done; there is no economy to analyze. Riskiness is a tangle, not a continuum.

Instead of relative riskiness, I have proposed the following criteria: 1 Gambling is risking wealth in a zero-sum game. If some players win, some other players must lose the same amount. The winnings and losings (after properly allocating taxes and the house's cut) add up to zero. Speculation differs from gambling in that it is not a zero-sum game. It can happen that all speculators win (though some may win more than others), that all lose, or that some win while others lose; and the sum of the winnings may be quite different from the sum of the losings. Speculation is, nevertheless, like gambling in that it produces nothing but rearranges- often to the great profit of the rearrangers- wealth that already exists. Enterprise is unlike speculation in that it uses wealth to produce new wealth, but it is alike in that it is not a zero-sum game. (If it were, it would be impossible for the economy to grow.) In a healthy economy it is possible for all reasonably astute producers to profit, at least to a degree. Prosperity in one business does not have to be counterbalanced by depression in some other; on the contrary, prosperity tends to spread.

Gambling, speculating, and enterprising all require money on a continuing basis. No sooner does one lottery pay off than its successor begins selling tickets. No sooner does the ball settle in the roulette wheel than the croupier calls for bets on the next spin. First and last, many billions are perpetually tied up in gambling of one sort or another (and we are speaking here only of legal gambling).

The sums invested in speculating are vastly greater. On a quiet day, close to a billion shares will change hands on the different stock exchanges in the United States, to which must be added the option trading on the futures exchanges. All of this must be financed.

Almost all of this trading is of old or "secondhand" securities and has no necessary effect on the enterprises that gave rise to them. It is not denied that there maybe indirect effects, as in events like the Campeau fiasco or in the way (absurdly exaggerated) in which the existence of a market for old investments may encourage the purchase of truly new issues. But the direct and ordinary effects are nil. It ordinarily makes no difference to an enterprise whether its stockholders are short term or long term, wise or foolish, genteel or riffraff. Nor does an enterprise ordinarily profit or lose from fluctuations in the market price of its securities. Although a price rising faster than the market average may make further financing easier to arrange and may also enhance the prestige and salaries of the firm's executives, the firm itself gets its money from each initial sale of its securities and is thereafter largely indifferent to what happens to the securities as old investments- except as a takeover or buyout becomes a possibility.

It is safe to say that practically the entire activity of the stock exchanges is devoted to speculation. There seem to be no statistics available on the proportion of exchange activity that concerns truly new enterprise, but even counting all new stock issues (and most of these merely refund old investments), it appears that the proportion is well under 1 percent. This speculative bias is likewise true of what preens itself as investment banking. Taken all together- stock exchanges, commodities markets, and investment banking- this business is very large. It is probably what President Calvin Coolidge had in mind when he said, "The business of America is business."

Exchanges of old investments necessarily cancel out. By definition, no new thing is involved; so whatever old thing someone buys, someone else has to sell. But the economy is not static, and the markets are not static, and something makes the exchanges worth the bother in the actual situation. That something is money.

Although no new thing is involved, the general level of the stock market- and of other markets, as well- can rise, because additional money goes into speculation.

Although it is theoretically possible for the general level of the stock market to rise merely because of a reduction in the supply of available shares, a bull market cannot be sustained without a persisting influx of money. Likewise, a panic will greatly increase the supply of available shares and will speed up the trading, so that a crash could theoretically occur without money leaving the market. Nevertheless, when such a panic subsided and the supply was reduced to normal levels, the market would quickly rebound to its prepanic level unless money had actually left it.

Needless to say, there is more to the stock market than the number of shares available. First, there are the "fundamental" values of the corporations that issue the stocks. It is reasonable for increased dividends or increased retained earnings to stimulate demand for a particular stock; but during the bull market from 1982 to 1987, the Standard and Poor's index of 500 industrials rose almost twice as fast as corporate profits after taxes. Second, and in recent years more important, the Federal Reserve Board's shifting maneuvers to control the interest rate caused reciprocal shifts in the value of every income-earning asset. The resulting volatility encouraged speculation. Neither of these factors is large enough to underwrite a bull market, and neither makes much difference in a crash. For such great movements, the market needs money coming in- or going out.

