Friends Don’t Let Friends Wear Dow Hats

Submitted by QTR's Fringe Finance

At some point, probably sooner than most people think, the Dow Jones Industrial Average is going to hit 100,000. And when it does, you can already picture the scene. It’ll be like every major milestone the Dow has ever hit so far combined.

CNBC will run a countdown. There will be breathless retrospectives about how far the market has come. Somebody will dig up footage from the New York Stock Exchange. And, almost certainly, we will print a stupid hat that says “DOW 100,000”.

Wall Street has been doing this for decades. One of the great traditions of the old NYSE floor was celebrating big round Dow numbers as though humanity had just split the atom for the first time. When the Dow first crossed 10,000 in March 1999, traders cheered, confetti flew and “Dow 10,000” baseball caps were tossed onto the floor.

And back then, maybe the hats actually made sense. The enormous advance in American equities over the preceding generations represented, to a meaningful degree, an extraordinary expansion in American productive capacity, corporate earnings, technological progress and real wealth creation. The country built things, invented things, became more productive and produced companies that generated vastly more earnings than their predecessors. Obviously monetary inflation existed then too, but there was something tangible underneath the milestone worth celebrating.

The hats became part of Wall Street folklore, particularly through Art Cashin, the legendary floor trader who bought his NYSE seat in 1964 and spent six decades becoming one of the most recognizable people on the exchange. When the Dow climbed back above 10,000 in October 2009, the hats came back out and Cashin put his rally cap on again. Shortly thereafter, he was donning a hat again at the 20,000 milestone.

And I’m sure more hats will make their way onto the floor when the Dow hits 100,000, which at this rate feels like it could happen before the turn of the decade. But instead of celebrating, we should remember: this number is nominal. And the further we travel into the modern fiat era, the less impressed I am by nominal milestones.

Creating another semiconductor fabrication process takes years of research. Building a factory takes years. Increasing worker productivity is difficult. Growing corporate earnings requires selling something people actually want at a profit. Creating another trillion dollars of nominal purchasing power requires considerably less effort. Those efforts deserve a hat.

That distinction matters because today we increasingly celebrate the scoreboard without asking how much the measuring stick itself has changed. Nominal numbers are wonderful things to celebrate if you don’t ask too many questions about what the unit you’re measuring them in is worth.

If tomorrow we woke up and every stock doubled in dollar terms while every house, gallon of milk, insurance premium, restaurant bill and salary also doubled, would America suddenly be twice as prosperous? Of course not. But hey….hats.

This is the fundamental problem with treating ever higher nominal stock market levels as some kind of national economic scoreboard. Dow 100,000 will absolutely contain genuine economic progress, including productivity, technological advancement, population growth, corporate earnings growth and successful businesses creating real value. I don’t dispute that for a second.

But unlike building a factory, inventing a new technology or doubling the productive output of a business, increasing the number of dollars in the financial system is not some Herculean accomplishment. And when the supply of money and credit expands dramatically over long periods, some of that expansion inevitably finds its way into the nominal prices of scarce and financial assets. Stocks don’t magically sit outside the monetary system.

Inflation raises nominal prices, and stocks are things with nominal prices. Companies eventually sell their products for more dollars, report revenues and earnings in more dollars and own assets valued in more dollars. Investors, meanwhile, value those businesses in those same dollars. Over sufficiently long periods, therefore, asking whether the Dow will reach some enormous nominal number isn’t particularly interesting. Given enough real economic growth, enough inflation and enough time, increasingly absurd nominal numbers become almost inevitable.

The interesting question is how much real prosperity those 100,000 Dow points represent and what those dollars will actually buy when we get there.

For example, when Wall Street first celebrated Dow 10,000 in 1999, the index really was...(READ THIS FULL ARTICLE 100% FREE HERE).