Economist on Wall Street (Peter L. Bernstein's Finance Classics)

Notes on the Sanctity of Gold, the Value of Money, the Security of Investments, and Other Delusions

Peter L. Bernstein

• Publisher: Wiley
• Year: 2008
• ISBN:
  9780470435199
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

One of the foremost financial writers of his generation, Peter Bernstein has the unique ability to synthesize intellectual history and economics with the theory and practice of investment management. Now, with classic titles such as Economist on Wall Street, A Primer on Money, Banking, and Gold, and The Price of Prosperity —which have forewords by financial luminaries and new introductions by the author—you can enjoy some of the best of Bernstein in his earlier Wall Street days.

Peter Bernstein's Economist on Wall Street is a collection of writings from 1955 to 1970. The book is especially interesting because so many of Bernstein's observations reflect the most important issues of the present—the outlook for inflation and its control, the intricacies of monetary policy, the future of the dollar, and the dilemmas of household finances. Bernstein was also concerned with developments in portfolio management, including the new influence of institutional investors and rules for optimal asset mixes. He provides light touches, too, as he indulges in fantasies and philosophical musings over a wide variety of topics.

With so many years of hindsight, we should not be surprised to find some of Bernstein's predictions running awry. But why? In each instance, these forecasts were biased by memories of the past. There is a big lesson to be learned there.

Economist on Wall Street is a remarkable book, with lasting relevance and keen insights into the art of investment management, the capital markets, gold and the dollar, and the fun of being alive.

Chapter 1

PRIORITIES IS . . .²

A fourteen-year-old boy died apparently of an overdose of pills yesterday, only hours after the Board of Education said it had no funds for security guards to fight narcotics problems at the school he attended. . . . Mayor Lindsay said, “This is a regrettable tragedy and I will ask for a full report on the incident from the Police Commissioner.”

—New York Times, February 17, 1970

 

 

 

 

 

Priorities is when you have reports instead of money to save human lives. Priorities is when you

 

have a boom in office building downtown and urban decay uptown. Priorities is when we grumble about paying higher rates for electricity and simultaneously grumble about air pollution from the local utility. Priorities is when we can afford to drop bombs on houses inVietnam and can’t find the financing to build houses at home. Priorities is when we cut back on appropriations for education and ask for extra appropriations for antiballistic missiles. Priorities is when you can take a walk on the moon but are afraid to walk down your own street. Priorities is when the Governor won’t ask for higher taxes in an election year and then there is no money to provide a cheap and efficient public transportation service. Priorities is when we are willing to spend money to buy television sets to sit home and see thoughtful programs about the problems of our society that we don’t want to spend any money to do anything about.

“Priorities” has been a cool word in the past. Today—and for many days to come—it will be the hottest word in our vocabulary.

For much of our history, including most years since the end of World War II, the American economy has operated with a margin of idle capacity and unemployed workers, so that increased demands from one area or another could be met with relatively little difficulty. Guns and butter was the cry. We could even have guns and butter and road-building and schools for a good deal of the time.

But now, as we look ahead into a new decade, the grammar is changing. For all the “and’s” read “or.” Affluent as we may be, the needs of our cities and our educational systems and our starved supply of housing and our defense establishment and our aspirations for more leisure and our burgeoning supply of 20- to 30-year-olds add up to astronomical numbers that even our fabulously productive economy cannot meet.

This means we will have to make some important choices. To a greater extent than most people realize, however, we have already locked ourselves into some crucially important choices. This will make the significance of selecting priorities even greater than it might have been otherwise.

To begin at the beginning: the direction in which we are moving and the largest of the deficiencies we are trying to overcome are all enormously capital-using. In other words, they require a large investment in labor and resources for a long period of time before they begin to bear fruit in quantity. Urban renewal, housing, education, public transportation, the drive against pollution, hospital building, and doctor training, to name just a few of the things we are in a hurry to accomplish, will absorb massive amounts of resources and will show results only gradually.

Furthermore, all of them require financing. Few of us have the ready cash to pay for a home without a mortgage, and the federal and local governments must have more tax revenues or borrow more money if they are to increase their expenditures. At the same time, as a result of the drastic drain on corporate liquidity in recent years, even moderate rates of business expansion now require high levels of external financing. In short, the urgent needs of our society imply intense pressures on our capital markets. This comes at a time when we are already absorbing a colossal volume of financing and when our usually efficient capital markets are groaning under the strain.

Since the external financing requirements of business are likely to remain high, since the unsatisfied demand for mortgages is enormous and growing daily, since state and local governments will have a clear need for tremendous sums, since the appetite of our defense establishment seems to be insatiable, and since major domestic federal programs are clamoring for attention, the probability is that we will have neither the real nor the financial resources to accomplish everything that we would like to accomplish.

