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Berkshire Hathaway Inc. Message Board

  • Madeleines_Dad Madeleines_Dad Jan 2, 2004 7:21 PM Flag


    As is my normal habit, I picked up a few books to read over the holidays. This year, it�s been economic �doom and gloom� type stuff. Don�t mean to be a dark or pessimistic person. Just like to have some balance to the normally positive spin that I see and hear in the business and market news each day. My wife laughs at some of the titles I come home with.

    One of my public library favorites this holiday season was John Kenneth Galbraith�s �Market Crash 1929�. My beautiful bride laughed out loud when I showed her this one. (She thinks I may have gone off the deep end.) Anyway, I liked it so much I decided to type a portion of Galbraith�s final summary for the benefit/aggravation of the readers here. Found his thoughts on the future likelihood of another 1929 type crash to be interesting. Hope some of you find it worthwhile as well. ===============================================================


    �The military historian when he has finished his chronicle is excused. He is not required to consider the chance for the renewal of war with the Indians, the Mexicans or the Confederacy. Nor will anyone press him to say how such acrimony can be prevented. But economics is taken more seriously. The economic historian, as a result is invariably asked whether the misfortunes he describes will afflict us again and how they may be prevented.

    The task of this book, as suggested on an earlier page, is only to tell what happened in 1929. It is not to tell whether or when the misfortunes of 1929 will recur. One of the pregnant lessons of that year will now be plain: it is that very specific and personal misfortune awaits those who pretend to believe that the future is revealed to them. Yet, without undue risk, it may be possible to gain from our view of this useful year some insights into the future. We can distinguish, in particular, between misfortunes that could happen again and others which events, many of them in the aftermath of 1929, have at least made improbable. And we can perhaps see a little of the form and magnitude of the remaining peril.

    At first glance the least probable of the misadventures of the late twenties would seem to be another wild boom in the stock market with its inevitable collapse. As those days of disenchantment drew to a close, tens of thousands of Americans shook their heads and muttered, �Never again.� In every considerable community there are, even now, a few survivors, aged but still chastened, who are still muttering and still shaking their heads. The New Era had no such sound guardians of sound pessimism.

    Also, there are the new government measures and controls. The powers of the Federal Reserve Board � now styled by the Board of Governors, the Federal Reserve System - have strengthened both in relation to the individual Reserve banks and the member banks. Mitchell�s defiance of March 1929 is now unthinkable. What was then an act of arrogant but not abnormal individualism would now be regarded as idiotic. The New Federal Reserve Bank retains a measure of moral authority and autonomy, but not enough to resist any Washington policy. Now there is also the power to set margin requirements. If necessary, the speculator can be made to post the full price of the stock he buys. While this may not completely discourage him, it does mean when the market falls there can be no out surge of margin calls to force further sales and insure that the liquidation will go through continuing spasms. Finally, the Securities and Exchange Commission is a bar, one hopes effective, to large-scale manipulation, and it also helps to rein on the devices and salesmanship by which new speculators are recruited.

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    • <I've been pulling my hair out over the Arthur Laffer article in Barron's since I pulled it out of the mailbox two hours ago. He says stocks are the cheapest they've been in thirty years.>

      I read this also. I found his analytical approach VERY interesting to read. Specifically when he talks about measuring S&P earnings by their tax reported earnings (NIPA), and that these earnings don't show the "manic jump" at the peak of the bubble and held steady in recent years. We all know S&P earnings are manipulated to some degree, both to smooth quarter to quarter results, to maximize reported earnings over real earnings (the "enron" model), and due to accounting changes such as forced goodwill writeoffs. NIPA sounds like a much more realistic view of earnings (as NIPA apparently includes option costs as well).

      Then Laffer then goes about "normalizing" the effective P/E ratio. First he does it to compensate for low interest rates, which provide a lower discount rate and effectively raise the value of todays earnings. Then he adjusts for lower tax rates, a lower tax rate creates a higher after tax return. Lastly, he believes a shift to more S corporations is also increasing after tax effective returns (though I don't see how this affects the S&P 500, my guess is that all or almost all are C corporations).

      The problem comes at the end of the article, where he claims the S&P P/E is currently 3.3 based on the above. That's where he is on the limb, and you're right, it's going to get sawed off real quick. I agree with each individual point he's making to some extent, but how he added them up to reach 3.3 escapes me and sounds pretty ridiculous...

    • 3.3 p/e Dow 36,000 all over again.
      Cha ching.

    • I got the Mariner Books pb edition with a new introduction Galbraith wrote in 1997.

      "The offshore funds insanity of the seventies, the big bust of 1987, less dramatic episodes and fears, all brought attention back to 1929 and kept the book in print. And so now again in 1997.
      That we are having a major speculative splurge as this is written is obvious to anyone not captured by vacuous optimism."

      The old man still had it in 1997.

      • 1 Reply to woodstein2002
      • <Galbraith wrote in 1997.

        "The offshore funds insanity of the seventies, the big bust of 1987, less dramatic episodes and fears, all brought attention back to 1929 and kept the book in print. And so now again in 1997.
        That we are having a major speculative splurge as this is written is obvious to anyone not captured by vacuous optimism.

