A Friendly Response to Mark Thornton, Joe Salerno, and Modern Austrians
Peter Thiel writes that "the value of a business today is the sum of all the money it will make in the future." This basic, pithy truth is too often forgotten when stock valuations are discussed.
It rates mention in consideration of Mises Institute senior fellow Mark Thornton’s assertion in response to my critique of modern Austrian thinking (“Where Are All the Austrian Scholars’ Yachts?") that it’s “generally the case in normal times” that Fed and other central bank rate cutting leads to higher stock prices. The excellent Thornton would agree that he doesn’t define “normal times,” plus by the estimation of all-too-many Austrians, there are never “normal times” since the big, bad Federal Reserve exists.
Needless to say, the fabled “Greenspan Put,” which says former Fed Chair Alan Greenspan could save investors with rate cuts, was always a myth. For one, it was only “true” until it wasn’t. Stocks certainly rallied after the 1987 crash, a crash that was followed by rate cuts, and so did they rally in 1998 amid similar rate cutting. But then correlation isn’t always causation.
Greenspan aggressively reduced rates early in the 21st century, only for the Nasdaq and Dow Jones Industrial Average to plummet in sickening fashion. The Bernanke Fed pushed down rates aggressively in 2008 only for stocks to plummet. Conversely the Fed raised rates consistently starting in 2014, and right through 2019, only for stocks to rally.
Stocks are a barometer of the future. When the future is seen as bright, stocks reflect this truth. When not bright, stocks reflect this truth too. Central bankers can't rewrite reality despite what you're told.
That’s why it’s disappointing to see Austrians somewhat reduce the movements of the deepest, most sophisticated stock markets in the world to the actions of the obtuse minds at the Federal Reserve. Central planning fails. Always. And sometimes it does so in murderous fashion. To then pretend, as Austrians do, that the “Fed did it” when it comes to stock market rallies is for otherwise wise Austrian scholars to channel Barack Obama’s odious “you didn’t build that” line. Obama says “others” and “communities” built that, while Austrians claim stock markets are in “normal times” so fake as to be stimulated by thinkers as dense as Ben Bernanke. No thanks.
Stock prices are once again the market’s expectation of all the dollars a company will earn in the future. Which raises a basic question: what on earth does the Fed fiddling with overnight lending rates among antiquated banks have to do with the valuations of the world’s most dynamic companies? Thornton contends that “the Fed’s artificially low interest policy distorts entrepreneurs’ investment decisions towards longer-term projects that are eventually revealed to be bad investments,” but implicit in his theorizing is that low, artificially arrived at credit prices not only result in credit abundance, an assertion that runs counter to all market-based theory related to price controls, but it also presumes investors are wholly tricked by central bank meddling such that they ignore what Thornton and other Austrians conclude to be distorted “investment decisions toward longer-term projects that are eventually revealed to be bad investments.” Translating the great Thornton’s contention, investors who populate markets aren't terribly wise, and they’re routinely duped by endlessly confused men like Bernanke. No.
Furthermore, if it were indeed true that equity market prices were rigged by Fed meddling, logic dictates that stocks would move upward in lockstep fashion to reflect the total artificiality of a Fed-induced rally. If markets are indeed distorted in an upward sense by the limp minds at the Fed, there would be no rationale to the movement. Shares of Sears would be just as ebullient as Wal-Mart shares, Ford shares just as buoyant as Tesla’s, plus Yahoo would still be a publicly traded stock; its shares soaring alongside search rival Alphabet’s.
Except that the above scenarios in no way reflect what’s actually happening in the stock market. Sears presently trades at 18 cents/share alongside a $75M valuation (versus $324 billion for Wal-Mart), Ford’s share price is half of its 52-week high, and then Yahoo’s valuation has plummeted throughout the 21st century despite it being worth $120 billion when it began.
