first of all I want to thank my connect

I can’t give you investment advice, but I can tell you what things mean.

The Dow Jones Industrial Average closed at 8990.96 yesterday. The last time it fell that low (prior to this month, of course) was June 2003. If the DJI means anything as an economic barometer, it means that the housing bubble collapse has destroyed 5 years worth of wealth: every citizen of the world could have taken half a decade off and we’d be no worse. Of course, that’s not true, which leads me to wonder what’s the use of the DJI.

The Dow Jones Industrial Average – forgive me if you’ve heard this – is a price-weighted average of the stock prices of 30 of the largest industrial companies in the U.S. The companies which make up this list – including American Express, Exxon Mobil, McDonald’s and Verizon; excluding Chase Bank, British Petroleum, Starbucks or Sprint – are selected by Dow Jones & Company. Dow Jones & Company also publishes The Wall Street Journal, one of the most widely read business periodicals in the world.

What I’m getting at: the DJI is not an exhaustive list of American companies; service industries are highly underrepresented. It’s not even an exhaustive list of American industries. The DJI is a list of businesses picked by a company that happens to have a particularly loud bullhorn. It has been a successful list. But there’s more to America than industry.

Gold became a currency because it had more use in exchange than it did in manufacture: people started trading it more than they were making it into jewelry (see Neal Stephenson’s Quicksilver for more). Similarly, the DJI is used more as a barometer than as an investment tool. When people talk about “how the market is doing,” they mean the Dow. A substantial minority track the Nasdaq or the S&P 500 in addition to the Dow, but most people look at one number.

This bothers me because I don’t like people making panicked decisions based on the behavior of 30 companies, none of which they invest in.

I don’t agree with Dean Baker at the American Prospect on every thing, but I find him a better thinker than either Paul Krugman or Thomas Friedman. For years he’s been the voice crying out in the desert, declaiming reductionist investment thinking with a simple motto: the stock market is not the “home team.” A surge in the DJIA could come from any number of things – inflation, a burst of good news, rosy economic forecasts, mob mentality, etc. The changes of the Dow represent the instinctive guesses of several hundred traders – hardly an accurate representation of the market as a whole.

What with the current panic – and I don’t know how else to describe week-over-week 1000-point swings in the DJI – Baker’s been hitting this drum louder than ever. From September 30th:

On January 3, 2001 the NASDAQ jumped more than 14 percent. What was the basis of this euphoria? Alan Greenspan had lowered the federal funds rate by a full percentage point in a rare special meeting. Investors were convinced that this meant that the fed would prevent a recession. Two months later the economy began losing jobs and entered a recession. It didn’t begin adding jobs again until the fall of 2003.

The moral of this story is that financial markets should not be viewed as the embodiments of wisdom about the economy. The big actors in the financial markets are subjects to bouts of fear and panic just like the rest of us. In fact, they might even be more subject to irrational mood swings because they sit around talking to each other all day.

The conventional wisdom in the media was that the economy would collapse in the absence of the bailout. I know of few, if any, economists who shared this view, even among those who supported the bailout. However, the disaster view undoubtedly permeated Wall Street just as the euphoria view permeated Wall Street in January of 2001.

We cannot look at the markets as an independent gauge of the impact of Congress not passing the bailout. The stock markets are reflecting the conventional wisdom in the media, they do not provide an independent assessment of the economy.

So if a few panicking people on Wall Street shouldn’t scare us, do we have anything to worry about? Sadly, yes.

Fed cuts key rate by half-percent: “The funds rate has not been lower since 1958, when Dwight Eisenhower was president.”

White House to banks: stop hoarding money*: ““What we’re trying to do is get banks to do what they are supposed to do, which is support the system that we have in America. And banks exist to lend money,” White House press secretary Dana Perino said. While there are limits to Washington’s power to affect banks’ behavior, the White House decided it was time to use its bully pulpit.”

Panicking brokers can hurt the stock market, and consequently the value of our investments, but little that they do can not be undone. The Dow was down to 8220 last week; it closed at 8990 yesterday; it could be back above 10,000 tomorrow. However, panicking bureaucrats wield power grossly disproportionate to their numbers. The damage they cause can put towns out of business and starve children. And Bernanke and Paulson aren’t listening to the Midwesterners whose homes are being foreclosed; they’re listening to their former colleagues at Goldman Sachs and Citigroup.

I can’t give you investment advice, but I can tell you what things mean. When a day trader panics, unloading half his portfolio based on what he heard in the men’s room, you can safely ignore him. When the President panics, rushing a bill through Congress and then assuring everyone it’ll take months to see improvement**, bar the door. Call him a liar. Spit when you hear his name.

And for the devil’s sake, don’t vote for any Presidential candidate who supported the bailout.

* First it was “speculators” shorting banks, now it’s “hoarders” stashing money. What’s next – Freemasons poisoning the wells? Jews drinking the blood of Christian babies? What century is this?

** Good thing they hurried, eh?


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