Stock markets are running out of fuel

The stock market deals in products that have exchange value but no use value. They are just paper receipts, some of which bring in a return. Not being used means these products can be bought and sold time and time again, indefinitely, except for mergers, acquisitions, buy-backs, bankruptcies, and the redemption of bonds at term. Having no use value makes them pure exchange value, which is determined partly by the rate of the return in dividends or interest, and more generally by supply and demand.

Demand has two basic forms. There are those in search of revenue, and there are those who bet that the price of the product they are buying will either rise or fall. The first are expecting an income, and will keep their acquisitions as long as it brings a return. The second are buying to sell, or selling to buy, over a short, sometimes very short, period of time. The first are investing in production or debt, while the second are speculating on a volatile market. The long term investor in search of an income depends on dividends or interest. The short term speculator in search of profit depends on prices moving up or down.

The dividends and interest paid out vary in absolute terms, because profits rise and fall and because the rate of interest on bonds emitted changes, and in relative terms, because the price of bonds and shares on the market is not constant. If 100 pays 2.5, that is 2.5%. But if the price goes up to 110, then 2.5 is only 2.27%. And if the price goes down to 90, then 2.5 is 2.78%. Dividends are a quota of profits, which can grow or shrink to nothing at short notice. This uncertainty means that when they do pay, they pay a higher rate than bonds. The medium term average price to earnings ratio has been around 16, which is about 6%. It has risen recently to almost 19, which is still over 5% and considerably higher than the interest paid by bonds (2%-3%). Considering that a yearly income of 10,000 needs an investment of 200,000 at 5%, or 500,000 at 2%, only millionaires can insure their retirement pensions.

A rise in the price of bonds and shares reduces their proportionate incomes. At some point these falling rates should discourage new investments and prices would fall back. Keynes estimated the limit to be 2%, below which investors would prefer to keep their cash. But that was a long time ago, when credit was still a minor actor. Nowadays a majority of payments are made with credit of some kind or another, and the stock market is no exception. In fact most nations have already spent two, three, or more years of their future incomes. And central bank policies of cash for debts and free credit (1) have reduced the supply of bonds, pushed up their prices and flooded the share market with easy money. It was a great party, but even the bottomless pockets of central banks ended up by feeling the political strain, and the effects on the productive economy were insignificant. Infrastructure was in disarray, productivity was stagnant, and gig employments were increasingly the only no-future prospects. So the party ended and the process is reversing in the US, while still continuing on a reduced scale in Japan and Europe. Now all eyes are on America. But the Federal Reserve’s reversal is incremental and slow. Interest rate increases are constantly postponed, and bond sales are small compared to those needed to fill the Treasury’s vast deficits. The party is over, but everyone is still hanging around wondering what to do next.

Prices on the stock markets move up and down. The upward movement is the result of more money going into the market and increasing demand. It is attenuated by more companies joining the market (initial public offers) and by bond issues, which increase supply. The downward movement is the result of money being withdrawn from the market and reducing demand. It can be attenuated by companies buying back their shares, and by central banks buying up bonds, which reduce supply. And both attenuations, if they are strong, can momentarily reverse the trend. However, the various flows of investments that make the trend must come from somewhere and go somewhere. These last few years, some of them were cash coming from quantitative easing and the trillions created by central banks. The rest was credit, notably corporations selling bonds to buy back shares. New money and free credit made the trend. Now both are running out of steam, and the upward movement they fuelled is beginning to turn down.

Since the low in 2008, there has been a huge increase in apparent wealth on the stock market, with no trickling down. As for growth in the production of wealth, it has barely kept up with population growth. Immense balloons of virtual riches are floating above the world’s stock markets and can no longer expand. Will they burst or just deflate slowly?

(1) Pierre Joseph Proudhon (1809-1865), the first to conceptualise anarchism, was a proponent of free credit for the workers, not the bankers.