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Volume 17 Number 11
At some point, and nobody knows when, the stock market is going to reverse its climb. It may
even collapse. It is interesting to speculate on what kind of political response that would
generate. Given the politics of entitlement and the propensity of the Fed to intervene, the picture
looks pretty grim.
Ideally, of course, the government and the Federal Reserve would do nothing. A virtue of the free
market is that its prices reflect underlying realities when they are permitted to do so. When they
are distorted by a credit-fueled "irrational exuberance," a correction restores rationality. For that
reason, falling stock prices would be welcome.
But because stock-ownership is so widespread, the financial socialists in DC will attempt to use
the public fear generated by a bear market to enhance their power. That's what they did after the
1987 crash, when the regulators imposed strict new controls. And in arguing for the Mexican
bailout in 1995, the demagogues openly invoked fears of falling stocks as an excuse.
Jim Grant of Grant's Interest Rate Observer reminds us that neither investors nor the public is
prepared for the consequences of a bear market. Speaking at the Mises Institute's conference on
"Austrian Economics and the Financial Markets" at the Toronto Stock Exchange, he argued that
many people have come to think that a 20 percent compounded return is some sort of natural
right. Certainly mutual fund dealers will not be adverse to lobbying for a bailout.
Grant points out that Fed-fueled bull markets are characterized by a loss of fear. Every stock is
believed to be a winner over time-and indeed this bet pans out so long as the boom continues.
But when it stops, fear is restored to an even greater degree than before it was lost. There will be
a tendency for people to look towards political leaders instead of market forces for safety-and
these leaders will be glad to oblige.
Gene Epstein of Barron's has an interesting (if ominous) theory about the Fed's likely behavior
in a bear market. At the same conference, he said he can imagine that the central bank will jump
into both the stock and stock futures market in a futile attempt to change market psychology. And
where will they get the money? They could sell bonds-to the public or to themselves.
Selling bonds means nothing more than going into debt, which must be paid at some point in the
future, either through taxes or inflation. If the Fed buy bonds itself, it does so with newly created
money, which is then injected into the economy. Both strategies create problems down the line
because they bring even more market distortions. If the Fed pumped in enough money, the result
could be hyperinflation.
In the same way, the Department of Treasury might go stock shopping too. It could use whatever
fictional dollars are resting in the Social Security "surplus" to buy up sinking mutual funds. It's
financial socialism, to be sure, but the Treasury has become its leading practitioner.
How could the Fed and the Treasury get away with this politically? Simple, says Epstein. Our
leaders will point out that the stock market is the best deal out there if looked at historically. By
strategically selecting base years, you can show that even in real terms, there is no better place for
your money. Also, they might point out, the best investment advice is to buy low and sell high.
Hence, the Fed and the Treasury are merely acting the way smart investors would act if they
weren't so overcome with fear.
The fallacy here is that government is deigning to know something about markets that market
participants themselves deem to be incorrect. From the point of view of the investor, past
earnings indicate nothing about the future. That stocks eventually made money between 1925 and
1965 means nothing for the person invested only in downtimes.
Moreover, stock prices do not fall because of mysterious fears floating in the air. A bear market
simply means that market players are unwilling to hold stocks at their old prices. For the Fed to
intervene in this judgment is to impose a form of price control-an action that is always and
There is an additional danger associated with government intervention in the stock market. Once
the feds become actual and potential holders of stock, they will exercise inordinate control over
the companies themselves. As owners, they can influence management. The potential for
corruption and eventual nationalization is extremely high.
Llewellyn H. Rockwell, Jr., is president of the Ludwig von Mises Institute in Auburn, Alabama.