Notable is that Alphabet, Amazon, Apple, Facebook and Microsoft are collectively up 10 percent this year, while the other 495 S&P 500 companies are down 13 percent. Implicit in the reasoning of Austrians who surely know better is that the Fed engineered this too. Indeed, Austrians can’t have it both ways. If they want to tie stock-market health to the tragically small minds at the Fed, they must then agree that the Fed’s various machinations that they take so seriously somehow resulted in the Fed fiddling finding the bluest of blue chips, all the while leaving the blue chips of the past behind. No, they don’t believe this. Please say they don’t!
There’s no story here. Share prices are a reflection of what investors think about the future, and as we see time after time, investors put out to pasture the businesses (lest the Fed obsessed forget, the blue chips of 2000 – GE, Yahoo, AOL, Tyco, Worldcom, Enron – are not the blue chips of today) they no longer are optimistic about in favor of those they are. The Fed has nothing to do with this. No doubt Thornton et al would, in a quiet moment away from rebuttals, responses and rebuttals, agree. Governments and central banks only know to prop up the known, not the unknown; meaning they would prop up yesterday at the expense of tomorrow....if they could. Of course if they could prop up yesterday, equity markets would reflect this blast to the past in brutal fashion. Crucial here is that when the 21st century began, Microsoft was devastated after the DOJ tried to rip it apart, Apple was near bankrupt, Amazon was “Amazon.org,” Google was unknown, and Facebook didn’t exist. Yet now they’re the reason for such good equity returns these last several years.
In short, if the Fed was the source of this or any rally, rallies always led by 5-10 names that almost certainly didn't lead previous market run-ups, then Thornton et al would have to believe that the microscopic minds at the central bank saw well into the future to make sure that the best of the best would reach trillion+ heights in 2020. No, they’re not that smart. Not even close. If they were, they wouldn’t be at the Fed.
Thornton’s colleague, Joseph Salerno, also criticized my critique. He claims I “misinterpret the Austrian business cycle theory." No, I just reject what makes no sense. The idea that the Fed, projecting its well overstated influence through a banking system that even Austrians acknowledge is a small player in terms of total credit, is somehow the driver of “business cycles” is hard to countenance. As always, if central banks and banks could create cycles, then they’d all do it.
Salerno then lurches toward the always puzzling Austrian theory that “bank deposits unbacked by reserves” drive some kind of cycle. This is funny, and it is firstly because if you bring up the “money multiplier theory” in the company of actual financiers, they always stare at you like you have one eyebrow. With good reason! What they would give for the capacity to multiply their lending or investing capabilities. If so, perhaps the banks that Austrians routinely heap so much scorn on wouldn’t routinely require bailouts.
But for the readers of this piece to disabuse themselves of multipliers, just get a group of two, three, four or five together. It really doesn’t matter. No reserve requirements, at which point I join the group with $100. I lend to the man on my left the $100, who then lends $100 to the individual on his left, who then lends it to the individual on his left. According to modern Austrian theory, there’s now $500 or some multiple of $100 circulating. Except that there isn’t. There’s just $100. When you lend money, you forfeit use of it. That's the point. What we'd all give to lend $100 only to still have that same $100 to spend. No doubt we could borrow $100 from someone else based on our $100 loan collateral, but that someone else would forfeit use of the money.
That there’s only $100 in the above scenario is a statement of the obvious that speaks to Salerno’s own innocence about money. No one exchanges it. Money changing hands represents goods and services changing hands. That’s why there’s tons of the so-called “money supply” in Manhattan, and very little in neighboring Newark, NJ. It’s not the Fed or sun spots or corrupt bankers that created the mismatch as much as there’s quite a bit more productive economic activity taking place in Manhattan.
Money is a consequence of production, not an instigator. That's why Mises himself was always so disdainful of the focus on "money supply." As he put it, ""No individual and no nation need fear at any time to have less money than it needs." Money has no purpose without production, at which point it migrates to it. Translated, financiers want to make a buck. That they do means that money will always find the productive, and will always be scarce where the productive are not located.
