Check your investing privilege

Why the American Stock Market has Gone Up Over Time

Erik Financial Education, Markets, Thoughts of a Mastermind 5 Comments


The American stock market has relentless gone up over the last hundred years as a result of innovation, a diverse supply of talent and resources, and a favorable political environment.

With these economic tailwinds, many people assume that the economy will continue to grow, and the stock market will continue to go up.

However, looking back in history, there are a number of favorable events which occurred which have benefited American companies and the government financially.

These events are typically ignored when people talk about finance and economics, but these events need to be discussed when thinking about investing.

In this post, I will be talking about why the U.S. stock market has gone up in value over time, talk about a few historical events which lead to these great returns, and discuss why I believe it’s important to consider non-status quo assets in your portfolio.

Challenging the Status Quo of Explaining Stock Market Growth

On this blog (and in my life), I’ve looked to implement certain thoughts and actions to ensure that I’m not being influenced by the wrong things. Namely, these thoughts and actions are:

Understanding WHY the American markets have gone up over time is a direct challenge to the data driven argument “the stock market always goes up“. 

In my opinion, it’s lazy to apply a simple average to a time series of 130 data points and extrapolate this average return into the future.

This is what most financial advisers and investment professionals do – 7-10% a year is what you can expect from equities (which is true when you apply a simple average to 130 years of annual market returns, but misses the bigger picture).

To challenge this data driven argument is not to say that “the stock market is a crappy investment” nor “the stock market will tank and stay down forever”. No, the stock market, like many things in the world, is cyclical and will naturally have tops and bottoms. With tops and bottoms, the economy will always recover (in some shape or form).

That being said, this post, again, is a direct challenge to your thoughts on the data driven argument behind “the stock market always goes up.”

There are a number of things which have taken place in the last 100 years which have made the micro- and macroeconomic environment primed the United States’ economy for ridiculous expansion and growth in the private and corporate sector.

These things may or may not happen in the next 100 years, so to expect the same results is misleading. Namely, to expect 7-10% returns after inflation going forward is silly (in my opinion).

The Goal of Looking to Understand Your Bias

the guide to banking for non-bankersBeing aware of the bias in your arguments is important.  This post will be an adventure into exploring the bias (unknown to them) of many personal finance “experts”.

First, I’m going to talk about investing in this post (in general), but need to make a disclaimer here that I’m not financial expert or adviser. When investing, please do your due diligence and research to determine which products are best for you, your family, and your future. 

Also, I need to say something else, I’m not a stock hater and in my retirement and investment portfolios, I own equities (both domestic and international). Also, I’ve read a number of personal finance books, and am a math major. Believe me, I get the math.

I’m just looking for the truth and looking to set up myself for a better future.

Through this exploration for truth, influence your thoughts along the way to becoming more thoughtful and knowledgeable about the world.

My goals in this post are the following:

  • I’m looking to examine and explore key events in history which lead to the growth and expansion of the markets in the United States.
    • Through this, I will expose a bias which I have recently became aware of.
  • I will look to argue that using comments such as “going forward, we will continue to experience 5-10% growth after inflation in equity investments” needs clarification and thought.
  • And I will look to challenge you on your investment strategy and thoughts as I have challenged myself 

Checking your investing privilege is to be aware of bias and correct for it. Let’s get into the post.

The Most Important Events for the American Economy since 1900

In time series analysis, it is not wise to completely ignore the concept of path dependence, i.e. the events in history impact today’s events.

When we looked at the United States economic system of capitalism a few posts ago, over time, a capitalist society will experience change and this change is driven by fundamental factors in the economy. These fundamental factors include population growth, technological growth, and a sound system of money.

Looking back on history and considering past returns in the stock market, it’s important to realize that there are other factors as well contributing to the economy from the political and geopolitical side of things.

A few events I believe we need to discuss which were very important leading up to today are:

  • Post World War 1 Developments in Europe
  • The First Removal of the Gold Standard (1933)
  • Bretton Woods Agreement in 1944
  • The Full Removal of the Gold Standard (Early 1970s)

Examining these events will help shed light on the investing privilege people in the United States have and will spark the challenge to my and your investment strategy.

I’m going to keep this at a relatively high level and give related reading to keep us out of a full rabbit hole digression.