Now there is one way to do it. Although business has insufficient cash flow to finance its expansion internally and although state and local governments are hard pressed to cover their expenditures right now, we could solve a lot of problems if the federal government could operate at a surplus. This would have a double advantage: The federal government would make no claims on the capital markets and, in fact, would be repaying debt out of the budget surplus and therefore putting money back into the coffers of the individual and institutional investors who buy the securities that businesses and local governments offer for sale. This is something of an oversimplication, because it depends to some extent on who pays the taxes, but the general concept is valid nevertheless.

If the federal government is to operate at a surplus and hence both relieve and replenish the capital markets, that means that revenues must exceed outlays. Which way are we to do it? By increasing revenues or by restraining expenditures? The degree to which the federal government can fulfill its share of improving the quality of life in the United States depends precisely upon this choice.

The problem is that the choice has already been made. The haste to remove the Johnson tax surcharge and the ultimate implications of the tax reform bill of 1969 both mean that the revenues of the federal government in the years ahead will be many billions of dollars less than they would have been if the choice had been made the other way. But this also means that the level of federal spending is going to be many billions of dollars less than it would have been otherwise. The only other choice is to persist in the disruption of our capital markets, to squeeze housing still further—or to revert to some type of credit control and rationing.

It is possible, perhaps even likely, that state and local governments will tax away the federal tax savings that Congress voted us last year and will therefore be able to fund some programs that might otherwise have been carried out on the federal level. Some people would even welcome a shift of responsibilities along these lines, and it does have certain attractions. However, it has two serious disadvantages. First, the citizens who end up paying higher state and local taxes may not be the same ones who get the full benefit of the federal tax savings. Second, the revenue-raising abilities of the states vary enormously: the rich states can improve themselves rapidly while the poorer states fall further behind. When projects are financed by the federal government, we can manage things in a more equitable fashion.

But we had best face up to the implications of what Congress has decided for us: The priority of our private pocketbooks is more important than the priority of our public needs. The federal government is going to have to count its pennies with great care.The question is not guns or butter, but guns or schools (and for “schools” you can read the whole array of urgent domestic programs).

How large a defense establishment can we afford? No question is more important today for our social and economic well-being. Note, the question is not: how large a defense establishment do we want? We have set up our priorities in such a way that we simply cannot have everything we might like the federal government to give us.We have to make the choice, no matter how difficult, now and in no uncertain terms.

The disarmament negotiations with the Soviets, the decisions with respect to Southeast Asia, the ABM controversy, and the fascination with new weapons systems are important not only in terms of what America’s role in the world should be and in terms of judgments concerning the intentions of other great powers; we are simply unable to make decisions in the foreign policy area without simultaneously making decisions that determine the rate of fulfillment of domestic needs.

That is why, for the first time since the period of disillusionment after World War I, the military is on the defensive in the halls of Congress and before the public. In view of the rapidly changing age-structure of our population, they are likely to remain on the defensive for a long time to come. And here is the crucial point: At more than any other time in our history, the fate of our economy is going to be determined by the view we take of our society and our sense of social priorities.

Here is one hopeful note on which to end this dissertation. From 1948 to 1969, the average increase in the Standard & Poor’s 500-stock index was more than three times as great during years in which defense expenditures were flat or declining as during years in which defense expenditures were rising. Excluding 1960 and 1961, when the usual relationship was reversed, the ratio was better than five to one in favor of years of flat or declining defense expenditures. Well, anyway, here’s hoping!

Chapter 2

THE FEEL OF THE MARKET

This group of essays consists essentially of current comment on what was happening in the stock market at the time they were written. Most current comment turns stale pretty fast, and much of the material I have turned out over the years would hardly qualify for a book of this sort. These pieces, however, do have some lasting relevance to what is happening today and to what is likely to happen tomorrow, because they draw attention to factors that most people were ignoring at the time.They represent hard efforts to predict the future in some kind of systematic fashion.

The first essay is concerned with Senator Fulbright’s hearings on the stock market in early 1955. Although at that time the Standard & Poor’s industrial average was 38 (it was to break up through 50 within 12 months and to double within seven years), and although volume was then running at only 2.5 million shares a day on the average, many people were worried about excessive speculation and overpriced securities. The ghost of 1929 was clearly still with us in 1955; the focus of attention was on the past to such an excessive degree that few people had any real awareness of the great bull market that still lay ahead. This piece is worth reading as a reminder of how we can be so much a victim of the current environment and of the past that we can seldom, if ever, guess the future.

