Home > Uncategorized > Quick thoughts on the stock market and the economy

Quick thoughts on the stock market and the economy

from Dean Baker

We are seeing the usual hysteria over the sharp drop in the markets in Asia, Europe, and perhaps the U.S. (Wall Street seems to be rallying as I write.) There are a few items worth noting as we enjoy the panic.

First and most importantly, the stock market is not the economy. The stock market has fluctuations all the time that have nothing to do with the real economy. The most famous was the 1987 crash which did not correspond to any real world bad event that anyone could identify.

Even over longer periods there is no direct correlation between the stock market and GDP. In the decade of the 1970s the stock market lost more than 40 percent of its value in real terms, in the decade of the 1980s it more than doubled. GDP growth averaged 3.3 percent from 1980 to 1990 compared to 3.2 percent from 1970 to 1980.

Apart from its erratic movements, the stock market is not even in principle supposed to be a measure of economic activity. It is supposed to represent the present value of future profits. This means that if people are expecting the economy to slowdown, but also expect a big shift in income from wages to profits, then we should expect to see the market rise. So there is no sense in treating the stock market as a gauge of economic activity, it isn’t.

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  1. August 26, 2015 at 1:28 pm

    There’s a problem with this:

    “Apart from its erratic movements, the stock market is not even in principle supposed to be a measure of economic activity. It is supposed to represent the present value of future profits. This means that if people are expecting the economy to slowdown, but also expect a big shift in income from wages to profits, then we should expect to see the market rise. So there is no sense in treating the stock market as a gauge of economic activity, it isn’t.”

    If this is true then the stock market is a measure of economic activity.

    Profits = Investment + Dividends – Household Saving + Government Deficit + Net Exports

    Therefore profits is a pretty good measure of economic activity. And so if the stock market reflects this it is also a good measure of future activity.

    Unfortunately the stock markets does not reflect this. But that is an entirely different issue.

    As for the recent decline, I find it very hard to believe this is not being caused by a major bubble bursting in the world’s second biggest economy.

  2. graccibros
    August 26, 2015 at 1:44 pm

    Really, Dean? You can’t see the connection between the Chinese financial market’s panic and what is laid out here by an Indian economist http://www.nakedcapitalism.com/2015/08/chinas-stock-market-collapse.html : a slowing manufacturing sector with too little internal demand, and flat or declining external demand, depressed commodity markets around the world, and the bursting of a real estate bubble and the absolutely irresponsible attempt over the past year to “make it all good again” by sending the average Chinese with a little savings to borrow/leverage to go into stocks? In that sense, you ought to see here a reflection of your own early analysis of America’s real estate bubble rise and burst, and add in the underlying structural difficulties plus a financial bubble, the latter being totally artificial and shocking, just looking at charts, to any observer, Ph.D or not. That alone would be grounds for worry about China’s further ability to manage. I repeat: no great economic power has transitioned from ag through an industrial revolution in the 19th-20th century without undergoing a major financial/economic crisis…China has been the exception: about to prove the rule?

    For once, I agree with Larry Summers based on what I saw yesterday morning on CNBC: a man who looked like he had been awakened in the middle of a bad dream, speaking as if every word and analogy he used might tip markets further into despair, while at the same time, speaking again as if walking a minefield, clearly stating that the possibilities were there for major trouble.

    You may be right in that much of the crazy swings on Wall Street over the past week are in Robert Schiller’s territory for explanations, and that there is not always close correspondence between underlying real economy troubles and finance, but Chinese financial markets, as ours did in 2007-2008 are recording recognition of real economy structural troubles, and I think China is having some of the same problems that the US did in the 1920’s-1930’s: fully moving from ag to industry, from a savings driven model to a domestic consumption model, troubles heightened by their extraordinary export model…

    Add in the fact that the integration of world markets probably has intensified since 2007-2008. Remember the sequence everyone one: the first signs of trouble in August 2007 were in hedge funds linked to real estate derivatives; then Bear Stearns and not until the fall of 2008 Lehman Brothers and the real dawning…As yet we have not heard that others beside China’s financial markets are frozen, and there is no mention of any particular casualty where leverage and speculation have come to roost as in LTCM in 1997-1998, or BS or Lehman Bros…much less AIG…but it’s hard to believe that they won’t be out there…some have thought it might be in highly leveraged oil and gas fracking ventures…

    It far too early too tell the degree of difficulty we may experience, but I’m with Summers, not Dean on the potential, and China is there already, that I am confident on…how potent will be their contagion effect and other’s dependency on them? From what I read, money is fleeing China in substantial amounts, despite capital flow laws, the nature of Chinese business ties in Hong Kong, Taiwan, Singapore mean it can still leak like a sieve…another sign that those closest to the underlying structures know there is real trouble, not just financial demons.

