Wall Street, we have a situation. We’re accelerating to the outer limits and about to crash into Ursa Major, and no-one can find the brake pedal.’ But no-one in ground control seems worried as equities accelerate into infinity.
The US equities market, roaring and soaring with no visible means of support, seems to be a perpetual motion machine. But there is no such thing. Some scientists have decided that the miracles of quantum electrodynamics and cosmology allow the universe to carry on expanding forever after the Big Bang, and investors are acting as if equities can do the same. But in the real world, what is chalked up on the asset side of your account must be marked in the debit side somewhere else. This is not an SEC recommendation: it’s the law of the universe.
So what cosmological constant fuels the seeming perpetual bull machine? Where is all this shareholder value coming from? In March the US chalked up its biggest ever trade deficit, so it’s certainly not overseas earnings pouring into the economy. Wages and salaries for most Americans are pretty much static. Any increase is far below that of the equities market. Corporate incomes, productivity – all the usual economic indicators – have been rising, but nowhere near as much as the Dow.
Most commentators assume that the flood of savings from millions of baby-boomers and others who want to ensure a comfortable retirement is what is expanding the universe. If they could buy perpetual youth, a lot of them would invest in that as well. But, alas, Ponce De Leon’s search for the fountain of youth discovered Florida instead, the land of perpetual retirement and insured CDs. The land of the ever-bloating Dow may be equally illusory.
If the stock markets were performing the functions that classical economics ascribes to them, this flood of money would be happily irrigating a massive burgeoning in plant and infrastructure. US growth rates in industry and commerce would be reaching new heights, instead of trickling along at a piddling 2.3 percent this decade – less than Germany.
Instead, most major corporations, far from raising money for investment, have money to burn – or at least to buy back shares and thus fuel the inflationary furnace of equities. Last year, US companies bought back $179 bn in shares, while only issuing $100 bn in new stock, which means that, even before dividends and interest, Wall Street is taking money out of enterprises, not putting it in.
So what is the value of a share? Normally it is assumed to be whatever monetary price it trades at. However, that only applies to the individual shares that are traded. The stocks that are not sold are deemed to have the value of those that are. Even if they are sold, the cash is immediately exchanged for similarly inflated shares, with neither case really tested against the real world.
In 1637 the Dutch Tulip bubble burst, when people who had mortgaged the farm to buy a better bulb suddenly found no-one to buy the resulting tulip. The purpose of the transactions was to re-sell at a profit, regardless of whether the tulip was in itself producing enough real wealth to justify the price. It’s the difference between investment and speculation.
When it comes to the real value, the question is how much would a predatory Klingon investor pay for the tulip (or the share of stock). When the price depends on fresh purchasers coming in, you have an economic bubble waiting to be pricked, a sort of spontaneous pyramid-selling scheme. All of that paper value exists until a significant number decide to cash in their chips around the same time, and precipitate the mother of all corrections, when the dopplerized expansion shifts into the red on the brokerage account. Just think of an interest rate rise.
Trekkies remember that black holes suck in energy, matter, everything. It’s been suggested that eventually, a black hole collapses in on itself, and pinches off from this universe to form another. Maybe that’s what will happen to the stock market. Certainly, all those paper profits may as well be in another universe for all their accessibility to investors.
The good news about the discontinuum between the equities market and the real economy is that with sound macroeconomic management, even a catastrophic crash need not affect most people, or even industry. Will industry become less efficient as the value of executive stock options plummets? I doubt it. No-one will want to jump into the career vacuum outside, even accepting the highly questionable theory that those options have done anything at all to boost productivity.
Some consumers will find that they were not as rich as they thought. And those who have bet their space suits are going to get as cold as the intergalactic hydrogen. The ones who are most vulnerable are of course those who are last in: they will probably be last out and worst off. I just hope that broker Scotty can beam us nice small guys out before we hit the black hole lurking in the Great Bear.
The Speculator