The belief that one can predict the future persists among all of us. The short pieces that follow the comment on the Fulbright hearings show how a sense of perspective on the present can sharpen our ability to foresee what the future holds for us. For example, the two articles on institutional investors drew attention to trends that were then only beginning to emerge and that have subsequently become primary factors in the security markets. “The Anatomy of the Bear” presents a technique for determining when bear markets are likely to touch bottom: This particular piece called the turn right on the button. I was lucky enough to repeat this feat in the spring of 1968, in the item entitled “The Gold Crisis and the Security Markets,” which was written just days before President Johnson’s famous television address of March 31—and almost seems to predict his whole speech. The market took off like a shot immediately afterward. Ever since I was retained by the New York Stock Exchange in 1959 to project long-run volume trends, I have been fascinated by the possibilities for market forecasting revealed by the patterns of trading activity; two of the essays explore this area in some detail.

The article on growth stocks appeared in the Harvard Business Review in 1956. I would hardly pick the same names to exemplify growth stocks today, although I turned out to be on the right track when I rejected the oils and the steels as growth stocks at the time—a position that was then close to heresy. Nevertheless, the concept still seems valid; a growth company is, like the entrepreneur in Schumpeter’s Theory of Business Enterprise, an inner-directed organism, capable of determining its own destiny through the creation of its own markets. The rather crude attempt to develop a new valuation formula for companies of this type was subsequently taken up by others, whose approach has been more sophisticated but whose basic concepts were identical with mine.

THE FULBRIGHT HEARINGS: A BLESSING IN DISGUISE?³

“One thing is apparent,” said Mr. Funston, president of the New York Stock Exchange, on the day the Fulbright hearings came to a close. “The need for public education to protect the public against emotional and uninformed actions is even greater than we thought.”

If there is any lesson to be learned from the Fulbright hearings, Mr. Funston has hit the nail on the head. It was not that the hearings themselves were such a circus (although Senator Fulbright’s emphasis on opinions rather than facts was not too helpful), but that the reactions of the public, the stock market, the newspapers, and the Administration were keyed to an astonishingly emotional pitch.

But after one has cut through the emotionalism, the hearings were far from a waste of time, and a dispassionate and objective analysis of what happened can be helpful to the intelligent investor.

If one is willing to read beyond the headlines and give some study to what the experts really had to say, there was actually quite a bit of meat in the testimony. Among other things, the hearings indicated the following four observations:

1. The stock market has risen sufficiently high and at a steep enough pace to cause considerable concern among many observers who are less “controversial” than Professor John Kenneth Galbraith. Professor Graham, General Wood, and Messrs. Eberstadt, McCloy, Eccles, Livingston, and Martin all expressed doubts about the present level of the market. (All those who are called upon to express an opinion about whether the market is high or low will be everlastingly grateful to Winthrop Smith of Merrill Lynch, who made it pleasantly respectable to say,“I don’t know!”)

2. An increase in margin requirements is very unlikely until the market rises substantially above its March highs.

3. While the capital-gains tax presents its problems, revising the law on capital gains presents equally insoluble problems. Result: the chances are that nothing will be done about it.

4. Dishonest practices and rigging à la 1929 seem to be reassuringly conspicuous by their absence, and no new major legislation in this direction is necessary. Self-discipline and policing of trading and exchange activities (including “tipping”) have been admirable except in cases where relatively small amounts of money are involved.

It would be interesting to know how many people bothered to find out what Professor Galbraith actually had to say. Certainly if one relied upon Senator Capehart’s intense reaction to get the drift of the professor’s remarks, one would think he had announced that Armageddon was just around the corner.

The fact of the matter is that Professor Galbraith has been writing a book about the fascinating year of 1929; an article in Harper’s magazine this summer was based upon it (and somehow failed to knock the Dow Jones Industrial Average down 20 points), and so was his testimony at the Fulbright hearings. He devoted almost all of his testimony to a scholarly and highly interesting dissertation on the history and nature of speculation and how it was illustrated by what happened in 1929. He did not predict that the stock market was about to fall out of bed, and he did not predict that we face a major depression. Indeed, he went to considerable length to point out how much sounder and more promising our present position is than the condition which existed in 1929. Finally, he...

Table of contents

• Title Page
• Copyright Page
• Dedication
• Foreword
• ORIGINAL FOREWORD
• Introduction
• ORIGINAL INTRODUCTION
• Chapter 1 - PRIORITIES IS . . .
• Chapter 2 - THE FEEL OF THE MARKET
• Chapter 3 - INFLATION AND THE ECONOMY
• Chapter 4 - GOLD AND THE BALANCE OF PAYMENTS
• Chapter 5 - HOW WRONG CAN YOU BE?
• Chapter 6 - THE ECONOMIST AS PORTFOLIO MANAGER
• Chapter 7 - PHILOSOPHY AND FANTASY
• INDEX