The stock market isn’t the economy.
We say that all the time. It’s almost a cliché. And, in many respects, it’s true. Stocks are overwhelmingly concentrated in the hands of society’s richest. The further they run, the faster the perpetual motion machine spins, ballooning the wealth divide and driving an even bigger wedge between Wall Street and Main Street.
In the post-Lehman era, monetary policy (well-intentioned or not) turbocharged things, inflating the value of financial assets, and thereby the fortunes of those who control them. Those who control no assets (or relatively few assets) don’t participate in the bonanza, and because that’s the majority of society (figure below), we tend to draw a distinction between Wall Street (“stocks”) and Main Street (“the economy”).
On the other hand, there’s a sense in which the stock market is the economy. Literally. Notwithstanding the tendency for investors, both “professional” and otherwise, to treat equities as poker chips, they’re actually ownership stakes in businesses — claims on profits generated by the companies which comprise the economy.
Unfortunately, many large corporations long ago decided that investors are the only stakeholders who matter. Over time, corporate America has morphed into a shareholder wealth maximization engine that produces goods and services on the side. If you can turn a profit making widgets or soft drinks that’s great, but it’s just as well if you can leverage the balance sheet and employ financial engineering to inflate earnings (and equity-linked compensation) with buybacks. That dynamic distances corporations from Main Street.
That brief indictment is tangential, but it’s obligatory. The point here isn’t to castigate corporate America, but rather to briefly explore a pervasive case of cognitive dissonance that comes up again and again whenever the Fed looks poised to turn the screws on the casino. Jeremy Grantham’s latest apocalyptic missive (which I critiqued here last week) is a textbook example. Consider this passage from Grantham:
One of the main reasons I deplore superbubbles — and resent the Fed and other financial authorities for allowing and facilitating them — is the underrecognized damage that bubbles cause as they deflate and mark down our wealth. As bubbles form, they give us a ludicrously overstated view of our real wealth, which encourages us to spend accordingly. Then, as bubbles break, they crush most of those dreams and accelerate the negative economic forces on the way down.
Fair enough. I won’t argue with that. However, it doesn’t square particularly well with the following passage, from the very same piece by Grantham:
[T]o participate in the upside of an asset bubble you need to own some assets and the poorer quarter of the public owns almost nothing. The top 1%, in contrast, own more than one-third of all assets. And we can measure the rapid increase in inequality since 1997, which has left the US as the least equal of all rich countries and, even more shockingly, with the lowest level of economic mobility, even worse than that of the UK, at whom we used to laugh a few decades back for its social and economic rigidity. This increase in inequality directly subtracts from broad-based consumption because, on the margin, rich people getting richer will spend little to nothing of the increment where the poorest quartile would spend almost all of it.
I wouldn’t argue with that either. I continually fall into the very same trap as Grantham, the only difference being I’m intellectually honest about it and he, as far as I’ve ever been able to tell, isn’t.
If asset bubbles primarily benefit the wealthy (because that’s who owns the assets), and if it serves no real economic purpose to keep enriching the richest (because they have the lowest marginal propensity to consume), then good policy would be to deliberately prick asset bubbles. They (the bubbles) aren’t doing much good for the real economy and besides, deflating them would de-risk the system and reduce inequality.
But then what about the first passage from Grantham? It specifically references increased spending based on bubbles and says that when those bubbles eventually deflate, the result is “crushed dreams.” When Grantham says “spend accordingly” (in the first excerpted passage) he presumably means regular spending, not spending on yachts and Bentleys. And when he speaks of “crushed dreams,” surely he isn’t suggesting we should mourn the billionaire who, prior to a burst bubble, was worth $20 billion, but after the “wild rumpus” (the title of Grantham’s latest) is only worth $10 billion. Rather, he must mean the dreams of everyday people. And yet, in the very same piece, he said the worst thing about bubbles is that everyday people don’t participate in them!
