October 9, 2021
“The proportion between the real recompence of labour in different countries, it must be remembered, is naturally regulated, not by their actual wealth or poverty, but by their advancing, stationary, or declining condition.”
– Adam Smith, The Wealth of Nations
It may come as a surprise to some, but in the mid-19th century, whaling was a major American industry. By major, we’re talking fifth largest in the U.S. According to Kevin Baker’s 2016 book America the Ingenious, this now-forgotten sector could claim annual revenues of $70 million while employing 70,000 people. In Baker’s words, “By the 1830s, it was whale oil that kept the lights burning and wheels turning in America.”
Then crude oil was discovered in Titusville, Pennsylvania, in 1859. The days of whaling and whale oil were numbered… What was once economically consequential ceased to be.
Fast forward 100 years to the 1950s, and it was steel that symbolized immense U.S. economic strength. The Fortune 500 was first published in 1955, and a look at the early rankings would reveal names at and around the top, like U.S. Steel, Armco, Jones & Laughlin, and Kaiser.
Let’s compare the endlessly changing team picture of U.S. commerce with that of the former Soviet Union… For help here, it’s useful to reference former Federal Reserve Chairman Alan Greenspan’s 2007 memoirs, Age of Turbulence. In it, he described a 1980s visit to the country that included spotting “a 1920s steam tractor, a clattering unwieldly machine” that looked positively ancient relative to the equipment used in the U.S.
Greenspan observed about the tractor:
Like the 1957 Chevrolets on the streets of Havana, it embodied a key difference between a centrally planned society and a capitalist one: Here, there was no creative destruction, no impetus to build better tools.
Nothing Is Sacred
In a capitalist system, there are no sacred cows… What no longer meets the needs of shareholders, customers, or both generally ceases to exist. In centrally planned societies, that which employs us is generally a forever concept – hence the economic desperation.
Described more vividly, if readers are looking for evidence of economic retreat, they need only find the countries in which the lineup of top businesses remains the same year after year, decade after decade. It’s a near-certain sign of decline because growing country economies are magnets for copious investments that relentlessly fund the replacement of existing commercial giants.
For example, while Circuit City was the top-performing U.S. stock in the 1980s, by the 2020s it had vanished. Blockbuster’s story is much of the same. In the ’80s and ’90s, “Blockbuster Nights” were so common that the home-video-rental leader continued trying to expand the business model into the 2000s. In 2005, the FTC actually disallowed Blockbuster’s planned acquisition of Movie Gallery on the belief that the combination would be too powerful. Notable here is that a largely unknown company by the name of Netflix twice offered itself up for sale to Blockbuster (no antitrust opposition there!), only to be rebuffed both times. Readers know how this story ended…
Considering the early part of the 21st century, when Blockbuster was still prominent, it’s fascinating to contemplate other corporations that were similarly well-positioned.
General Electric (GE) was the most valuable company in the world, with a market cap of $585 billion. The company viewed as the next GE, and crowned as such on the cover of Barron’s, was Tyco. Enron was then seen as one of the best-managed companies in the world. The Internet increasingly factored into how we lived and worked, at which point Yahoo and AOL were the dominant players. So powerful was AOL that its merger with Time Warner was held up for a year based on the worry that such an influential combination would bring on “servitude” for customers with realistically nowhere else to turn…
What has been written so far is hopefully a reminder that natural recessions and market corrections are signals of progress rather than scenarios we should fear. They’re very often indicators that good is being replaced with great. This is why we should shudder every time politicians promise to “bring back” jobs, or to fiddle with market forces that are delivering near-term pain – whereby ailing companies are allowed to fail. More realistically, economies gain strength from weakness and decline simply because they’re a sign that a much better future is being rushed into the present by lightly regarded corporations and unknown entrepreneurs that will soon be prominent.
The Futility of the Fed
This brings me to the stock market… Supposedly its buoyancy over the last 12 years has had an artificial quality to it. To believe pundits on the Wall Street Journal‘s editorial page, the opinion page of the New York Times, and even ferociously free-market centers of thought like the Mises Institute, the Fed has been the author of the bull market in U.S. shares. Left, Right, and Center claim that when it comes to the multiyear “bull,” the Fed can take credit.
But this consensus across the ideological spectrum is incorrect… Better yet, the popular view that the Fed has engineered the multiyear rally enjoyed by investors is quite literally impossible.
If the Fed could prop up the markets, then there would be scant markets to prop up. The clues to the previous assertion have already been laid out, but for now it’s useful to digress somewhat into the traditional arguments spread by the news media for the why behind modern market exuberance.
