Where is the Bottom?

The entry was updated December 10, 2008.

A picture of the Dow Jones stock value since 1930 gives some perspective on forcasting the bottom of the continuing stock market crash.

First, Reagan's drive for "less government" in the 1980s slashed the regulatory actuaries. They are the people responsible for helping ensure economic risks are well defined and transparent. This is one of the basic underlying assumptions of a market (perfect information).

Then, Clinton continued the trend that fostered excessive growth of the speculative financial services industry at the expense the real economy. Financial services don't produce anything. In a healthy economy, financial services represent a small fraction of the economic activity that facilitate investment in production of real products and services that lead to job creation and benefits shared widely by society. A financial services economy creates fewer jobs and distributes the wealth to a tiny fraction of the people.

Ours has not been a healthy economy for the past few decades. This unhealthy shift is expressed in a shift of profits from manufacturing to the financial industry in the table below.

Industry	1980 Profit	2005 Profit
Manufacturing	45%	18%
Financial	18%	45%

Our economy has become hollow, which underlies the original question: How far down will the hollow part of the economy collapse before it reaches the solid foundation (assuming we don't artificially prop up the hollow part by a bailout)?

We can explore this question in terms of the Dow Jones stock index shown in the graph above. Stock values started to go up in the mid-1980s in response to Reagan deregulation. The growth trend went up gradually indicated by the hand-drawn line that intersects the present year at a Dow Jones index of about 8,000.

Stock values started to shoot way up in the mid-1990s in response to Clinton's de-regulatory policies and the dot-com mania. We can see the dot-com bubble burst in 2000, and the re-bound induced by additional de-regulatory policies of George W. Bush between 2001 and 2007.

Once the hollowness of the economy was exposed in late 2007, the current big crash came, and we're all wondering "where is the bottom?"

If we believe that the growth spawned by Reagan policies was solid growth, then the upward trend line might suggest a bottom at 8,000. But was the trend in growth under Reagan policies real or itself hollow? I think growth under Reagan policies was somewhat hollow too. So, where is the bottom?

Lets assume that the stock value before the 1980 Reagan influence was solid. Lets also assume that the world population is a reasonable rough expression of an underlying foundation to support economic growth indicated by stock values.

The world population was about 4,400,000,000 in 1980, and the Dow Jones was 1,000. The world population was about 6,600,000,000 in 2007, a 33% increase. A 33% increase in the Dow Jones would be about 1,333. Not much increase. So, lets assume that in addition to 33% population growth, the product-demanding middle class quadrupled since 1980.

Assuming the Dow Jones companies serviced that demand, which it didn't, the Dow Jones would be 4,333, add inflation and maybe the bottom is at 5,000 - 6,000, which would be optimistic.

Remember, we're not talking about artificially inflated stock prices. We're taking about stock values that represent a solid underlying foundation of producing something demanded by real needs, not the "need" for the tiny elite minority to create personal wealth.

Update 1: I've added some more thoughts after talking to a friend. It might seem obvious, but the observation is that bottoms don't happen at the beginning of a recession, they happen at the end of a recession. Not sure I completely buy that, but there is some logic to it.

Update 2: Paul Krugman, December 19, suggests we might not be there yet. It has something to do with Tobin's "Q" Ratio.

Sources:

Manufacturing and Financial industry profit estimates are from Figure 2.1, in "Bad Money," Kevin Phillips. Original Source: Ray Dalio, Bridgewater Associates.

Economy: A Mess

Stocks plummet after retail, unemployment data

3% drop is big. Watch it swing right back up. Such swings have typically preceded past major economic crashes.... kinda like the nasty wobble before wipe-out, the bright light bulb before burn out, and the wild energy of a fly before death.

Jobless claims jump is bad omen for economy.

"Omen"? It's been a year since the big mortgage melt-dwon, and their still talking about omens for the future?

U.S. House Price Decline Could Be Worse Than Great Depression.

The higher the price, the further it has to fall. Raise your hand if you've heard a friend say, "If I had to buy my house now, I couldn't afford it." A modest house and a solid middle-class income... some speculators got rich and we're paying for it. But don't worry, the free market always corrects itself.

I was a little surprised by the date of a past article of mine. Remember the August 2007 real estate melt-down? Here's what I wrote in May 28, 2007:

Watch the real estate situation unravel this summer. Congress will try to save it, placing the burden on future tax-payers (so much for a "free" market in which bad business decisions are allowed to play out). We've seen it before in the same way the S&L double-scandal was swept under the rug. The twin debts will grow. Eventually, foreigners will diversify out of dollars, more so than they are already, and the US will decline like Spain and Britain did. The "hope" is that the US will do so with grace rather than a holocaust.

Photo Credit: "mess" by skepticillusion.

Sweetheart Insider Loans for Bush

Once upon a business digest...

President Bush has called for an end to some of the very insider transactions that he used as a director of Harken Energy in the late 1980s. Mr. Bush received two low-interest loans and then benefited from the company's relaxation of the terms of one loan. On Tuesday, he challenged directors to "put an end to all company loans to corporate officers."

Dan Bartlett, the White House communications director, discounted suggestions that Mr. Bush was being hypocritical in calling for an end to loans of a kind he once received. Mr. Bartlett said that while such loans had been properly used in the past, they had recently been abused.

Yea, right. More details on the loans.

Bush a Phony Businessman:

In 1986, Bush's company, Spectrum 7, was on the brink of insolvency. Harken bought it, paying Bush and his partners roughly $2 million in Harken stock. Bush's name and connections were the main reasons Harken was willing to offer so much to purchase the otherwise ruined Spectrum 7, pay impressive director's and consultant's fees, and generous loans to someone who had yet to launch a successful business venture.

More serious questions surrounded Bush's 1990 sale of his Harken stock. Basically, Bush used the loans to buy Harken stock. Bush later sold the stock on inside information shortly before the company announced major losses. In 1991, the Security and Exchange Commission investigated Bush for fraud, including failure to report the stock sale, but... when you're the President's son, justice doesn't seem to apply the same as it would otherwise.

Harken pulls an Enron: Facing large end-of-year losses, Harken sold a chain of gas stations for $11 million to a group of investors, including Harken's chair and a director. Harken received $1 million, and loaned the rest to the investors. In an Enronian bit of accounting, Harken posted a $7.9 million current profit. Harken's executives obtained approval for the transaction from Harken's directors, among them Bush.

I've directly quoted extensively from The Truth About George . Com [2].

Sources:

1. New York Times, Business Digest, July 11, 2002.

2. TheTruthAbout George.com

Dollar Slipping From Position as Foreign Exchange Reserve

The word, "Yikes!" comes to mind:

The dollar swooned amid speculation that China will seek to diversify some of its foreign currency stockpiles beyond the greenback.

The 13-nation euro hit a fresh record against the dollar -- rising to $1.4729 -- before falling back [to $1.4554]. The dollar lost ground following word that a senior Chinese political figure said China should spread its $1.43 trillion foreign exchange reserves beyond the dollar into the euro and other strong currencies.

Sources:

Associated Press, Stocks Plunge With Dollar; Dow Down 360, Tim Paradis, November 7, 2007.