This is a vexing quandary and, again, I do sympathize with Grantham because I have a difficult time reconciling these issues in my own writing. The truth, as it turns out, is that not all burst bubbles actually do affect regular people. Some bubbles deflate with virtually no impact on the real economy at all. That’s not me editorializing. It’s a fact. Real bubble historians (so, not self-appointed experts) have explored this issue systematically in academic papers and books, including “Boom And Bust,” by William Quinn and John Turner.
It would be helpful if we could predict, ahead of time, which prospective busts are likely to manifest in economic suffering for regular people (Main Street, as it were) and which are more likely to result in damage that’s confined to speculators and the rich (Wall Street, if you like).
In that regard, the figure (below) may be instructive. Or it may not. Whatever it is (or isn’t), it’s germane in the context of everything said above.
I suppose that chart speaks for itself, but just in case, BofA’s Michael Hartnett spoke for it.
“Main Street is more levered to Wall Street than ever before,” he said, in a note published late this week. “US financial assets are 6.3x the size of US GDP,” he added, calling that “the biggest picture.”
Somewhat ironically, then, the “quickest route to recession is a Wall Street crash,” as Hartnett put it.
Everyone is leveraged up because fiscal policy has been missing for 20 years. If you want to get rid of the asset ‘bubble’, you need to give people a chance to deleverage. Instead we’re gonna tell them to delever without doing anything to support the lives (i.e., the demand) they’ve built on cheap money.
The worst part is that a majority of congress is going to see this drama as a reason to break out the belt-tightening rhetoric again.
I would argue that this is by design and the desired outcome by the ideology that currently enraptures the Republican Party. Their underlying ethos is a baseline of nihilistic destruction as part establishing (or re-establishing) a highly stratified social caste system.
Everyone gets killed by a stock market crash. Housing crashes also, leaving millions underwater on their mortgages. State and local finances tank, leading to layoffs of public employees, including teachers. It’s true that the Fed encourages these bubbles, but I’d agree that they have little choice at this point but to do everything they can to keep the markets propped up.
I’m looking at Chart 2 and can’t help but believe my lying eyes
In the absence of pensions, workers are having to participate in markets to have a chance at relaxed retirement.
With interest rates perpetually low it is impossible to build wealth by saving. This is the driver for bubble finance. In the last two bubbles housing was a major participant. Housing is the most sought after asset by main street economy participants. I would argue that maybe in the past bubbles like dot com didn’t impact them but going forward I would expect housing to be a player in all bubbles as are vehicles. This means everyone is harmed by bubble finance. Additionally, working class citizens are also harmed by the ancillary layoffs that follow bubbles. Whenever they do deflate cutting jobs and benefits always follows leaving those with underwater homes and cars without income. This actually exacerbates the bubble deflation. With no worker protections and no retirement benefits, the rich keep their assets while the poor try to start over again.
Bubble finance is a known entity. We also know that the are created and destroyed by Fed policy now. In my mind there is no better metric to drive your investment thesis than what the Fed is currently doing. If they are in QE then buy anything, it all goes up. If they are in QT get on the sidelines and wait.
While it’s acknowledged that rich people don’t spend money. They actually do spend some on campaign finance. This has absolutely benefited the Republicans most. It’s why they are in love with any government action that benefits the rich. They are intentionally enabling the wealthy to gain more power in the wealth spectrum because it means more money to invest in campaigning and probably some side money personally.
The economy, including the ‘market’ is a complex system with lots of forces in play. As H points out time and again, the folks who are supposed to analyze it, the economists, still don’t understand how the thing really works. Push on it here, or here, and what happens. No one quite knows for sure.
The Fed has no certainty of how their actions will exactly impact such a complex dynamic – aim, shoot and pray. It should go without saying that if there was a straightforward way for the Fed to ‘fix’ the whole mess they would have done it a long time ago. I’m not sure this is a good analogy, but it occurs to me it’s like a steam ship with a coal boiler. The Fed is the guy who shovels the coal, but doesn’t have control over course, steering, navigation, weather and whatever else might affect the ship.
I can’t shake the idea that the market is the economy, or at least a good proxy. That’s not to say it isn’t a tangled mess. Who owns the market is a separate issue. Market ownership is a straightforward reflection of the unequal distribution of wealth.