Key Event #1: Post World War 1 Developments in Europe

To start this discussion, we need to go all the way back to the early 1900s and talk about World War 1. In particular, I want to touch on Germany because what happened next had a huge effect on the rest of the 20th century.

When Germany went to war in World War 1, they took on a ton of debt to finance their war efforts and thought that if they won, they would be fine.

World War 1 ended, and Germany was not a winner.

The winning countries imposed reparations on Germany and the German government already in debt, had to figure out how to pay for their lose.

Start up the printing presses! The German government started printing money and soon enough, the currency was falling to the point where the consumer price index went from 12 in 1920 to 726,000,000 in 1923.

Out of this hyperinflation lead to a destruction of the economy and lead to the rise of Hitler and the second world war.

Related reading (a piece from 1970): Hyperinflation of the Weimer Republic in Germany in 1923

Key Event #2: The Great Depression and the First Removal of the Gold Standard

Around this same time, the United States was having it’s own boom and bust, but this was at the national level. I’m sure you’ve heard and read about The Great Depression of the 1930s – it was a very interesting time where the economy nearly failed completely.

To deter people from cashing in deposits and depleting the gold supply, the U.S. and other governments had to keep interest rates high, but that made it too expensive for people and businesses to borrow.

In 1933, to try to save the economy, President Franklin Roosevelt ordered that all people turn in their gold to the government at $20.67 an ounce. After collecting thousands of ounces of gold, he declared the price of gold to now be $35 an ounce, thereby inflating the money supply and effectively saved the United States economy.

This saved the economy, and allowed the United States to get back on track, and in the coming years, be in a position to influence the outcome of World War 2.

Related reading:

Key Event #3: Bretton Woods System and 1944 Agreement

Around the time World War 2 was ending, delegates from 44 countries met to create a new international monetary system. The main goals of the meeting of the 730 delegates were to ensure a foreign exchange rate system, promote economic growth, and prevent competitive devaluations.

Under the agreement, currencies were pegged to the price of gold, and the U.S. dollar was seen as a reserve currency linked to the price of gold.

Countries promised that their central banks would maintain fixed exchange rates between their currencies and the dollar. If a country’s currency value became too weak relative to the dollar, the bank would buy up its currency in foreign exchange markets. That would decrease the supply, which would raise the price. If its currency became too high, the bank would print more. That would increase the supply and lower its price.

The dollar became the world’s reserve currency, essentially guaranteeing that the U.S would have a seat at the table globally going forward.

Related Reading:

Key Event #4: The Full Removal of the Gold Standard

When the 70s rolled around, the United States was starting to experience some troubles economically. Many economists and historians describe this time as stagflation, meaning, inflation and recession at the same time.

Since the dollar was still the world reserve currency, the U.S. dollar was in demand else where, but because of the $35 peg to gold, the dollar had a lot of pressure on it, and President Nixon, at the time, kept making moves to deflate the dollar to keep the United States competitive. in the global markets.

At this time, the Bretton Woods agreement was dissolved – as it was not performing as intended, and the United States was in an interesting spot.

In 1974, President Nixon completely decoupled the dollar from gold, ending the gold standard completely.

Now, banks could create money as they wish, gold was free to be priced at whatever the market thought it should be priced at, and the economic situation of the United States was saved from stagflation (inflation ran wild in the 70s, but at the same time, production increased taking it out of a recession.)

Related Reading: see above.

The High Level Consequences of these Events and How They Affect My Privilege

overview of economic systemsThe two events in particular which have set the United States up for success are #3 and #4: Bretton Woods, and the full removal of the Gold Standard.

To summarize, Bretton Woods positioned the dollar as the world reserve currency and ensured that there would always be demand for dollars.

Through this agreement, since the demand for dollars was quite high, the United States government needed to start the printing presses and start sending dollars all over the world.

Once this was proven to be unsustainable, the Gold Standard was removed in full, and the United States government could take on as much debt as possible because dollars were (and still are) needed for the majority of trade.

With this reserve currency status, a strong military, and increasingly better technology, the United States economy has been able to grow and grow and grow without harm.