  3. BC
    August 26, 2015 at 4:30 pm

    “First and most importantly, the stock market is not the economy.”

    This is demonstrably false for the US, and arguably rather naive. The US economy has become so hyper-financialized that total net flows to the financial sector (and its top 0.001-1% principal owners) equal total annual output of the economy. Therefore, after net flows to the financialized sectors, the US economy cannot grow in real terms per capita. As well, if net flows to the financialized sectors cease growing or contract, “the economy” does likewise.

    QE, ZIRP, and NIRP only exacerbates hyper-financialization, which in turn worsens wealth and income inequality and its pernicious effects.


    Moreover, household net worth is contracting at similar rate as in 2008, 2001, 1981, and 1974, all of which were the onset of recessions and bear markets for equities. A bear market for equities will exacerbate the YoY contraction in household net worth.


    Finally, with “health” (“illth”) care at 18-19% of GDP (and 51% equivalent of private wages), the differential growth of spending for “health” care as a share of PCE per capita is at the same rate as 2008 and 2001, i.e., recessions.

    Thus, it should be no surprise, then, why retail sales ex autos are growing at the slowest 3- and 6-month average YoY rates since the onset of recession in 2008. The bottom 80-90% of US households have no discretionary disposable income.

    The stock market has only recently begun to reflect the emerging recession-like conditions, as the stock market has become a “lagging” indicators since the late 1990s (when hyper-financialization commenced with the Dotcom bubble) rather than a leading indicator as is still widely believed.

    Therefore, contrary to Baker’s assertion, the stock market has become “the economy”, which thus allows the Fed, TBTE banks, and Wall St. to use the stock market to hold hostage gov’t policy and “the economy”.

  4. graccibros
    August 26, 2015 at 6:02 pm

    Thanks BC. This is usually Dean Baker’s strength: looking closely at some key historical data to measure the contemporary.. So Dean, which ones are feeding your” don’t worry, we’re ok sense”?

    BC: can you tell us more about that sharp descent in the grey line, about the composition of the St. Louis Fed’s real personal expenditures formulation…just two key components…? is that enough?

    As to the real estate market in the US, it has been touted as one of the strong points by ” we’re ok talking points”; but there is a Chinese “flight to safety” component mixing the economic fears with fear of political persecution…here from the “Wolf.” I don’t want to oversell it, the magnitude is 10-20% in selected upscale markets:


    And now let’s look at Yanis Varoufakis’ data from the Global Minotaur, on China’s decline in domestic demand: he’s focused on the tension between too much investment vs. too little spending…the trends were clear at the time he broke off for publication in 2011…and let’s not forget that the trigger for the Friday “fire in the theater” alarms came from a Chinese manufacturing decline, a big one…that’s pretty hard data for a very important sector…seems like a level head would think twice about keeping their money swimming against that current…


  5. BC
    August 26, 2015 at 7:22 pm

    gracci, thanks for the questions.

    The health care/final sales graph was just to show that real final sales is decelerating while health care is accelerating, which is typical during recession and reflective of the disproportionate effect of health care costs vs. final sales, income, and spending.

    As for the Chinese effect on (un)real estate prices, clearly it is a factor. I have personal anecdotal evidence of the phenomenon occurring in various metro areas on the Left Coast.

    I estimate that China’s real GDP per capita is no faster than ~2%, driven largely by wage gains and household spending, whereas exports, production, and productive, profitable investment are taking a large bite out of GDP.

    China’s labor force has been contracting for three years running. Labor costs have been rising and production weak or contracting, resulting in productivity of no more than 1%. Therefore, at a population growth rate of 0.5%, China’s potential real GDP per capita by definition is less than 1% and close to 0%, which is the average post-2007 trend rate for the US, EZ, and Japan.

