Guest post by Wim Grommen. Mr. Grommen was a teacher in
mathematics and physics for eight years at secondary schools. The last
twenty years he trained programmers in Oracle-software. He worked almost
five years as trainer for Oracle and the last 18 years as trainer for
Transfer Solutions in the Netherlands.
The last 15 years he studied transitions, social transformation
processes, the S-curve and transitions in relation to market indices.
Articles about these topics have been published in various magazines /
sites in The Netherlands and Belgium.
The paper “The present crisis, a pattern: current problems
associated with the end of the third industrial revolution” was accepted
for an International Symposium in Valencia: The Economic Crisis: Time
for a paradigm shift, Towards a systems approach.
On January 25 2013, during the symposium in Valencia he presented his paper to scientists.
The Dow Jones Industrial Average (DJIA) Index – the oldest
stock exchange in the U.S. and most influential in the world – consists
of 30 companies and has an extremely interesting and distressing history
regarding its beginnings, transformation and structural development
which has all the trappings of what is commonly referred to as pyramid
or Ponzi scheme.
The Dow Index was first published in 1896 when it consisted of just
12 constituents and was a simple price average index in which the sum
total value of the shares of the 12 constituents were simply divided by
12. As such those shares with the highest prices had the greatest
influence on the movements of the index as a whole. In 1916 the Dow 12
became the Dow 20 with four companies being removed from the original
twelve and twelve new companies being added. In October, 1928 the Dow 20
became the Dow 30 but the calculation of the index was changed to be
the sum of the value of the shares of the 30 constituents divided by
what is known as the Dow Divisor.
While the inclusion of the Dow Divisor may have seemed totally
straightforward it was – and still is – anything but! Why so? Because
every time the number of, or specific constituent, companies change in
the index any comparison of the new index value with the old index value
is impossible to make with any validity whatsoever. It is like
comparing the taste of a cocktail of fruits when the number of different
fruits and their distinctive flavours – keep changing. Let me explain
the aforementioned as it relates to the Dow.
Companies Go Through 5 Transition Phases
On one hand, generally speaking, the companies that are removed from
the index are in either the stabilization or degeneration transition
phases of which there are five, namely:
1. the pre-development phase in which the present status does not visibly change.
2. the take-off phase in which the process of change starts because of changes to the system
3. the acceleration phase in which visible structural changes –
social, cultural, economical, ecological, institutional – influence each
other
4. the stabilization phase in which the speed of sociological change slows down and a new dynamic is achieved through learning.
5. the degeneration phase in which costs rise because of
over-capacity leading to the producing company finally withdrawing from
the market.
The Dow Index is a Pyramid Scheme
On the other hand, companies in the take-off or acceleration phase are added to the index. This
greatly increases
the chances that the index will always continue to advance rather than
decline. In fact, the manner in which the Dow index is maintained
actually creates a kind of pyramid scheme! All goes well as long as
companies are added that are in their take-off or acceleration phase in
place of companies in their stabilization or degeneration phase.
The False Appreciation of the Dow Explained
On October 1
st, 1928, when the Dow was enlarged to 30
constituents, the calculation formula for the index was changed to take
into account the fact that the shares of companies in the Index split on
occasion. It was determined that, to allow the value of the Index to
remain constant, the sum total of the share values of the 30 constituent
companies would be divided by 16.67 ( called the Dow Divisor) as
opposed to the previous 30.
On October 1
st, 1928 the sum value of the shares of the 30
constituents of the Dow 30 was $3,984 which was then divided by 16.67
rather than 30 thereby generating an index value of 239 (3984 divided by
16.67) instead of 132.8 (3984 divided by 30) representing an increase
of 80% overnight!! This action had the affect of putting dramatically
more importance on the absolute dollar changes of those shares with the
greatest price changes. But it didn’t stop there!
On September, 1929 the Dow divisor was adjusted yet again. This time
it was reduced even further down to 10.47 as a way of better accounting
for the change in the deletion and addition of constituents back in
October, 1928 which, in effect, increased the October 1
st,
1928 index value to 380.5 from the original 132.8 for a paper increase
of 186.5%!!! From September, 1929 onwards (at least for a while) this
“adjustment” had the affect – and I repeat myself – of putting even that
much more importance on the absolute dollar changes of those shares
with the greatest changes.
How the Dow Divisor Contributed to the Crash of ‘29
From the above analyses/explanation it is evident that the dramatic
“adjustments” to the Dow Divisor (coupled with the addition/deletion of
constituent companies according to which transition phase they were in)
were major contributors to the dramatic increase in the Dow from 1920
until October 1929 and the following dramatic decrease in the Dow 30
from then until 1932 notwithstanding the economic conditions of the time
as well.
Exponential Rise in the Dow 30 is Revealed
The 1980s and ‘90s saw a continuation of the undermining of the true
value of the Dow 30. Yes – you guessed correctly –further “adjustments”
in the Dow Divisor kept coming and coming! As the set of constituents of
the Dow changed over the years (almost all of them) and many shares
were split the Dow Divisor kept changing. By 1985 it was only 1.116 and
today it is only 0.132129493. Indeed, a rise of $1 in share value of the
30 constituents actually results in 8.446 more index points than in
1985 (1.116 divided by 0.132129493). Had it not been for this dramatic
decrease in the Dow Divisor the Nov.3/10 Dow 30 index value of 12,215
(sum total of the current prices of the 30 constituent shares of
$1481.85 divided by 0.132129493) would only be 1327.82 ($1481.85 divided
by 1.116) in 1985 terms. Were we still using the original formula the
Dow 30 would actually be only 49.395 ($1481.85 divided by 30)!
The crucial questions today are:
1. Is the current underlying economy strong enough to keep the Dow 30 at its present level?
2. Will the 30 constituents of the Dow remain robust or evolve into the stabilization and degeneration phases?
3. Will there be enough new companies to act as new “up-lifters” of the Dow?
4. When will the Dow Divisor change – yet again??
The Dow 30 is the Greatest of All Ponzi Schemes
I call on the financial community to take a critical look at the Dow
Divisor. If it is retained societies will continue to be deceived with
every new transition from one phase to another and the greatest of all
Ponzi schemes will have major financial consequences for every investor.
A version of this article, entitled “Beurskrach 1929, mysterie
ontrafeld?”, was first published in Dutch in the January 2010 issue of
“Technische en Kwantitatieve Analyse” magazine which is a monthly
publication of Beleggers Belangen (Investment Interests) in the
Netherlands and on several sites there including:
Beurskrach 1929 mysterie ontrafeld? op Historiek.net (English version
Stock Market Crash 1929, Mystery Unraveled?
Wim Grommen is a guest contributor to
http://www.FinancialArticleSummariesToday.com, “A site/sight for sore eyes and inquisitive minds”, and
www.munKNEE.com, “It’s all about MONEY” of which
Lorimer Wilson is editor.
Posts
From the Bioinitiative Working Group
