18 Jun 2014

Is There a Reason For Stock Market to Be So High?

Conspiracy, Efficient Markets Hypothesis, Federal Reserve 55 Comments

ZeroHedge has an interesting post relaying an FT report that central banks and other government institutions around the world have invested $29.1 trillion in market investments such as equities and gold. The ZeroHedge article then gives this interesting chart:

World stock vs GDP

Analysts who reject “conspiracy theories” might tell a plausible story about the above chart along the lines of, “As the conventional outlook on economic growth slipped, central banks around the world announced more aggressive measures to boost growth. This showed investors that central bankers were less worried about [price] inflation, and so investors revised their long-term forecasts to include stronger real growth as well as higher [price] inflation. The result was higher spot prices of stocks.”

Yet notice that even this type of “non-conspiracy” explanation still shows that global stock markets are rising because of central bank policy, not because of a healthy economy. Anybody who comes to the table with the idea that printing money doesn’t generate lasting prosperity should conclude that the stock market is overvalued.

Does that mean it will crash next Tuesday? Of course not; if it did imply that the market would crash next Tuesday, then people would try to get out beforehand and the market already would have crashed (and our heads would explode because I just contradicted my premise).

The “rational expectations” worldview keeps you honest, as it were, but it doesn’t actually mean the guys at ZeroHedge (or here at this blog) are wrong when we say, the stock market is very vulnerable.

55 Responses to “Is There a Reason For Stock Market to Be So High?”

  1. Philippe says:

    Bob,

    do you think that the central banks can keep equity markets rising without the consent, or agreement, of private investors?

    • guest says:

      The short answer is “No”.

      But the only reason they’re consenting is because they don’t understand that rising paper money value does not equal rising wealth.

      This is what Peter Schiff was trying to get across to Art Laffer before the crash of 2007, in the following video (starts at about 01:25):

      Peter Schiff was Right (2006-2007 Edition)
      http://www.youtube.com/watch?v=sgRGBNekFIw

      [Art Laffer:] “What he’s saying is that savings is way down in this country, but wealth has risen dramatically. …”

      [Peter Schiff:] “… it’s not wealth that’s increased in the last few years: We haven’t increased our productive capacity. All that’s increased is the paper values of stocks and real estate. But that’s not real wealth, no more than the NASDAQ was wealth …”

      • guest says:

        Slight correction: “does not NECESSARILY equal rising wealth”.

      • Philippe says:

        “But the only reason they’re consenting is because they don’t understand that rising paper money value does not equal rising wealth”

        So you don’t think that the market is rational?

        • guest says:

          Maybe we need to do a better job at defining our terms:

          [Time stamped]
          Critics Say, “You Libertarians Are Soulless Materialists”
          [www]http://www.youtube.com/watch?v=eZGtcNcyyTI#t=6m59s

          He [Mises] never says that human beings are strictly logical. … The point is that people are still operating in a Means-Ends framework. That’s what he’s talking about when he says that they’re behaving rationally. … It does not invalidate anything Mises says that people sometimes behave illogically …

          Praxeology – Episode 5 – The Rationality of Action
          [www]http://www.youtube.com/watch?v=Nx_Rz0jDo80

          Action is always necessarily rational because an acting man is always aiming his action to satisfy some desire.

          So, when people *believe* that the paper they’re using is worth something, it is “rational” for them to make the connection that a rise in paper money values equals a rise in wealth.

          They are wrong about the relation between paper notes and wealth, but they *are* acting “rationally”.

          • Harold says:

            Indeed. Rothbard said ““Let us note that praxeology does not assume that a person’s choice of values or goals is wise or proper or that he has chosen the technologically correct method of reaching them.”

            Rothbard makes it clear that the origin and nature of the goal is not what we are talking about, only that there must be a goal in order for there to be action. It is possible that a persons values and goals fluctuate randomly or alter in any manner, logical or otherwise, and this would not contradict the claims of praxeology.

          • Major_Freedom says:

            guest, Philippe is onto a rather good point. It is not good enough to argue that “the” explanation is fully satsified by saying market actors continually make mistakes about money versus real wealth.