        The old man still had it in 1997. ">

        Did he also call the "speculative splurge" of 96, 95, 94, 93, 92, 91, 90, and the eight we had in the eighties as well? Stopped clocks always have "it" once per cycle.

        In this case, if you had gotten out of the DJIA in 97, you would have missed almost doubling your money in 3 years, and even if you held through a trio of crappy years you'd still be up 50% in six years.

    • Great Galbraith excerpt! Much appreciated! Cheers!

    • Yet, in some respects, the chance for a recurrence of a speculative orgy remains good. No one can doubt that the American people remain susceptible to the speculative mood � to the conviction that enterprise can be attended by unlimited rewards in which they, individually, were meant to share. A rising market can still bring the reality of riches. This, in turn, can draw more and more people to participate. The government preventatives and controls are ready. In the hands of a determined government their efficacy cannot be doubted. There are, however, a hundred reasons why a government will determine not to use them. In our democracy an election is in the offing even on the day after an election. The avoidance of a depression and the prevention of unemployment have become for the politician the most critical of all questions of public policy. Action to break up a boom must always be weighed against a chance that it will cause unemployment at a politically inopportune moment. Booms, it must be noted, are not stopped until after they have started. And after they have started the action will always look, as it did to the frightened men of the Federal Reserve Board in 1929, like a decision in favor of immediate as against untimely death. As we have seen, the immediate death not only has the disadvantage of being immediate but of identifying the executioner.

      The market will not go on a speculative rampage without some rationalization. But during any future boom some newly discovered virtuosity of the free enterprise system will be cited. It will be pointed out that people are justified in paying present prices � indeed almost any price � to have an equity position in the system. Among the first to accept these rationalizations will be some of those invoking the controls. They will say firmly that controls are not needed. The newspapers, some of them, will agree and speak harshly of those who think action might be in order. They will be called men of little faith.


      A new adventure in stock market speculation sometime in the future followed by another collapse would not have the same effect on the economy as in 1929. Whether it would show the economy to be fundamentally sound or unsound is something, unfortunately, that will not be wholly evident until after the event. There can be no question, however, that many of the points of extreme weakness exposed in 1929 or soon thereafter have since been substantially strengthened. The distribution of income is no longer quite so lopsided. Between 1929 and 1948 the share of total personal income going to the top 5 percent of the population with the highest income dropped from nearly a third to less than a fifth of the total. Between 1929 and 1950 the share of all family income which was received as wages, salaries, pensions and unemployment compensation increased from approximately 61 percent to approximately 71 percent. This is the income of everyday people. Although dividends, interest and rent, the income characteristically of the well-to-do, increased in total amount, the share dropped from just over 22 percent to just over 12 percent of total family income. In the ensuing years the improvement in income distribution tapered off and slightly reversed itself. It remains far better than in the twenties.

      • 1 Reply to Madeleines_Dad
      • Similarly, after 1929, the great investment trust promotions were folded up and put away, although eventually they were replaced in part, and alas, by mutual funds and offshore funds, Equity Funding and the Real Estate Investment Trusts, which became the casualties of the post-1970 collapse. However, the SEC aided by the bankruptcy laws, flattened out the great utility holding company pyramids. Federal insurance of bank deposits, even to this day, has not been given full credit for the revolution that it has worked in the nation�s banking structure. With this one piece of legislation the fear, which operated so efficiently to transmit weakness, was dissolved. As a result one grievous defect of the old system, by which failure begot failure, was cured. Rarely has so much been accomplished by a single law.

        The problem of the foreign balance is much changed it was from what it was twenty-five years ago. Now the United Sates finds itself with a propensity to buy or spend far more than it sells and receives (Editors note: Gulp!!).

        Finally, there has been a modest accretion of economic knowledge. A developing depression would not now be met with a fixed determination to make it worse. Without question, ceremonial conferences would be assembled at the White House. We would see an explosion of reassurance and incantation. Many would urge waiting and hoping as the best policy. Not again, however, would people suppose that the best policy would be � as Secretary Mellon so infelicitously phrased it � to �liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.� Our determination to deal firmly and adequately with a serious depression is sill to be tested. But there is still a considerable difference between a failure to do enough that is right and a determination to do much that is wrong.

        Other weaknesses in the economy have been corrected. The much maligned farm program provides a measure of security for farm income and therewith for spending by farmers. Unemployment compensation accomplished the same result, if inadequately, for labor. The remainder of the social security system � pensions and public assistance � helps protect the income and consequently the expenditures of yet other segments of the population. The tax system is a far better servant of stability than it was in 1929. An angry god may have endowed capitalism with inherent contradictions. But at least as an afterthought he was kind enough to make social reform surprisingly consistent with improved operation of the system.


        Yet all this reinforcement notwithstanding, it would be unwise to expose the economy to the shock of another major speculative collapse. Some of the new reinforcements might buckle. Fissures might open at other anew and perhaps unexpected places (Editors note: consumer and federal debt, derivatives). Even the quick withdrawal from the economy of the spending that comes from stock market gains might be damaging. Any collapse, even though the further consequences were small, would not be good for the public reputation of Wall Street.

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