Krugman has a slightly different take. He says that higher P/E ratios will be the norm from now on in -- and therefore stocks will earn like bonds, without the premium they've had before.
May 28, 2000
RECKONINGS / By PAUL KRUGMAN
Money for Nothing?
E conomists don't usually make good speculators, because they think
too much. Like the famous if apocryphal professor who refused to
pick up a $100 bill, they tend to assume that if there were money
to be had, someone would already have taken it.
However, caution that can be a liability on the trading floor is an
asset off it. Sometimes the observant do spot opportunities for
large, risk-free gain -- $100 bills lying in the street -- that
others have somehow missed. But a wise man doesn't assume that such
opportunities will present themselves on a regular basis, and he
certainly doesn't use that assumption as a basis for his family
budget -- or his plan to save Social Security.
It is a fact that historically stocks have been a very good
investment. The best-known demonstration of that fact comes from
Jeremy Siegel of the University of Pennsylvania, who has pointed
out --in his book "Stocks for the Long Run" -- that during the 20th
century anyone who was willing to buy and hold for long periods
would almost always have done better buying stocks than bonds. So
there wasn't a tradeoff between risk and return: stocks were just a
better investment, period. It turns out that there was a $100 bill
lying on the sidewalk (quite a few billion bills, actually) that
for some reason nobody picked up.
But many people have misunderstood what that observation means. It
doesn't say that there is some natural law guaranteeing that stocks
will always be a great investment; it says that historically stocks
have been underpriced. Investors weren't willing to pay as much for
claims on corporate earnings as they would have if they had
properly understood how low the risks were.
And a funny thing happened on the way to the 21st century: the
price-earnings ratio -- the price of a dollar of corporate earnings
-- soared. In the period studied by Professor Siegel prices were on
average less than 15 times earnings, and stock investors on average
earned a real return of 7 percent. Nowadays the price-earnings
ratio is on average more like 30. Is this irrational exuberance, or
did investors finally absorb Professor Siegel's lesson? Either way,
that $100 bill has now been picked up. If stock investors now have
to pay twice as much as they used to for a claim on earnings, and
if profits grow in the future as they have in the past, those
investors should now expect to earn only half the historical rate
of return.
And yet many of those offering plans to reform Social Security --
among them, of course, advisers to George W. Bush -- insist that
stocks are the answer, and that it is safe to assume that stocks
will keep on yielding 7 percent forever. And if you try to point
out that buying a piece of corporate America is much more expensive
than it used to be, they just repeat the mantra that stocks have
historically been a great investment. In other words, that $100
bill was there yesterday, so it must still be there, right?
Is the odd susceptibility of first-rate economists to such a naïve
fallacy a triumph of wishful thinking over analysis, or a
disingenuous bow to political expediency? Recent remarks by Mr.
Bush offer evidence of good old-fashioned American disingenuity at
work.
In a May 15 speech he asked his listeners to "consider this simple
fact: even if a worker chose only the safest investment in the
world, an inflation-adjusted U.S. government bond, he or she would
receive twice the rate of return of Social Security." That's an
amazing fact; it's even more amazing when you realize that the
Social Security system invests all its money in, you guessed it,
U.S. government bonds. But the explanation -- which Mr. Bush's
advisers understand very well, even if the governor does not -- is
that today's workers are not only paying for their own retirement,
but also supporting today's retirees. And if you think that's a
minor detail -- that the question of how to meet existing
obligations when workers are allowed to invest their contributions
elsewhere is a side issue -- let me assure you that I too would
have no trouble devising a painless plan to save Social Security,
if you let me assume that a large part of the system's obligations
would magically disappear.
Or maybe "magic" isn't quite the right word. How about "voodoo"?
Copyright 2000 The New York Times Company
__________________________________________________________________________ Michael Pollak................New York City..............mpollak at panix.com