by Archie M. Richards, Jr., CFP^®
March 19, 2001

Stock prices got belted again last week. What's going on?

The most important cause of the market decline has been the Federal Reserve's wretched approach to producing money. A year ago, the Fed thought the economy was growing too fast. (The idea that the twelve Fed Governors know at what rate the economy should grow is ridiculous.) Anyway, they implied they would continue raising rates and restricting the money supply until the economy slowed down.

As is often true with government policy, the actual results were opposite to the intended results. People figured they'd better borrow and buy right away, before the rates went up further. The Fed kept on restricting money production to raise the rates, and the economy kept on growing. Finally, in the fall of 2000, the Fed let it be known that rates would be lifted no further. The economy screeched to a halt. Having bought more than they needed, people and companies quit buying.

Realizing that it had overdone the job, the Fed quickly brought the rates halfway down, implying that it would lower them more. The reaction now is equivalent to that of last year. People are waiting to borrow and buy until the rates fall further.

Instead of putting the rates up or down gradually, the Federal Reserve Governors should change them all at once to the proper level. If they doesn't know the proper level (which they don't; they put on their pants one leg at a time just like the rest of us), they should stop trying to fine-tune the economy and just expand the money supply at a steady pace, letting interest rates be determined by market forces.

Here's the second reason stock prices are hitting the skids: Income tax rates are too high, especially of the rich. According to the U.S. Department of Agriculture, approximately $175 billion is invested each year in American agriculture and manufacturing. This is about $9,000 per year for each full-time-equivalent worker. Without this capital, productivity and pay would be rotten. Think hard, now: Who do you suppose supplies the bulk of the $175 billion?

You're right: the wealthy. Congress should therefore lower the top tax rates, enabling the rich to maximize capital investments so that even the disadvantaged may be employed at good wages. Congress has been too namby-pamby. Low-end tax rates hardly matter; the poor pay little in income taxes anyway. Congress should cut the higher tax rates a whole bunch, effective immediately.

Now for the third reason stocks have taken it on the chin: Internet companies have gone through the same process other major technologies went through earlier: railroads in the 19th Century, automobiles in the early 20th Century, radio in the 1920s, and electronics in the 1950's. On each occasion, a great many companies came into being. Stock prices went up but then tumbled. The technologies didn't die, but the number of companies supplying them winnowed down to a few. The Internet is far from dead; indeed, it may prove to be the most revolutionary of all.

If you own a broadly diversified portfolio of stocks, don't sell. By the time a falling stock market is front-page news, it's too late to sell. By the time people are selling simply because prices have been falling, it's too late. By the time media people are asking, as one did recently, whether stock prices "can ever recover," it's too late.

If you hold cash (money market funds are crammed with the stuff), don't wait for people to feel better about stocks before buying. Stocks do not rise because people feel better. Instead, people feel better because stocks rise.

Don't wait for economic and business news to improve before buying. Prices don't generally move as a result of news becoming known; they move several months before the news becomes known. The collective guesses about the future by the potential buyers and sellers of stocks are remarkably accurate.

Most people, including the pro's, underperform the market. For the bulk of your portfolio, therefore, why try to outdo it? Are you in the market to make profits or to prove you're Superman? Try the former. Ride above the fray. Use the broadest possible index funds of the world's stocks and hang on through thick and thin.

Yes, stock prices are thin now. But thick approaches. With technology advancing rapidly and governments gradually becoming less intrusive, the world's economic prospects over the next couple of decades are truly wondrous.