Thanks for an interesting post. Now, I wonder, is there any reason other than irrational exuberance that there might be an aweful lot of money in the stock market? So much that historic notions of reasonable P/E ratios no longer make sense? I could be wrong about this, but in the 1970's people usually had pensions for retirement but over the course of the 1980's that started to change:

In 1978, Congress amended the Internal Revenue Code, later called section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation.[2] The law went into effect on January 1, 1980,[2] and by 1983 almost half of large firms were either offering a 401(k) plan or considering doing so.[2] By 1984 there were 17,303 companies offering 401(k) plans.[2] Also in 1984, Congress passed legislation requiring nondiscrimination testing, to make sure that the plans did not discriminate in favor of highly paid employees more than a certain allowable amount.[2] In 1998, Congress passed legislation that allowed employers to have all employees contribute a certain amount into a 401(k) plan unless the employee expressly elects not to contribute.[2] By 2003, there were 438,000 companies with 401(k) plans.[2]

So, here is what I think.

In the mid nineties things got out of control. They knew it was a bubble. It got huge. Really really huge. If you compare the late nineties DJIA with the late eighties Nikkei, it looks the same. A massive, massive bubble. No one should have been buying stocks in the late nineties.

The Japanese dealt with this by attempting to wring the excesses out of their system coercively. The result was 15 years of anemic growth and a stock market that only goes down.

So, instead, we blew a bubble... We blew it at just the right time. As the original bubble fell apart around 2002 the new bubble, based on loose cash, took its place.

Below these bubbles the real economy still grows. In fact, because of the bubble, our real economy grew faster during this decade that it would have if they had just let the post millennial crash occur.

The idea is to run the bubble until the actual size of the economy catches up... They chose the moment to deflate it. They chose to raise the interest rates. They knew what would happen.

If 8,500 is a reasonable value for the DJIA in 2008 after years of bubble assisted growth, imagine how unreasonable it must have been in the late nineties. Imagine how unreasonable Dow 10,000 was.

Do we need another bubble? Maybe we don't. Maybe our valuations are now close enough to reality that we can simply proceed from here.

The only problem that we have right now is that I think the wizards that are running this process have lost control of the deflation. Its not happening as gracefully as they had hoped. This is a very dangerous time.