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Posted on October 1, 2007 -
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By John Reizner |


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There is unsaid in our daily life a social contract between all the players. Individuals are able to live their daily lives in a manner without much fear because of this contract, unless one lives in an area where this contract has broken down. You might call this unseen force in ordinary life the confidence that people have that their persons, social, economic, spiritual lives will be protected from the actions of others in that society, or from their government. We have enacted laws, and have institutional structures to protect us, such as the judicial system and religion, however imperfect they are. We have laws on the books to protect the citizenry. The Ten Commandments states that it is not right, for example, for men or women to kill each other, or to steal, and so on.

The strength of the American society and free economic system shows that persons coming from different cultures can coexist peacefully while having ample opportunity to be upwardly mobile. This faith in our system of government and in our form of capitalism draws immigrants from all over the globe to participate in our democracy. Over the 200 plus years of our country, we have survived recessions, depressions, World Wars, and even a Civil War, when the political consensus was broken – and our democracy has persisted.
 
I came of age during the interesting period of the Vietnam War era, where society was divided between the supporters of the war, and many young people, who exited from society by “dropping out” and joining the growing “hippie” counterculture. The confidence that many young people had in their government’s policies and its supporters was strained. In 1966, the stock market had passed 1000; a level which would not be seen again for 16 years afterward. Inflation was beginning to brew from keeping a foreign war going. Government had had a guns and butter policy – in other words, our society was rich enough to support a war and domestic spending – at the cost of the inflation racked 1970’s, when stock returns were quite poor and the Dow fell under 600 in mid decade.
 
I was only thirteen and very impressionable when the movie “If”, directed by Lindsay Anderson, starring young Malcolm McDowell, premiered in London in 1968. A friend of the family escorted me to the box office for the movie, rated X in those days in New York City, and we sat down to watch the film, which was the telling of a repressive British private school. I don’t want to spoil the movie for you, (parental guidance strongly advised) but the social contract was broken in the movie between students and their elders – and the results are at the end of the film. Of course, the film is called “If.” The contract, the confidence in their system, could not keep these British schoolboys, at least in the film, from uprooting the institutions with which they were surrounded.
 
There is also a definite factor of the influence of confidence in our economic life, and specifically the level of confidence underlying the stock market. Breaks in the market like the ones we have experienced recently stir up fears among investors that their economic life will be impaired – that if you are in the stock market you will lose a lot of money because the stock market is declining: a perceived truism. The break in the market causes a loss in confidence. Of course, one might say the stock market is merely reflecting the health of our domestic economy and the rest of the world’s level of economic activity. So a loss of confidence in the market might reflect an ongoing recession, surging inflation, bank failures or mortgage defaults, etc., or the market drop might be a financial event, where the drop simply feeds on itself (such as the Crash of 1987).
 
Fear causes many investors to lose confidence and act in a manner that may be contrary to their economic interest in the market – for example, selling stocks when they are at bargain levels. In that case, the investor loses “confidence” in the market as it falls, and does not believe that it will continue to be a good store of value and continue to appreciate – so he may sell his stocks while feeling fear. I write about the idea of not being led around by one’s emotions when investing in my article, Stock Market Investing and the Power of Contrary Opinion..
 
The exception to the rule of the viability of long term investment in the stock market is in the hands of our elected officials, who if they are not enlightened, may enact policies which cause the economy to fundamentally falter for an extended time, as in the 1930’s and 1970’s – or for the Federal Reserve to miscalculate and cause an ordinary recession to get deeper or to cause the economy to overheat. In my article, Hedge Funds, Deriviatives, Debt, China and the Risk of Systemic Market Panic.
 
I write a bit of the systemic risks out there that could cause a economic breakdown in the economy and stock market.
 
So just as the social contract holds the bonds of our democracy together and permits its citizens the possibility of living full lives, the level of underlying confidence in our free market system keeps our stock market from a catastrophic breakdown. Only terrible miscalculation by our government officials or by the Federal Reserve serves to threaten this bond.

 

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