            You have to split the market up into inflation stages, similar to how Austrians do so with capital goods.

            Those financial institution who sell bonds to the Fed ARE gaining in the Austrian subjective value sense. That is why they trade. They value the money more than the bond(s).

            So far so good. Now, in order to reconcile this with your argument about “the market” conflating money with real wealth, you have to realize that the argument being made isn’t that market actors are continually conflating the two, because even a primary dealer who is fully versed in Austrian theory, would not necessarily be conflating money and real wealth by selling bonds to the Fed. They could understand the process completely and STILL sell the bonds anyway.

            Where the conflation of money and real wealth takes place is in the minds of SOME market actors who believe in the abstract argument that more money means more wealthier.

            And like the initial receivers of money, these people who are mistaken about the abstract argument of money versus wealth would ALSO be gaining if they sold whatever they sell, for money.

            The whole time everyone who sells X for money are doing what’s in their best interests. They are not “wrong” in this process. People who trade goods for money really do gain, or else they would not trade. Subsequent to that, new information may come about, that leads to regret or what have you.

            During euphoric stock market booms, not all, but there are some people throughout the stages of inflation who equate rising stock prices with rising wealth. Since a gain is a gain is a gain, even those investors who know better, would have an incentive to buy stocks and then sell them to “the bigger fool”, so to speak.

            The market cannot be argued as rational or irrational or anything else that has to do with human consciousness. The market is millions of individual actors behaving in accordance with private property ethics, that’s it. This process is not “smart”, or “dumb”, etc.

            Philippe is making the mistake of believing that to utilize concepts of human consciousness to describe markets, we have to believe a universal, single consciousness concept applies to it. But that is just confusion.

            • guest says:

              And like the initial receivers of money, these people who are mistaken about the abstract argument of money versus wealth would ALSO be gaining if they sold whatever they sell, for money.

              The whole time everyone who sells X for money are doing what’s in their best interests. They are not “wrong” in this process. People who trade goods for money really do gain, or else they would not trade.

              All true, but the gain is accomplished through fraud, is my point.

              If your competitors take advantage of artificially low interest rates, you’re going to want to do the same, even if you’re an Austrian who understands the fraud that’s taking place.

              The reason is because, through their politically acquired advantage, they will run you out of business.

              What other choice would you have, than to do what they’re doing?

      • bora says:

        come on, why did you link to that woman? Now I want to strangle someone or/and jump of the bridge. The amount of venom and feces she’s poured on Schiff is astounding and all of it in this fracking mother-like tone, while pretending to be oh so cool headed – ugh, childhood PTSD hits me..

    • Major_Freedom says:

      Philippe:

      “do you think that the central banks can keep equity markets rising without the consent, or agreement, of private investors?”

      Do you think dollars can remain in circulation as a generally accepted medium of exchange if the government stopped threatening people with kidnapping and time in a cage and likely sexually assaulted, i.e. stopped taxing people in dollars, stopped enforcing debt settlement in dollars through the courts, and only printed dollars and ASKED if people would like to hold them to store value?

      Do you think that people are using dollars completely because they believe paper notes are worth more for money purposes than all other possible commodities?

      • Philippe says:

        people don’t buy stocks so as to pay taxes, do they?

        • Major-Freedom says:

          People accept dollars out of habit, which Mises’ regression theorem explains.

          But this habit is nevertheless constrained to being forced to pay taxes in dollars, that is, even if a person chooses not to accept dollars by introducing his own unique habit, of say accepting only gold as a store of value and medium for his own exchanges, he would still be forced at gunpoint to pay “capital gains” taxes…in dollars. So he would be coerced into getting sucked back into the dollar system in that he would have to acquire dollars to pay taxes, and in order to acquire dollars, he has to accept dollars rather than only gold, in his exchanges.

          As long as people continue to use dollars out of habit, or custom, or national pride and statist faith and duty, then this coercive aspect of dollars is not manifested in outright physical aggression. But the threat is still there, just to nip things in the bud before it becomes a serious competition to the state toilet paper system.

