By Louis Woodhill
From Real Clear Markets:
Friday’s scary 611.21-point plunge in the Dow Jones Industrial Average was not what it seems. Although it was a political earthquake, the British electorate’s vote to leave the European Union (EU) had only a minor impact on the real value of U.S. equities. Here’s why.
The Dow is a price, and every price is the ratio between the real market value of the item in question and the real market value of the dollar. Looked at from this point of view, at least 78% of Friday’s decline in the Dow was caused by the failure of the Federal Reserve to do its basic job, which is to keep the dollar stable in value. At most, only 22% of the Dow’s fall can be attributed to Brexit.
Of course, Janet Yellen and her merry band on the FOMC* believe that their job is to centrally plan and manage the entire U.S. economy, and not merely to provide the markets with a dollar with a constant value, so that producers, consumers, savers, and investors can just get on with it.
There is a huge element of self-interest in the Fed’s relentless accretion of power. Chair Yellen is well aware that if the Fed were to confine its role to delivering a stable dollar, she would not be a celebrity. The media would not hang on her every word.
OK. Regarding Brexit and the Dow, here is the calculation.
The best indicator of the real value of the dollar is the CRB Index**. At 2:30 PM EDT on Friday, the CRB Index closed at 188.69, down 2.50% from Thursday’s close. At that time, the Dow was at 17,441.26, down 561.89 points, or 3.16%. This means that, at the close of trading in the CRB Index on Friday, the “CRB Dow,” which is the Dow divided by the CRB Index, was lower by 0.68%.
So, what we can conclude from Friday’s trading is that Brexit, momentous as it was politically, accounted for at most 21.65% of the drop in the Dow, and the Fed’s failure to keep the value of the dollar stable caused the other 78.35%. In reality, given how damaging an unstable currency is to an economy, it is likely that if the Fed had been keeping the dollar stable in terms of the CRB Index, Brexit would have had little or no impact on the value of U.S. equities.
However, let’s assume for the moment that Brexit accounted for all of the 0.68% fall in the “real” value of the Dow (i.e., the CRB Dow) that had occurred by 2:30 PM EDT on Friday, or even the 0.92% decline that existed as of 4:00 PM EDT. These are not large daily moves. There have already been days during 2016 when the CRB Dow was up by as much as 2.97% and down by as much as 2.86%.
So, in the market’s judgment, Brexit was not a big deal for the U.S. economy. On Friday, as they have been for decades now, investors were much more concerned about what our flailing, failing Federal Reserve will do (or will not do) next regarding the real value of the dollar.
Brexit did have a huge impact upon the value of U.K equities, however. While the FTSE 100 was down by only 3.15% on Friday (the Dow declined by 3.39%), the “real” FTSE 100 (i.e., the FTSE 100 divided by the CRB Index expressed in U.K. pounds) plunged by a massive 7.80% (vs. less than 1% for the “real” Dow).
So why would the British people vote for something that would instantly make them 7.80% poorer? The late Jude Wanniski, the author of The Way the World Works (1978) would not have been surprised by the outcome of last Thursday’s referendum. Wanniski, were he still with us, would also not be surprised if Donald Trump becomes the next president of the United States.
Free markets are inherently self-correcting. Money talks, and economic actors have to listen to the voice of the people or go bankrupt. In Wanniski’s “political model,” societies get into trouble when their political elites-the people that wield the power of the state-lose touch with the wisdom of ordinary people.
Unfortunately, a disconnect between ordinary citizens and the elites that govern them is occurring all over the world right now. This has led to the rise of right-wing political parties in continental Europe, Donald Trump in the U.S., and, most recently, Brexit.
As Wanniski notes in The Way the World Works, economics are important to ordinary people, but they are not the most important things in life. In 1987, an 18-month-old baby, Jessica McClure, fell down a well in her aunt’s back yard in Texas. Until she was rescued 58 hours later, the plight of this one little person drove all economic news out of the American public’s consciousness. More recently, terrorist attacks have had the same effect. The electorate prizes life far more than money.
Worldwide, the political classes have been coalescing into a transnational elite, with some of them starting to consider themselves “citizens of the world.” These people hold themselves to be refined, sophisticated, and far superior to the unwashed masses, who are, in any case, just a bunch of racist, sexist, homophobic, Islamophobic morons, desperately clinging to their Bibles and their guns. In response, the electorates of the world have been starting to push back, by whatever means happens to be available to them.
In England, the leadership of both major political parties, the Conservatives and Labor, favored remaining in the European Union. The ordinary citizens of the U.K. just gave them a stinging rebuke. In response, David Cameron has done the honorable thing, and has announced that he will resign as prime minister.
For at least the past fifteen years, Americans have been forced to subsist on a diet of progressivism (from Obama, the Democrats, and the Federal Reserve) and “progressivism light” (from Bush 43 and the Republicans). In response, the electorate has made Donald Trump the Republican nominee for president. Trump is far from the ideal solution to the problem of America’s out-of-touch elites, but he is what was available in the political marketplace.
Can Trump win? Of course he can. However, if he wants to win, he has to curb his “loose cannon” rhetoric, and put forward a strong “pro-growth” economic plan.
In addition, Trump must get that many of the contentious issues facing the nation right now would be best handled via national referendum votes.
Jude Wanniski was a strong supporter of referendums, as a way of forcing political elites to heed the will of the people. On Sunday, June 5, Swiss voters crushed (by nearly 77% to 23%) a proposal, favored by elites on both the political right and the political left, to provide every citizen with a “Universal Basic Income” (UBI). Then, on June 23, the British electorate defied their “betters” and voted for Brexit.
Donald Trump has been campaigning as a spokesman for ordinary people. There is no better way to give voice to ordinary citizens than to allow them to vote in national referendums. And, high on Trump’s list of issues to be put before the people should be a proposal to impose a monetary rule upon our arrogant, out-of-control Federal Reserve.
*The Federal Open Market Committee, which is the 12-member body that determines the Federal Reserve’s monetary policy.
**The CRB Index is a commodity price index comprising: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gasoline, and Wheat.
Louis Woodhill ([email protected]), an engineer and software entrepreneur, and a RealClearMarkets contributor.
Photo Credit: Katrina.Tuliao