Central Banks endorse the economic Sophism that high Asset Prices create Prosperity, rather than that Prosperity leads to high Asset Prices
Monthly Market Commentary: October 1, 2016
87 years old Jack Bogle founded the Vanguard Company in 1974. Today, Vanguard is one of the most respected and successful companies in the investment world. [In 1999, Fortune Magazine named Bogle as “one of the four investment giants of the twentieth century.”] In 1975, Bogle founded the Vanguard 500 Index Fund as the first index mutual fund available to the general public. Bogle’s innovative idea was that with his index fund, which would simply mimic the index performance over the long run, he would achieve far higher returns with lower costs than actively managed funds.
According to Bogle, we shouldn’t expect “a revisitation of the ’80s or ’90s, when stocks returned 18% a year…. Those planning on a comfy retirement or putting a kid through college will have to save more, work to keep costs low, and - above all - stick to the plan.”
The Wall Street Journal explains that “Mr. Bogle relies on a forecasting model he published 25 years ago, which tells him that investors over the next decade, thanks largely to a reversion to the mean in valuations, will be lucky to clear 2% annually after costs. Yuck.
Then why invest at all? Maybe it would be better to sell and stick the cash in a bank or a mattress. ‘I know of no better way to guarantee you’ll have nothing at the end of the trail,’ he responds. ‘So we know we have to invest. And there’s no better way to invest than a diversified list of stocks and bonds at very low cost.’”
Normally, I would not spend much time discussing Indexing. The point I want to make is that for the average investor (by definition a relatively small investor) “there’s no better way to invest” than Bogle’s strategy of investing “in a diversified list of stocks and bonds at very low cost.”
However, I am referring here to the average investor and not to the savvy financier who knows how to select one of the few active managers who actually outperforms an index over time, or an investor who has sufficient analytical skills and discipline to select companies that beat the index over time.
In a recent article for the Financial Times, William White observed that
“The monetary stimulus provided repeatedly over the past eight years has failed […] Debt levels have risen […] Consumers have had to save more, not less, to ensure adequate income in retirement. At the same time, easy money threatens two sets of undesirable side effects. First, current policies foster financial instability… and many asset prices bid up to dangerously high levels. Second, current policies threaten future growth. Resources misallocated before the crisis have been locked in through zombie banks supporting zombie companies. On the demand side, accumulating debt creates headwinds, leading to more monetary expansion and more debt […] On the supply side, misallocations slow growth, which again leads to monetary easing, more misallocation and still less growth.”
I have a high respect for Bill White as an economist because he identified the problems correctly. Unfortunately, I cannot agree with his view that “Only government action can resolve a global solvency crisis.”
Therefore, I expect more of the same: larger fiscal deficits, larger governments that will own not only their public debts but increasingly also equities through their respective central banks, which will happily continue to print money.
In this context my readers should remember the words of Paul Volcker:
“It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency towards more inflation, not less. [I]f the overriding objective is price stability, we did better with the nineteenth-century gold standard and passive central banks, with currency boards, or even with ‘free banking.’ The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy.”
With kind regards