  2. Jims says:

    How does inflation effect the stock market?

    Is the meddling of central banks in the market a sort of inflation, like easy credit or increase in money supply?

    Keep it simple for the amteur, please.

    • guest says:

      This might be what you’re looking for:

      SchiffReport: Schiff CNBC Squawk Box 6-13-06 [Flashback]
      http://beforeitsnews.com/gold-and-precious-metals/2014/05/schiffreport-schiff-cnbc-squawk-box-6-13-06-flashback-2589154.html

      Peter Schiff: “Let’s go back to the 1990′s. The Fed created a lot of inflation. What Americans did with their money, is they spent it on imported products, because America lacked the industrial capacity to produce those products ourselves. So money went abroad. That kept the lid on prices. But it didn’t end there. Foreigners, used those dollars, that we created to bid up U.S. stocks. They invested in our stock market. That produced rising stock prices that was inflation. When the stock market bubble burst, foreigners then recycled those dollars into the bond market, that produced a rise in bond prices,, it dropped interest rates, allowing Americans to bid up real estate prices. Americans then used their added home equity to borrow more money and send more dollars abroad which foreigners used to bid up natural resource prices that were necessary in the production process. So, rising stock prices, rising real estate prices, rising commodity prices are all a result of the inflation that the Fed has been creating.”

      • enough says:

        Schiff’s statement is historically inaccurate. The trade deficit fell during the 90s. The trade deficit started to grow after the dollar appreciated 30% on the trade weighted index. That happened because the IMF required developing countries to hold higher dollar reserves following the asian financial crisis. The trade deficit grew from 1.2% of GDP in 97 to 5% of GDP in 2005. That money (the resulting capital account surplus) was funneled into the housing market by Wall Street.

        • Major_Freedom says:

          Did Schiff say the deficit rose during the 1990s? Absolutely or relative to GDP?

    • tom says:

      Yancy touched on it below, but the general gist is that when the Fed buys bonds it is removing assets from circulation in exchange for $$$. The relative rate of assets to $$$ changes and you get higher prices of the remaining assets.

  3. Dean T. Sandin says:

    My thoughts, when someone like Scott Sumner says “the Fed said they are buying more assets with out-of-thin-air funny money and the stock market went up, therefore investors think the purchases are good for the economy” is always “or they are adjusting their prices to expected inflation”. When you give people a bunch of new money, maybe the things they tend to buy go up in price? I think this answers Philippe’s question above, and maybe Jims’s.

    • Philippe says:

      “When you give people a bunch of new money”

      But people have to sell things to the Fed to get that money.

      • Dean T. Sandin says:

        Please elaborate.

        • Philippe says:

          to get ‘a bunch of money’ from the Fed, you have to sell them stuff which is worth ‘a bunch of money’.

          • guest says:

            Does the Fed have to sell that person something that’s worth a lot of stuff?

            Because printing paper isn’t worth what they’re receiving. It’s paper [cloth].

          • tom says:

            This doubles the effect by pulling assets off the market and increasing dollars.

          • Dean T. Sandin says:

            Do you actually think increase the quantity of money has no effect on the price level? I assumed you were implying an argument, not just stating an obvious fact. By “elaborate” I meant “make your argument”.

            By buying financial assets and holding them, the Fed both reduces the quantity of assets available on the market (reducing supply), and increases the number of dollars available to buy them (increasing nominal demand). So the price goes up. I’m saying that the new money can be spent on other types of assets (stocks), and therefore the price of those goes up, too, relative to the things that these people buy less of in comparison to people who don’t buy and sell financial assets for a living.

          • Matt Tanous says:

            Not really. They have to sell something the Fed declares is worth that much. It could be absolutely worthless. If the Fed wanted to buy the gum off the bottom of my shoe for $1 billion, it could do that. It would just declare that a billion dollar piece of used gum.

      • Major_Freedom says:

        Which people? Not everyone.