Put a slightly different way, we have been living in a time of unprecedented peace and prosperity

To look back and say, “the stock market always goes up” is to at the same time ignore the fact that the stock market has only gone up because of the environment it operated in – namely one of peace, stability, and progress.

This is privilege and something that cannot be ignored.

A Case Study for Lower Expectations: Japan

Before going forward, I’m going to touch on another country’s market history. We know what events were critical in setting up today’s economy. I want to look at a very interesting case in the world which is counter evidence to that the market always goes up and to the right: Japan.

In the 1980s, Japan was a huge player in the world economy. What seemingly was a boom, ended up being a bust.

The stock market in Japan peaked in the late 80s and hasn’t recovered since. This was fueled by easy money and speculation.

japan nikkei 225 over time

In a mature economy, this is probably how the stock market should look. For reference, here’s the Dow Jones over time:

dow jones over time

Wait, is that a chart of Bitcoin? (I’m just joking 😉 )

While charts are cool in all, I want to dive a little bit deeper and remind you of something I talked about in the first article of this series: the earth is a closed system. Remember, the economy is a subset of the environment and is subject to the laws of biology and physics.

Ignoring Population Growth in Economics is Not Smart

Something VERY commonly ignored is how population growth affects the economy, production and profits. 

Companies are obsessed with growth. How do you grow as a company? Sell more products to more people or more businesses. More people is a variable in the sales equation, so an ever growing population is important. (Why unsustainable growth is sought after, I don’t know, but this is again, a conversation for another day)

Let’s look at two charts now examining the working population of Japan and the working population of the United States:

working population of japan

In recent times, the working population of Japan has been decreasing, and with this decrease comes a lack of demand for goods. Now, the United States:working population of the united states

As I mentioned above, we are subject to the laws of biology and physics. The above curve looks to be leveling off (and it is certainly less parabolic than the curve of the Dow Jones.)

To grow as a company or a nation, the fundamental source of this growth (besides energy) is human beings. Without an increasing number of humans, the markets cannot go up and up forever (regardless of the “technology” that comes into existence.)

Examining these two graphs, and also looking at the respective stock market charts leads me to believe that if easy money is not involved, then there will be a disconnect between current expectations and future results.

Unfortunately, I think that could be sooner rather than later, but that’s just my opinion.

Further Examining The United States Economic Situation

Two other points I want to make here before moving on is looking at the current monetary situation of the United States.

First, I want to talk about easy money and how this has fueled much of the growth of the economy. Here’s a graph of the greater money supply in the United States.

mzm money stock over time

What’s your dollar actually worth? While some may say, “the stock market protects me from inflation“, and yes, I agree with you.

But with easy money and credit, comes the need to constantly fulfill those debts. At some point, something has to give.

Second, (which may or may not be a result of this easy money), the United States is in a peculiar debt situation.

gdp to debt united states

Out of the 1950s, the United States experienced a huge technology and standard of living boom, and was able to grow GDP much faster than debt.

However, looking today, considering the headwinds of population growth, limited resources, climate change, social and political tensions, and a change in the attitude towards work, it will be interesting to see what happens next.

I’m not an expert or a guru. I’m just presenting facts which have influenced my thinking and actions.

A Challenge to Traditional Personal Finance Investing (or is it?)

Having a platform like this on the blog  allows me some cool opportunities. An economist from Romania emailed me the other week pitching me to review his book. He sent me a PDF copy and asked if I’d be interested in an interview.

Last weekend, I read his book, and it challenged me in ways I hadn’t been challenged before.

Being from Romania, his take on the world was a little bit different and made me think in ways I hadn’t before. Specifically, it made me take off my “United States Cheerleader goggles” and think about my investing privilege.

A few questions for you:

  • if you lived in the Middle East, what would your investment portfolio look like?
  • if you lived in a country that didn’t respect property laws, what would your investment portfolio look like?
  • what if you lived in a country that didn’t treat businesses fairly, what would your investment portfolio look like?

I’m going to take a guess that your investment portfolio would not be predominantly stocks. It would probably contain some precious metals, some digital assets (if possible), cash, and maybe real estate or bonds? I’m not sure, I’ve never talked to someone living in the Middle East.

Up until a year ago, I was 100% stocks (outside of my house) because personal finance advice states that for a person in their 20s, since the market is “always up and to the right”, I need to expose myself to this upward trend to the max.

