In a complex juncture where few wise people “read” the real facts of economies, it is time to face structural questions:
- How is real wealth produced?
- What is its relationship with profits from the financial markets?
- How can we distinguish “bubbles” from real growth?
Many people believe – and on the surface they are not wrong – that a general increase in stock prices is an important factor in the strength of an economy. However, this is an arguable observation – even though all the mainstream financial news outlets are pushing it.
The view that the stock market drives economic growth comes from the empirical observation that changes in stock prices are a “beacon” of developments in economic data.
A study by Frank Shostak partner at the Mises Institute points out that various economic indicators are influenced, to a large extent, by the money supply, which also affects stock prices – that is, the artificial money supply produces “values” that have no real relationship with the production of wealth.
It is known that price is the amount of money demanded per unit of a good or service and is formed by the set of choices of those participating in a market. When an increased money supply enters a market, more money is spent on those goods, which means their prices will tend to rise – see inflation in some cases.
Furthermore, when the money supply increases, it is not immediately channeled into all markets. Instead, it moves from one market to another with time lags. Additionally, the time lag for changes in stock prices is shorter than the time lag for changes in the money supply and economic activity. That is, while the market is measured by the climate or what they call the psychology of the crowd with regard to the current economic cycle, in the real economy the productive structures are transformed at different rates and rules.
The stock market does not drive the economy
Consequently, after a time lag, the effect of changes in the money supply manifests itself first in changes in stock prices even before transformations in economic activity occur. Therefore, given this situation, the common belief is that the stock market drives the economy. If, however, the time lag of liquidity flow was shorter than developments in real economic activity versus stock prices, then one can conclude that the economy drives the stock market rather than the other way around.
Obviously, the observation does not explain the actual processes of wealth production. Despite the observation that changes in the stock market lead to changes in the economy it does not mean that the stock market drives economic activity.
- Can the rise in investor optimism due to stock price increases cause them to rally further in a herd behavior – is this the formation of a self-perpetuating price formation system?
If the money supply does not increase, a rise in stock prices will divert liquidity to them from other assets, thereby pushing the price dynamics of other assets lower.
- Could rising stock prices facilitate boosting economic growth?
For this to happen, increases in stock prices must cause an expansion of the economy’s capital base – real investment that will strengthen the productive base – which would allow the production of goods and services to increase.
According to Ludwig von Mises in his book Human Action, “Stock market speculation cannot undo past actions and can change nothing about the limited convertibility of existing capital goods (ie into real values) ». Namely, investments in a money market tell us little about the real strength of the economy and its growth dynamics.
Saving vs consumption
Therefore, when economists claim that a particular factor is important in driving economic growth, one must consider the relationship of that factor to the savings pool. In other words, it is about the capitalistic connection of production activity with consumption in the context of the capitalist mode of production – because otherwise we talk about “bubbles”.
- Does the factor support or undermine saving?
Following this reasoning, we can suggest that a rising stock market does not expand the savings pool and therefore cannot generate positive economic growth.
- What about the view that a stronger stock market makes people more optimistic about the future?
This, in turn, is believed to boost demand for goods and services and economic growth.
Optimism is not enough
It is not the psychological disposition of individuals that determines whether their demand can be met, but whether they possess a sufficient amount of means. One may be very optimistic about the future, but without adequate means, one cannot obtain the goods one desires – despite the intensity of one’s desire for something. Improved psychology can do very little to boost economic growth without the support of saving.
Furthermore, central bank monetary policies undermine the savings pool, which, in turn, will undermine wealth creation and real economic growth. Despite the popular view that an increase in the money supply accelerates economic growth, money alone cannot do this. More money cannot replace savings, and anything that depletes savings undermines economic growth.
Real money and economic cycles
According to Richard von Strigl in his book Capital and Production, suppose that in some country the productive activity has to be completely rebuilt.
The only factors of production available to the population apart from labor are those provided by nature. Now, if production is to take place within a cycle, say of the duration of a year, then it is self-evident that production can only begin if, in addition to these initial factors of production, there is available a subsistence fund for the population—real i.e. resources – which will provide his food and every other need for a year.
The larger this fund, the greater the cyclical factor of production that can be undertaken and the greater the output will be. It is clear that under these conditions the “correct” length of the roundabout production method is determined by the size of the subsistence fund or the period of time for which this fund is sufficient – the primary accumulation of real material resources for the need of metabolism with nature.
Increase in stock prices and wealth
Some economists believe that rising stock market prices due to easy money policies by central banks increases wealth. This increase in wealth then helps stimulate overall spending in the economy, which, in turn, is supposed to expand the overall output of goods and services.
However, increases in stock prices due to loose monetary policies cannot increase real wealth in the economy. Conversely, accommodative monetary policy weakens the wealth creation process by depleting the savings pool. When these policies increase the money supply, they set in motion an exchange of “nothing for something,” diverting wealth producers to non-wealth-producing activities.
Central Bank policies and investor mistakes
Historically, the market has chosen stable values such as gold, and in the absence of central banks, an increase in stock prices will reflect an increase in the pool of savings and lead to economic growth. It should be noted, however, that the increase in economic growth is not due to higher stock prices but to increased savings.
The monkey – investment advisor
This is not the case with the current rise in stock prices.
The emergence of bull-bear markets in the current monetary system is a response to central bank monetary policies that jeopardize the virtuous cycle of economic growth
Any monetary policy, whether accommodative or tight, is bad news for the savings creation process – the accumulation of which is a key process for wealth creation.
Central bank policies hinder investors’ ability to distinguish wealth-producing activities from unproductive ones, creating financial bubbles and leading to faulty investment decisions.
Unable to identify real wealth producers, investors become gamblers with the stock market acting as a casino.
Economic theories such as the efficient market hypothesis—that the market internally produces the optimal outcome for its participants—argue that it is futile for investors to attempt to identify wealth producers versus non-producers.
In fact, Burton Malkiel, one of the pioneers of the efficient market hypothesis, has even suggested: “A blindfolded monkey throwing darts in the financial pages of a newspaper could choose a portfolio that would perform just as well as a carefully selected by an expert’. That is, Casino Capitalism.
Although popular wisdom holds that a bullish stock market increases economic growth, that is debatable. Without improving the capital infrastructure, regardless of the state of the stock market, it is not possible to strengthen the real economy and the wealth produced.
The disruptive fluctuations of the stock market characterized as bull / bear markets are the result of the monetary policies of the central bank. These policies undermine the savings creation process and turn the stock market into something akin to a casino.