  4. enough says:

    You need to learn some math. The stock index rose at a slower pace as expectations for growth fell. In other words, the index behaved exactly as you would expect. When growth expectations exceeded 3%, the stock index grew 22%. When growth expectations were below 2.9%, the stock market grew 11%.

    • tom says:

      Perhaps you should learn some finance. Stocks are an initial purchase cost, their value “should” be related to future expected returns. Lower future expected returns “should” mean a lower current price- not slower growth in prices.

      • Bob Murphy says:

        I think you guys are both making valid points, and the issue is timeframe. I.e. I think I could come up with an internally consistent model that exhibits the effect “enough” is describing, but of course I could also show what “tom” is talking about.

  5. Innocent says:

    How much of the stock market growth is attributable to the rise in GDP growth. In other words how much of production is now the mis- allocation of production due to expected rise in consumption due to ‘net worth’ rising once again?

  6. Gamble says:

    Steep tax rates force people to invest, often throwing caution to the wind. So long as you beat tax rates, you consider yourself a successful investor.

    • Scott H. says:

      I thought steep tax rates just took my money and impoverished me.. I didn’t know they also forced me to invest. And, I have never heard of anyone trying to beat their tax rate as an investment portfolio benchmark.

      • Gamble says:

        Steep taxes force us to save, invest and consume differently than we otherwise would.

        In your own words you said that steep taxes impoverish you. Why would you not want to make 1% more than impoverish?

        IT is not that you are trying to beat your tax rate. IT is that even a 1% gain is better than a 100% loss.

  7. Josiah says:

    What is the story that “conspiracy theorists” would tell about this chart?

    • Bob Murphy says:

      (A) The ZeroHedge take: That central banks and other government agencies are directly buying and manipulating stock prices.

      (B) That lizard people are going long on the S&P.

      • Josiah says:

        lizard people are going long on the S&P.

        I’ll buy that.

        • Major_Freedom says:

          ..for a dollar.

          Nyahhhhhh

      • skylien says:

        But isn’t Zero Hedge just reporting what the FT says?

  8. Yancey Ward says:

    The US government is slowing devolving into the monetization method of government finance.

    Philippe wrote:

    “When you give people a bunch of new money”
    But people have to sell things to the Fed to get that money.

    What has the Feb bought that will eventually be resold? The way I look at it, government bonds have been/are being removed entirely from the market of goods, services, and financial paper and replaced by dollar debits- in other words, more dollars chasing fewer buying opportunities. The rise in the prices of the things called “wealth” is not, and should not be a surprise.

    Now, if the Fed really does intend to shrink its balance sheet, the process will reverse itself. Thus I expect the Fed will never reduce its balance sheet over a period of more than 6 months to a year.

    • Raja says:

      Why do you believe the Fed ever needs to reduce its balance sheet? Most rational people are assuming that since Fed took those stocks, bonds and all kinds of assets on its balance sheet that it has to unload them. Just like the Fed doesn’t need money and can create it at will, so can it use that money and not worry about releasing those assets back into the market. I am not saying Fed wouldn’t want or like to eventually, but the way conditions are Fed isn’t retarded and knows probably that doing that would crumble the market itself. So the most logical conclusion is to keep it with the Fed and somewhere in the distant future unload that stuff or let it eventually reach maturity in case of bonds.

      Those who are talking about the fake wealth or paper wealth. They are in my opinion partially right. Lets look at this this way: If Bob believes the market is rigged and artificially being propped up and avoids it, while Raja being not so intelligent just is so excited by the rise in markets that he keeps buying stocks, the end result is that Raja might end up with a lot more paper wealth than Bob. That doesn’t dispute there are enough resources behind the paper wealth but it does mean that when Raja goes to buy that Ferrari he’s going to have enough funds to do that where as Bob might not. The only caveat is that Raja doesn’t continue to hold when the markets start dropping.

      When Peter Schiff talked about phony wealth he wasn’t talking about an individual. He was talking about the productivity of the country as a whole. The individual on the other hand has limited options in the face of monetary inflation and government intervention. The idea is to minimize the loss of principal and wealth and not get so bogged down in the theoretical aspect of it as to forget that the Fed intervention does create bubbles and these bubbles are lucrative for those who are not sitting on the sidelines waiting for that theoretical armageddon to take place.

