On Wall Street
By Robert Kuttner
Until very recently, a lot of intelligent people had convinced themselves the bull market could last forever. So why not give Social Security pensioners a piece of the action?
But of course markets fluctuate. Over the very long term, stock prices have averaged a real annual return of about 7 percent, reflecting economic growth and corporate earnings. But that's just an average; sometimes the market stays depressed for decades.
The flip side is periods such as the past decade, when the stock market quintupled. Much of the stock run-up of the 1990s was the result of just one factor -- disinflation.
As inflation gradually declined over the 15 years, the stock market played catch-up. With falling inflation, a given rate of corporate profit justified ever higher stock prices.
For example, when the inflation rate is 12 percent, corporate earnings of 10 percent are dismal and the share price stagnates. But if inflation declines to 3 percent (as it has), 10 percent earnings are sweet and the share price rises.
Inflation, however, has bottomed out. The all-important ratio of prices to earnings is close to its 1929 peak. And corporate profit projections are now falling.
Stock prices become unsustainable when they stop reflecting corporate earnings and begin reflecting nothing more than investors' belief that other investors will irrationally bid up share prices even higher. This is known on Wall Street as the "greater fool theory." If some bigger fool than you is buying, the stock price will rise -- and you should buy, too. That game can go on for a while, but not indefinitely.
To appreciate the irrational behavior of stock markets, consider some of what influenced a recent bout of volatility. On a Tuesday, the 300-point drop in the Dow was triggered when one of Wall Street's great bulls, Ralph Acampora of Prudential Securities, incautiously declared that sagging stock prices would spread from smaller stocks to blue chips. Then on Wednesday, the jittery market took heart when another prestigious analyst, Abby Joseph Cohen of Goldman Sachs, declared that many stocks were actually "undervalued." Any market that can dip and soar based on the daily prattlings of oracles is not a stable market.
This brings me back to Social Security. Wall Street firms are now crusading to divert Social Security revenues into stocks. Presumably, an infusion of Social Security money would conveniently prop up stock prices and generate some nice fees, too.
This scheme is being sold to pensioners as an opportunity to cash in on the bull market. But this bull market is (was?) very likely a once-in-a-generation phenomenon. Stock investments do make great sense over the long haul, but most pensioners need their money in the relatively near term.
There is something very attractive in the ideal of a people's capitalism. Share-the-wealth crusaders have long advocated a universal nest egg, giving everyone what the late Louis Kelso called a "second stream" of income from investment. But despite scheme after scheme, we never quite seem to get there.
In the 1920s, the so-called American Plan promised broad employee profit-sharing as an alternative to trade unionism. The American Plan vanished with the Depression.
In the '50s, major corporations set up pension plans. But fewer workers now have company pensions than a generation ago.
Employee Stock Ownership Plans, authorized in the 1970s, were another panacea. ESOPs, however, are mainly a tax dodge for management, and virtually none gives employees voting control.
The '80s brought a proliferation of IRAs, Keoghs, and 401(k) plans. But little of the benefit goes to the bottom two-thirds.
Sharing the wealth remains a very radical idea. Typically, a piece of the rock depends more on government mandates than on voluntary generosity by employers. And the one such universal mandate is still . . . Social Security.
If the market really tanks, people will feel a lot less wealthy, and they will reduce their spending accordingly. That in turn will deepen the economic downturn. In such circumstances, we will have renewed appreciation for the economy's "automatic stabilizers" -- the leading example being Social Security.
We're a still a long way from people's capitalism. It's certainly a worthy goal. But the way to get there is via universal pensions or other such nest-egg programs, not by using Social Security to play the market, or rescue it.
The writer is co-editor of the American Prospect.
© Copyright 1998 The Washington Post Company