What caused the US stock market to spectacularly crash in 2008 is intimately connected to what caused the market to boom from 1980 to 2007. In broad terms, the long market boom, which took the Dow from 875 to over 14,000 at its peak in the fall of 2007, was the result of two interconnected forces: money creation and redistribution.
Economically, the great puzzle to solve is not why the market crashed, but why it performed so far above the rate of economic growth for so long. Why should the stock market, which is composed of nothing more than a broad section of corporations, on average perform any better than the overall rate of economic growth, upon which it surely rests?
Consider the following graph of the stock market and M3, the Federal Reserve’s broadest measure of money creation (M3 was discontinued in 2006, but the series is kept up by several different private economists). Notice that the performance of the stock market (as measured by the Dow) is far above the rate of productivity growth or the rate of real economic growth.
The fractional reserve nature of most modern banking systems means that money creation takes place in a decentralized manner; during this period, much of that money found its way into financial markets, in the form of leveraged buyouts, stock buybacks, and the effects of increasing leverage on the part of investment banks and the explosive growth of the highly-leveraged hedge fund industry. Much of this borrowing went to purchase equities, bidding up prices dramatically.
At the same time, the shifting balance of power between labor and capital made it possible for corporations to hold down wage growth, resulting in an unprecedented 20 year period of falling real wages in the US. This caused corporate profits to increase, along with share prices, as stockholders re-evaluated the new distribution of income between labor and capital.
The problem, of course, is that neither of these forces are sustainable. The share of income going to labor can fall, allowing the share that goes to profits to rise, but labor’s share cannot fall far without producing resistance. In the US, that resistance was weak, in part because of a new innovation: leverage for consumers. Unfortunately, the new kinds of consumer credit that were invented and eagerly used by US consumers were rarely used for any kind of investment, so debts mounted without an increase in income to pay them back.
As for money creation, it must eventually lead to inflation. No one can truly create wealth out of thin air, so when money is created far in excess of economic growth it must cause rising prices somewhere. If it causes rising consumer prices, we notice it and demand a solution, but if it causes rising stock prices, we celebrate it. But the money is not real, and the prices cannot last. At this point, it seems likely that the Dow will fall to 5500, which would give the Dow a traditional bear market dividend yield of 6%. Given the extent of money creation thus far, a strong possibility is that the Dow shows strong growth, perhaps rising above 10,000, or even above its record heights. While this may reassure investors, such an outcome would simply be the first manifestation of inflation that will not be confined to financial markets this time around.
No comments:
Post a Comment