Another round of wealth destruction

 

Stock markets are probably the best examples of how both supply and demand determine prices. Elsewhere, prices are influenced by numerous other factors such as government grants, transport costs, wages and patents, while demand is encouraged by credit. Demand on the stock exchange is also bolstered by credit, but supply has no production costs or sell-by dates, and depends entirely on whim or the possessor’s need of cash.

Stock indexes go up when demand is stronger than supply. This occurs when fresh money goes on the market and increases demand, while supply is reduced by shareholders waiting for prices to rise. Alternatively, indexes go down when supply is greater than demand. This occurs when the fresh money runs out, and when shareholders either need cash or decide that cash is a better guarantee of value than shares. Shares for cash or cash for shares are the two trends that make share prices rise or fall.

The easy money of tax cuts, repatriated profits and free credit has run out. Demand has weakened and that has pushed down share prices. And falling share prices signal that it is time to sell. As many shares do not pay a dividend, the only profit to be made is by speculating on their prices going up or down, by buying to sell at a higher price, or by selling to buy at a lower price. But both bets are self-realising, as buying pushes prices up and selling pushes them down. Right now, shareholders are in a selling mode and prices are falling. If this continues, it will encourage more selling and even lower prices. This coincidence of falling prices and companies publishing the last semester’s results, mostly up to expectations, has been explained by the prohibition of share buybacks during this period. If this is the case, buying will start again soon and prices will go back up. But it would also signify that share prices depend on company buybacks, that the only fresh money on the market comes from company profits and debts, and that companies are feeding the stock market instead of investing in production and increasing wages.

The stock market is where productive capital and financial capital meet. It is where wealth flows one way or the other. The classic model sees unspent incomes buying shares and bonds to allow industry and commerce to expand and increase production and sales. Financial capital becomes industrial and commercial capital. But the flow can apparently be reversed. When companies use profits and debts to buy back their shares, it is productive capital that becomes financial capital. Wealth is moving from industry and commerce to finance. And the financial sector has shown time and again that it is where wealth can be the most easily and abundantly destroyed.