Most notably, more than a few market watchers point to the various “quantitative easing” (“QE”) programs engineered by the Fed as the source of easy returns since 2009. It might sound compelling at first glance, but such a view ignores how the Bank of Japan has conducted somewhere north of 11 QE programs since the 1990s (really, who’s counting at this point?), but its Nikkei 225 is still well shy of all-time market highs reached in 1989.
Moving to Europe, the ECB has, for the most part, mimicked the Fed’s QE machinations since 2009, but with vastly smaller results. Considering the world, while the S&P 500 Index has returned nearly 400% since bottoming in 2009, the MSCI All Country World Index can claim returns roughly a quarter of the S&P’s.
Let’s allow common sense to enter the equation… The Fed was able to conduct its various QE programs by putting to work bank reserves held at the central bank. In particular, the Fed purchased Treasuries and mortgage bonds with an eye on pushing interest rates down at the long end, and with its mortgage security buys, the Fed was working to prop up the housing market.
OK, but what about the subsidization of government spending or the propping up of housing consumption (the very consumption that ended in relentless tears in 2008)? Both would boost forward-looking markets… If you’re tongue-tied, it’s with good reason. Subsidization of government spending wouldn’t trick the markets, nor would the central bank doubling down on housing consumption.
Some say that the Fed, in pushing yields of bonds so low, engineered a rush into higher-yielding investment opportunities that could only be found in the stock market. It sounds intriguing at first glance, but a cursory second look at the yield curve in Japan over the decades shows lower rates across the curve, but no corresponding stock market rally. Better yet, the scenario imagined by the Fed-reverent would give the impression of a “great rotation” out of low-yielding bonds and into equities over the last 10 years. Except that the 10-year Treasury note yielded 3.26% in 2009 versus 1.55% in 2021. There’s just no story there.
Optimistic Bulls and Sober Bears
Still, others will point to the Fed “printing” trillions of dollars that had to find a home, ending up in U.S. shares. Nice try, but there’s nothing to this, either… Indeed, if we ignore that the Fed isn’t “printing” money in the first place (it’s borrowing existing bank reserves held at the Fed), we can’t ignore that in any market there are always and everywhere buyers and sellers.
Translated for those who need it, in order for a QE-deceived bull to express optimism in the stock market, a sober QE bear must be able to express an equal amount of pessimism. In markets, the passions of the bulls are leavened by the pessimism of the bears… by definition.
Such central bank mysticism also ignores how equities are valued in the first place. Stock prices represent the market’s expectation of all the dollars any company will earn throughout its existence. Looked at through the prism of QE, what would the Fed’s bond-buying have to do with equity prices?
And for those who think QE represents currency devaluation, and that devaluation is good for stocks, please think again… When investors put capital to work, they’re buying future returns in – you guessed it – dollars. So with this in mind, the notion that market fiddling meant to devalue the currency would actually boost equity returns brings new meaning to absurd.
Some offer the empty and trite rationale of “don’t fight the Fed”: the central bank wants a strong market, and it will get it because it’s, well, the Fed. It all sounds so compelling until we remember that the Fed aggressively cut rates in 2001 only for the Nasdaq, S&P, and Dow Jones Industrial Average to collapse anyway. The Fed can’t alter reality, and in the early part of the 21st century, investor sentiment turned bearish. The Fed similarly slashed rates in 2007 and 2008 to stem a falling market, only for stocks to fall further. In 2015, the Fed began a series of rate hikes that took place over several years, only for U.S. shares to rally.
After that, it’s worth bringing up the obvious question: Why on earth would market interventions by inept central bankers actually instigate the upward direction of the deepest, most informed markets in the world? To believe the Fed narrative (basically a variation of Barack Obama’s errant “you didn’t build that” line: stock market edition), one would have to believe that the 20th century, when economic planning from the Commanding Heights was thoroughly discredited, never actually happened. It’s not a serious approach to market or economic analysis.
The Truth-Telling Market
As opposed to rigged playthings for allegedly wise central bankers, stock markets are brutally honest sources of bright light that constantly expose the corporations that aren’t delivering for shareholders.
To offer up but one of many examples, ExxonMobil (XOM) was the world’s most valuable company in 2008 with a market cap of $492 billion. Its valuation has halved since then and fallen all the way to $58 billion in 2020. GE? While it could claim the world’s highest valuation of $585 billion when the 21st century dawned, at $116 billion it’s now literally a fraction of its former self.
If the Fed could render markets artificial with its vain rate machinations, logically prices would remain artificially high across the board, and without regard to their existing and future prospects. But long-term shareholders of GE and XOM know differently. Stock markets are harsh truth-tellers…
To see why, it’s very useful to once again travel back in time to when the 21st century began. Only this time, rather than focus on the high-flyers, we will turn our eyes to corporations that were largely dismissed back then as yesterday concepts, never concepts, or that literally didn’t exist.
