HELPING PHYSICIANS ATTAIN FINANCIAL SECURITY
By Robert M. Doroghazi, M.D., F.A.C.C.
Why we are Having Problems and How to Resolve Them
Part II: Historical Background from WW II to the Present
In the previous issue, I noted we have had many panics/recessions/depressions prior to the 1930s, but always bounced back stronger than ever. I posited that changes made during the Progressive Era, compounded by government intervention, contributed to the unprecedented length of what came to be known as the Great Depression, and is contributing to our problems now.
In this issue, I review economic history from WW II to the present.
After WW II, the US had it all: the money, military and political hegemony, the culture, and the technology. Our corporations; General Motors, Ford, Chrysler, IBM, AT&T, RCA, US Steel, Bethlehem Steel, GE, Merck, Sylvania, MGM, Boeing, McDonnell, Coca Cola; were the best in the world. Through the 50s and early 60s, we had almost zero inflation and full employment.
Then the Vietnam War: If we had a leader who really wanted to win, it could have been over in 30 days. Instead, we squandered our young men, our money, and our moral high ground. The Great Society finished what Roosevelt had started with the New Deal in the 1930s. I am not saying that old-age pensions (Social Security) and medical insurance for the elderly (Medicare) and the poor (Medicaid) are bad. To the contrary; they are laudable and important goals of a compassionate people. A society is best judged not by how they treat the rich and powerful, but rather their concern for the weak and vulnerable. The problem is that we are now dealing with the unintended consequences: 1) Where do you stop? 2) People came to rely upon the government (and the politicians who derive their power from doling out the money) rather than on their own self-reliance.
Johnson wanted guns and butter. What we got was a bloody nose, inflation and rising unemployment. In 1971, de Gaulle demanded gold in exchange for France’s rapidly depreciating dollars. Treasury Secretary John Connally famously said “The dollar may be our currency, but it’s your problem”. Nixon closed the gold window; the last link to the discipline of the gold standard was broken.
Stagflation, further worsened by the first oil embargo, dominated the decade. By 1980, when adjusted for inflation, the DJIA was down more than 80% when compared to the peak of 1966 (the market sensed the results of what Johnson was doing), a bear market almost severe as the Great Depression. Fed Chairman Paul Volcker raised interest rates until the inflationary spiral was broken. The dollar was strong. The 1980s and 90s were times of real prosperity with an increase in the standard of living in the US. We even had a balanced budget.
By traditional measures, such as dividend yield and Price to Earnings ratio (P/E), the stock market of March, 2000 was at least twice as over-valued as the market of 1929. Bubbles; unsustainable, unrealistic prices, are typically followed by a crash, a depression. The excesses; the debt, the inefficient businesses, the people who got greedy, the stupid decisions, the fraudulent practices, are purged from the system. Prices fall far enough that stocks and other assets become real values (often below replacement costs), and the prudent people who had saved their money swoop in to pick up the bargains. Business activity picks up and the cycle starts anew.
By late 2002, the DJIA had dropped about 37%, from 11,750 to 7,500. I believe history will show that this is where the big mistake was made. Secular bear markets typically suffer at least a 50% drop. Historical comparisons suggests that the Dow should have dropped to 5,000, or even lower. It would have been painful indeed, but it would have been over. It is critical to note that at this time everyone was in good shape; the banking system was sound, unemployment was much lower than now, and the finances of governments at all levels were sound. We could have taken our lumps and moved on.
Enter the man known as “The Maestro”, Federal Reserve Chairman Alan Greenspan. Rather than let the process complete itself, he lowered interest rates and kept them low. Everything went up, and everyone was happy (for a while, at least). The central bankers had conquered the business cycle. No more boom and bust.
The easy money fueled the greatest real estate bubble ever. People who could never hope to pay the money back, and some who never intended to pay it back (Liar loans), were loaned more than the already-inflated price of the home. Mortgage originators no longer kept the notes on their books to suffer the consequences if they went bad. They just took the fees and sold the notes to the government-backed Fannie Mae and Freddie Mac. Now the bad loans were everyone’s problem. Wall Street execs took home billions in bonuses, even while their firms were imploding. When housing went bust, it took the financial system with it.
The flood gates were opened, the printing presses were smoking. US government debt is now above $14T (not including unfunded liabilities), the government borrows 40 cents of every dollar it spends, one US dollar buys an amount of gold almost invisible to the naked eye, unemployment remains high, and our elected officials seem unable to address the problems.
In Part III of this series I will define what I believe the problems are and in Part IV provide scenarios on how this all may end.
RMD
Michael Lewis, author of The Big Short, has now written about the unfolding financial crisis in Boomerang, was interviewed on CNBC on 10/3/11.
Q—Is this (the current financial crisis) a replay of 2008?
A—The financial crisis never ended. It is Act II of the same story.
RMD comment: One of the basic points of this series of articles is there must be a period of pain after a bubble; there is a price to be paid for the excesses. Everything done so far has merely delayed the inevitable day of reckoning, which will just make it worse.
Barron’s (9/3/11). Michael Martin, a trader, has written the soon-to-be-published The Inner Voice of Trading.
“Martin says traders lacking “emotional intelligence” are destined to fail…problems arise because intelligent people (RMD comment: like physicians) have difficulty differentiating between self-esteem and intelligence. This may be why some have difficulty accepting losses…
The most disciplined traders quickly limit losses…
Not everyone is that disciplined. Martin says many traders wait for markets “to come back” rather than admit having made a bad decision…
Many unseasoned traders sell the winners and hold the losers. As Martin writes in his book, “That’s like pulling your flowers and letting your weeds bloom”.
RMD comment: This is excellent advice. I suggest you read the above several times and think about it, and buy the book when it becomes available.
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