To blindly follow this advice bothered me and sent me on a search for the truth.

Why It’s Important to Challenge Your Investment Thesis

earthI’m going to make an incredibly strong claim here: to say that the Dow Jones or S&P 500 will “always go up and to the right” is an exercise in elitism and arrogance.

Here’s the thing: unpredictable sh** happens all the time. 

Going back 100 years, America rose to superpower status and still is one of the leaders in the world today, economically and politically speaking. In 100 years though, do you believe that it still will be a superpower?

While I’m hopeful this will happen, there are no guarantees.

Thinking a little bit more critically, think about what is happening right now geopolitically… what happens if the dollar loses world reserve status? What happens if a world war happens?

My point here is, again, to think critically. Being extremely overweight stocks makes sense in backtesting, but going forward, I find it very difficult to accept such a straight forward answer. I even am having difficulty thinking being overweight domestic stocks and bonds (status quo assets) makes sense, but that’s a discussion for another day.

Over the past year, I’ve looked to diversify into other areas and feel better about my personal situation, but that doesn’t help you.

I wrote this article to shed some light on these developments, and hopefully this article has given you some food for thought in this area of your financial life.

Check Your Investing Privilege

Check your investing privilegeI’m incredibly lucky to have been born in the United States. I was born into a great family, received a solid public education, went to a public college for both my Bachelor’s and Master’s degrees, got into debt, have paid off some debt, got into other debt, and now am building wealth for the future – I’ve told this story a few times on this blog.

There is no doubt, I’m privileged in my life.

With this privilege, it has allowed me to think critically about my situation and the current macroeconomic situation in the United States and world.

If you’ve made it this far, thank you. My point in this article is that to use data driven arguments without looking at the bigger picture is short sighted.

Many people say, “you can’t predict the future”, but then go on to say that retirement is a few short years away because, “look, at 7-10%, I’m going to be a millionaire in 10-20 years guaranteed even if there is a recession or two”.

Unfortunately, life isn’t that easy (and if it is, then maybe I’m just a huge cynic and need to shut up).

My parents, grandparents, and relatives certainly didn’t have it this easy, and had to work hard and account for every dollar they earned. It seems this paradigm has shifted – easy money, easy credit, and 10% returns every year. This seems too good to be true.

The main point, since there’s a lot here, is that going forward, it is unreasonable to assume the same returns in the future as occurred in the past (unless the U.S. Government goes full print mode and we get hyperinflation).

I hope this article has got you thinking about your future. Critical thinking is crucial for long term success. 

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Comments 5

  1. In this particular case I don’t necessarily disagree with the possibility. With a but.

    Immigration has the very real possibility of changing the population trajectory . Furthermore the actual inflation numbers under our current system are not truly driven by the amount of funds in the economy. It’s driven more by people’s perception of the US. The full faith in the US government. Will that be enough? Don’t know.

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      Yeah, that might be a reason why certain politicians are wanting open borders to keep the show going.

      Also, yes thank you, inflation based on consumer prices is different than increasing the money supply (which seemingly was lost by the Fed coming out of 2008…?)

  2. I appreciate your out of the box thinking. I agree with a bunch of it. The US has had a fortunate series of events economically in the last century.

    I’m currently not predicting 7% returns over the next 100 years. Nobody knows for sure what the future will bring. What I can say is that investing in a stock (or a collection of them via an index fund) is buying an ownership stake in a business that’s sole purpose is to grow.

    Nobody knows for sure what will happen next but I’d argue that it’s one of the best bets out there.

    I’m looking forward to reading about the other asset classes you suggest will be better long run buy and hold investments. Real estate and business values are very much tied to the economy where they are located in so it’s not the solution for the risks you identify.

    Bonds are loans and by nature have a lower risk profile and therefore lower expected returns than stocks.

    Who knows what Crypto will turn into. Any given cryptocurrency could be a 10 bagger or go to zero. I’m not betting my future on it for sure.

    Index funds are not perfect but I think they are the best option available to most of us.

    I appreciate your challenge of the conventional thinking but I’ve yet to see your preferred alternative.

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  3. Pingback: This Week's Thriftiest Content - July 28, 2018 | Thrifty Enough

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