    • Enopoletus Harding says:

      As of now, some 12-13% of Federal debt is held by the Federal Reserve.
      http://research.stlouisfed.org/fred2/graph/?g=DLJ

    • Gamble says:

      The Fed buys all the junk debt and mal investment.

      If the assets were valuable, nobody would ever go to the Fed, instead they would sale on the open market for a much higher price and the joy of freedom.

  9. Neil says:

    I do not think the stock market will come crashing down in nominal terms. In terms of gold and silver, however, I think it will. I see precious metals currently in the beginning stages of a long ascent into the stratosphere, finally reacting to five and a half years and counting of continuous ZIRP, in concert with the seemingly endless doses of QE, both unprecedented monetary maneuvers in American history. Mises said that further credit expansion buys time for policy makers, helping them to avoid an immediate crisis and push it into the future. They bought that time. But that time that they bought may now be expiring, and the chickens may finally be coming home to roost. Unfortunately for the policy makers, the consequences of delaying the crisis into the future are hyperinflation. That’s it. There is no other way to pay for their profiligacy now. They’ve unconciously made the choice to experience the crisis later, and now they will see their currency crumble. If you have the barbarous relic, you will sleep well when the others are howling.

    • Mike M says:

      Neil, I think you are spot on.

      The S&P in terms of gold peaked in 1999 dropping 89% in gold terms in 2011. It has since recovered some of that drop with loss to date in gold terms of 73%.

      Both the S&P and gold could double from present positions and in real terms you would be treading water. CNBS would tell you otherwise of course.

      Then again, if you don’t beleive gold is money, its just an academic excercise.

      • Cosmo Kramer says:

        Factoring in dividends, stocks are the clear way to go in the long run. P. metals shouldn’t be held long term.

        • Mike M says:

          That wasn’t the point. You’re conflating investment and money

          • Cosmo Kramer says:

            In real terms, you were better off investing in stocks for 100 years than the yellow metal. Cash being the worst decision of course.

    • Cosmo Kramer says:

      There will be no hyperinflation.

      • Mike M says:

        Thank you for the confident declaratory statement. You should be a Fed Governor

      • skylien says:

        Whatever, but there will be a wealth shock, this or that way.

      • Neil says:

        If there is no hyperinflation, then a very basic tenet of Misesian economic theory is false. I understand how hyperinflation in the U.S. may seem like an impossibility due to nothing more than our own normalcy bias. How could something so grand, so stable, so good, and so normal enter into a cycle of destruction? Emotionally, I must admit, I feel the same way. But intellectually, I must conclude that the profligacy of U.S. policy makers cannot simply be swept under the rug. Balance must eventually be restored. And when that balance is thrown completely out of whack with decades or centuries of irresponsible monetary and fiscal policy, the only way balance is restored is through absolute destruction. A forest fire is a great analogy of how the laws of nature occasionally require the total annihilation of something that is seemingly permanent.

        Why do I believe that the time is nigh for such a momentous event in our nation? The answer is simple. Look at monetary policy and you will see that we have reached its extremes. And not only have we reached them, but are stuck at them. Does it not make you wonder, when looking at the history of policy in this country, why ZIRP cannot be ended even after countless all time highs have been reached in the stock markets and those same markets have more than tripled in value since the bottom five years earlier? The gears of finance and banking are grinding, and are wearing down. The machine is smoking and the emergency lights are flashing, but we are still pushing full throttle. Eventually, it will blow up.

        Look on the bright side though. If we can manage to get out of this mess unscathed for the most part, and without hyperinflation, then we can probably all come to agree that Keynesianism really isn’t such a bad idea after all.

        • Cosmo Kramer says:

          Hyperinflation is a choice, not a certainty,

          • Anonymous says:

            Exactly. As I said, they have already made that choice by implementing policies to delay the crisis, even if was made unconsciously.

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