Implicit, or actually explicit in Salerno’s theorizing is that the dollar that liquefies so much global trade has multiplied into nothingness thanks to it being "unbacked by reserves." There those market-friendly Austrians go again! Even though producers of goods and services the world over generally only trust the dollar to referee exchanges among producers, even though the world’s richest, most productive people tend to measure and store their wealth in dollars, Austrians claim a persistent devaluation of those very dollars. Once again we’re asked to believe that Salerno et al see clearly what is opaque to the rest of the world, including the world’s greatest financial and commercial minds.
Salerno claims that a falling currency is not rejected by the producers of wealth, but then he’s likely never been offered Iranian rials, North Korean won or Venezuelan bolivar for anything he values. Better yet, what if his employer suggests denominating his future paychecks in the rial? Will he take the Iranian currency if offered it instead of the dollar? The question answers itself. Notable is that the persistently devalued rial (3,500 times since 1971) has now been switched to the toman. Would Salerno take the toman? Again, readers know the answer.
That they do discredits his assertion that the dollar is persistently being devalued. No doubt there are periods during which Treasury’s oversight is much worse than bad (think the 1970s, think the 2000s, for example), but to pretend that devaluation is an always scenario with the dollar as Salerno does is to misunderstand money, markets, and the ability of people to switch to currencies not regularly in decline.
Which brings us back to the argument that began this friendly debate. Austrians are walking it back somewhat, but they’ve long claimed an ability to see things that we mortals don’t see, including economic crack-ups ahead of time, along with a withering dollar that’s multiplying into nothing. Explicit there yet again is a belief that market actors are incredibly dense for them not seeing what Salerno et al claim to. Austrians properly profess a love of markets and market signals, but the modern disciples of Mises would have us believe markets are fairly stupid; the latter most apparent in consideration of Salerno's view that a dollar accepted just about everywhere in the world is a rather junky currency persistently sliding to nothing. Oh my, what yours truly would give to know which currency signal can be found on Salerno's pay stubs....
To be clear, this statement is not a ringing endorsement of dollar policy these last several decades. Money that's not consistently stable as a measure of value isn't perfect money. Futhermore, there have been periods of dollar devaluation and instability that have plainly weighed on growth precisely because the unit's flaky nature rendered the investors who power all economic progress a bit gun shy. At the same time, this is a statement that the dollar isn't nearly as wrecked as Austrians believe it to be. If it were, it would no longer be used to facilitate exchange around the world.
The modern Austrian view about the dollar also presumes remarkable stupidity on the part of investors. Indeed, while it’s popular in academic circles to claim Fed rate and “money supply” meddling is the source of market ebullience, those who actually invest keep returning to the basic truth that a stock price is the market’s projection of all the money a corporation will ever earn. Looked at in terms of U.S. equities, stock prices are a reflection of all the dollars a corporation will ever earn. Dollars is italicized for a reason. Please read on.
Salerno offers up all manner of charts that equate money growth with devaluation (by that logic the Argentine peso has been crushing the Swiss franc for years…..), but if so, why would stock prices be rising? Really, why would investors buy that which is priced in a currency that U.S. corporations earn, and that continues to decline in value?
The answer to the above question is a reminder that while the dollar’s oversight since at least 1971 has been less than stellar, it hasn’t been nearly as bad as Salerno and other Austrians want us to believe. For them to dispute the previous assertion is for Salerno et al to yet again presume that markets are shockingly obtuse, while modern Austrians are all-seeing. It insults modern Austrians not one iota to say their presumed knowledge of markets is well overstated. Indeed, none of the world's greatest investors would ever claim to know a fraction of what they claim to.
So with that, it’s time to move on to other subjects. Ludwig von Mises’s books still rarely leave my side, plus one of the greatest experiences I ever had was giving a speech at the Mises Institute. Salerno introduced my talk. Hopefully this friendly debate won't shut the door to future invites. Indeed, my first visit was a major thrill.