Coded gray.

Wednesday 19 December 2001


Pic of the day: Night at castle Camelot. (Screenshot from, appropriately enough, the game Dark Age of Camelot.) Notice the small but prominently displayed Holy Grail symbol. Heh. All things are connected, are they not?

Milton Friedman vs. me

Ok, this seriously baffles me. In an interview printed in the Norwegian finance magazine Kapital, Milton Friedman estimates that the current recession will end within second quarter 2002. Hello? 2002? I really donít hope so.

Please notice that I have great respect for Friedman. He got a Nobel prize in economics, right? And I'm just some guy. He may not be the father of market economy, but certainly one of its greatest and most influential spokesmen. Definitely a man worth listening to. But not this time, I think.

The world economy, and its champion, the American economy, is fundamentally healthy. It should be able to stride along briskly in the next decade or longer, bringing growth and prosperity to millions of new people each year. But not right now. Right now, America (among others) need to shed some past mistakes. Most notably, the inflated stock market. The stock market has been bubbly for years. It has become normal to consider shares something you buy to sell them, not to own them. But this is not the true nature of a stock market. A stock market is not a casino or a horse race where you bet on winners and losers. It is a marketplace where you buy businesses, in whole or (usually) in part.

For the economy to work optimally, share prices have to come down to the point where you pay for the dividend you expect to receive, not for the stupidity of someone willing to pay you a lot of money when you sell the shares.


"Hey wait!" I hear you cry (well, actually I donít, itís the voices in my head, but you get the drift), "Even the green armchair economist knows that a corporation is not forced to pay out all its profit in dividends." As a matter of fact, it is common - and even prudent - to retain some of the profit in the company, for future investment or as a buffer against harsher times. The owners donít lose anything, since the value of the shares go up accordingly. Say you buy shares for $10,000 and after a fabulous year your shares generate a profit of $2,000. If you need the money, you just sell $2,000 worth of stock. Thatís what the stock markets are for, to facilitate this kind of transactions.

Let me first say that I consider this practice to be too common today. I understand that it is more practical to finance gradual growth through investing funds as they accumulate, rather than first paying them out to the shareholders and then issuing new shares. Thatís just too much bureaucracy. But overdoing this is a sign that you donít trust your owners, and that is a bad thing. The fact that "everyone does it" is even worse. Any major investment (such as taking over another company, buying a new factory etc) ought to be financed by issuing new shares. If the owners really like the idea, theyíll place their money on the table. The owner is next to God. The company is just a tool, and the administration is its handle. It has no right to mistrust the hand that wields it. Many of the troubles and indeed scandals that we have seen in recent years stem from the fact that the owners are too remote from the companies, and the administration goes like the proverbial mice dancing on the table when the cat is outside. Let the cat in, and things will improve immensely.

Second, even when dividend is withheld, the economic reality remains the same. The only difference is that it becomes harder to say what should be the real value of the shares. When you buy shares, you do not only buy the current capital in the company, but also the future profits that will be retained. And who knows how much that might amount to after some years? These are the estimates that have shown themselves too difficult for the amateur investor, and so they become prey to more experienced traders. But as the cattle keep marching in, the investors upgrade their greed, and we get a runaway bubble. It all depends on finding the greater fool who will pay more than you did. A pyramid scheme. This is bad for business in the long run.


The point of all this is that the economy will remain unstable for a while, until the bubble has run its course. Economic cycles tend to overshoot; certainly it did that during the good times. If anything, we can expect the pessimism to overshoot too, bringing the prices briefly under the realistic level.

If growth resumes in less than half a year, I fear we won't be rid of the excesses, and we will continue to mis-allocate resources in the years to come. Friedman should have more faith in the market than that ... But hey, I'm just some guy. Let's wait a year and see what happened.

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