In 2000, Microsoft (MSFT) was still highly valued, but it was on the verge of a largely lost 10 to 15 years. Having been late (or never arrived) to the Internet, along with search, social media, and smartphones, investors had lost much of their former excitement for the Redmond, Washington software giant. This showed up in its stock price. It was mostly flat from 2000 right up through 2013.
Amazon? A peddler of books, CDs, and DVDs, it was known as “Amazon.org” given its inability to turn a profit. Shareholders were mostly ridiculed for owning its shares since, well, you know, well-overdone optimism about the Internet retailer was already priced.
Google? It was largely unknown. While by 2006 it had grown fast enough that it was neck-and-neck with Myspace (remember that?) for daily visits, the users of it were much rarer in 2000. In 2000, it was still private, with good reason.
“What would I do? I’d shut it down and give the money back to shareholders.” Who uttered those words? It was Michael Dell. He was talking about Apple in 1997. By 2000, Apple was alive after nearly going bankrupt in ’97, but as evidenced by it nearly going under (Bill Gates saved it) not too many years before, there was a “trust, but verify” quality to its shares. Put another way, returns since 2000 are loud indicators of how little faith investors initially had in the plans of Steve Jobs.
Facebook? The social media giant didn’t yet exist. Mark Zuckerberg was still a student at Phillips Exeter.
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FAANG Stocks and Defanged Banks
So, what’s the point of listing Microsoft, Amazon, Google, Apple, and Facebook? Nonexistent, lightly regarded, or seen as past their prime in 2000, these companies are now the five most-valuable corporations in the world in 2021. How things change!
Looked at through the prism of the Federal Reserve, central banks have been trying (blessedly without success) to rewrite market realities for as long as they’ve existed. While the Bank of Japan (“BOJ”) went to “zero” in 1999 without market or economic consequence, the Fed tried to mimic the BOJ’s laughable stab at the impossibility that was “easy money” in the early 2000s. The good news is that it failed, much as the BOJ did.
How we know this is because what mattered in 2000 soon enough did not… While GE’s flame dimmed over time, Enron went bankrupt in 2001, Tyco flopped in 2002, Time Warner dropped AOL from its masthead in 2003, and Google floated its shares in 2004… thus bringing market heft to the end of Yahoo as a player in search.
Imagine then if the Fed could actually prop up stock prices as is commonly assumed. If so, the demise of some of the U.S.’s most dominant corporations in 2000 wouldn’t have been so swift. In which case, some pretty mediocre corporations would be hogging precious resources to the certain detriment of the U.S. economy, along with the stock market that is a reflection of forward-looking investor sentiment about that economy.
It cannot be stressed enough that while the failure of one or many corporations could never doom the stock market or the economy for any notable time frame, stasis would be devastating to markets. That’s because, as evidenced by the corporations and industries that dominated the U.S. economic landscape in 1850, 1950, and 2000, the unquestionable driver of economic progress has long been a replacement of the existing commercial order with mostly unexpected, and often unheard-of, new entrants.
To believe the narrative about the Fed and the stock market, you would have to similarly believe average thinkers with last names like Bernanke, Yellen, and Powell not only knew how to trick markets, but also knew what companies to push into the past at the same time they knew which replacements to anoint on the way to nosebleed valuations. “Ludicrous” doesn’t adequately describe the obtuse thought processes that have put the Fed at the center of a multiyear equity run.
On the other hand, greatness does… which explains the vast differentials in returns within countries around the world populated by central bankers trying to force exuberant valuations via voice and artificial rate commands. The problem for most of these economic fabulists is that they don’t “central bank” in countries with companies like Amazon, Apple, Facebook, Google, and Microsoft – the five corporations that, without, there wouldn’t be much of a stock market rally to think of.
The U.S. equity boom has been a consequence of rare genius – genius that likely wouldn’t have had access to the human and physical resources necessary to take flight absent the past being pushed into the past by market forces.
If the Fed were really as powerful as so many think it to be, such that it could engineer bull markets, then GE, Enron, Blockbuster, AOL, and others would still be around… using up precious resources to the detriment of much greater replacements. In other words, if the Fed could juice markets, there would be no markets to juice.
John Tamny is Vice President at FreedomWorks, editor at RealClearMarkets, and author of many books. His latest is When Politicians Panicked: The New Coronavirus, Expert Opinion, and a Tragic Lapse of Reason.
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Contributor, American Consequences
With Editorial Staff
October 9, 2021