When money leaves the market in a crash, as in 1987, it simply disappears. If it went into cash, we'd see an instant doubling and redoubling of M1. If it went into productive new investment, we'd see a sharp rise in output. If it went into the bond or money market, we'd see a sharp fall in interest rates. If it went into commodities or real estate, we'd see sharp rises in those markets. (A large part of the 1987 money apparently did go into real estate-and was subsequently lost in the recession that started in 1990.) If it went into consumption, we'd see a sharp rise in retail sales and, presumably, in consumers' prices. If it went, in some marvelously balanced way, into all these things, we'd see a sharp rise in GNP. If it went abroad, it could only be to places isolated from international finance. But after a crash we see none of these results. The money vanishes.

On October 20, 1987, as a free-fall threatened, Chairman Alan Greenspan announced, "The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." Thus a full-fledged panic was averted, but evidently the readiness was all. All four money measures fell, on a seasonally adjusted basis, from September to October, while in November M1 fell further, and M2, M3, and L went up only $2.4 billion, $15.0 billion, and $13.9 billion, respectively.2  (These comparatively small increases cannot, of course, be summed, since the latter of each ordered pair includes the former.) If they were the result of the Federal Reserve Board's offer, they were new money, not money that bad somehow safely escaped from the market, and anyhow they represented only a small fraction of the amount lost in the crash.

It is not possible to say absolutely bow much money disappears in a crash. Estimates of the losses in 1987 seem now to have settled at around a trillion dollars.3 Whatever it was, a vast sum simply vanished. It fell into a black bole, never to be seen again. Some people and some institutions had it one day; no one had it the next. The market was not a casino; the winnings were a long way from equaling the losings.

Yet the macroeconomic effect seems to have been slight. From this it is reasonable to infer that given the way the producing economy is organized-especially the way its rewards are distributed-it had no use for all those hundreds of billions of dollars. At the very least, we can say that the producing economy did not actually have the use of those hundreds of billions, whether it could have used them or not, and that the so-called recovery or expansion went on its sluggish way as though that money did not exist.

It is also reasonable to infer that the people who lost that money, whether as individuals or as managers of institutions, had no better use for it than to put it into the speculating economy.4 We could, of course, argue about particular cases, but by and large this was true; and it certainly was true that they made no better use of it in fact. Many were no doubt foolish, but many others carefully considered the existing opportunities for productive investment and for consumption and rejected them for the stock market, perhaps as a lesser evil.

The uses to which they could put their money are, after all, limited. It could go into consumption, hoarding (or liquidity preference), new productive enterprise, or existing securities. If money goes into consumption, it causes the producing economy to expand; if it is invested in productive enterprise, it reduces the rate of interest the producing economy must pay to finance current business or expansion. if, however, it is held liquid or invested in existing securities, it is thereby denied to the producing economy and plays no part in it. Thus, as money flows into the speculating economy, the producing economy loses the increased sales or more manageable financing it might otherwise have enjoyed.

It loses nothing it actually is making use of, and this fact helps explain the producing economy's relative imperviousness to the 1987 crash. The producing economy b\had not used the money that went into the bull market and so was not affected when the money was lost. What the producing economy lost is merely what might have been. The loss or deprivation came at the very beginning and continued to grow as long as the bull market continued. The bull market climbed on the backs of the deprived.

****************************************************************************************************************** 1. The New Leader, September 7, 198 1, pp. 9-10.

2. A slightly different picture is given by the fact that "the weekly reporting banks in New York City expanded their loans to brokers and to individuals to purchase Or carry securities from $16.7 billion in the week ending October 7 to $24.4 billion in the week ending October 2 L" See Andrew F. Briminer, "Distinguished Lecture on Economics in Government: Central Banking and Systemic Risks in Capital Markets," Journal of Economic Perspectives 3, no. 2 (Spring 1989); 15. It will be noticed that $7.7 billion in new loans amounts to less than I percent of the money said to have been lost in the crash.

3. Ibid., p. 11. 1 should not be surprised if professional opinion finally accepted a much lower figure for the amount lost. Either way, apologists for the stock market are faced with a dilemma. If the amount lost was large, the exchanges must be brought under tighter control; but if the amount lost was small, no harm will be done to the economy by bringing them under tighter control.

4. The distinction between the producing economy and the speculating economy is essentially the same as that made by Keynes between the "industrial circulation" and the "financial circulation." See John Maynard Keynes, A Treatise on Money, vol. 1, The Pure Theory of Money (London: Macmillan, 1930), pp. 41-43. 1 have chosen to use different terms because speculation today plays a much greater role than it ever has before, with the possible exception of the first quarter of the eighteenth century. ***************************************************************************************************************