    With Brazil, Russia, and Canada in recession, and Oz on its way there, 70-75% of the world economy is at no faster than “stall speed” and likely already in recession, which is reflected by no growth for global trade in real terms per capita.

    Thus, the commodity price crash and incipient bear markets for junk bonds and equities are unambiguous indications of another global debt-deflationary recession underway (the second of the Long Wave debt-deflationary regime of “secular stagnation”).

    Not only will the Fed not raise rates, they will rather more likely resume QEternity, perhaps as soon as later this year.

  6. August 26, 2015 at 8:04 pm

    Quick rethinking of the stock market
    Comment on ‘Quick thoughts on the stock market and the economy’

    The monetary order, banking, and the stock market are institutions that evolved historically. Like in biological evolution the outcome of this messy process is often suboptimal. Institutions can and must be designed and constructed. The U.S. is particularly bad at institution building.

    Mortgage financing, for example, is a very old and rather simple business. In Germany it was institutionalized in 1900 with the Mortgage Banking Act. This law was so well-crafted that it worked with minor modifications until 2005 when it was abolished in an act of institutional suicide. This was when deregulation was the hype of the day, which lasted until Wall Street’s meltdown. This financial mega crash first of all showed one thing: what happens when you do mortgage banking the American way.

    Remember that the investment banks literally invented and pushed subprime lending and the derivatives superstructure. No classical mortgage banker, neither in Germany nor in France, would ever have touched this type of business. It is important to realize that after 1900 there has never been a real estate boom-bust cycle in Germany. That is quite remarkable when one considers that Japan, the U.S., Britain, Spain and many other economies have been badly devastated by real estate busts.

    Interim results: (i) financial crises are the result of a bad institutional design, (ii) the U.S. is particularly untalented at institution building, (iii) in the international arena, according to a variant of Gresham’s Law, bad institutions crowd good institutions out, (iv) without well-crafted counter-measures the financial superstructure quite naturally deteriorates and becomes a menace to the real economy.

    Therefore, the question is not: does the stock market have an effect on the real economy? but: should the stock market be allowed to have such an effect in the first place? Or, even more fundamental, is a stock market needed at all or can its useful functions be taken over by a better designed institution and its negative impacts thereby eliminated?

    The stock market wrecked the U.S. economy in the 1930s and in 2008. This is sufficient proof of a dilettantish institutional design of the financial sector including the central bank. For China the fundamental question is whether she needs a stock market at all. It should not be impossible for the Chinese economists to come up with a superior institutional design that shields the real economy from dysfunctional international shifts between liquidity, stocks, and bonds.

    With a plan-B in place, China could let equities crash, buy the rest cheap, close the stock market, regain her full financial sovereignty, and live happy thereafter.

    Rethinking economic theory is indispensable because neither Walrasians nor Keynesians have found out until this day how the market system works.

    Egmont Kakarot-Handtke

  7. BC
    August 26, 2015 at 10:10 pm

    Egmont, well said, but I would argue that financial crises are the nature of capitalism, that is to say, the necessity of exponential growth of credit/money supply, profits, and capital accumulation versus the sustainable growth of profitable extraction of low-entropy resources and the resulting growth of high-entropy value-added output per capita.

    Credit/money supply and population can conceivably grow at an exponential rate, whereas the profitable growth of extraction of resources, investment, production, and profits, including debt service, is constrained at a thermodynamic/energetic/exergetic log-limit bound per capita at a local or regional scale, and terminally on a finite, spherical planet.

    Consequently, since the onset of Peak Oil in 2005-08 (world oil production per capita is at the level of 2004-05), the world has reached the thermodynamic/energetic/exergetic log-limit bound per capita for growth on a finite, spherical planet, i.e., “Limits to Growth”.

    The stock market historically has been a wealth-transfer mechanism from labor, profits, and capacity of gov’t to provide social goods to the rentier top 0.001-1% who already own a disproportionately large share of financial assets RATHER THAN a wealth-creating mechanism. Each time market capitalization and wealth and income concentration has reached current levels as a share of GDP and earned income/labor share, i.e., 1820s-30s (“Era of Good Feelings”), 1880s-90s (“Gilded Age”), and the 1920s (“Roaring Twenties”), there was a debt-deflationary depression and a protracted era of decelerating real GDP per capita.

    As George Brockway (“End of Economic Man”) noted over twenty years ago, a stock market boom/bubble should not be perceived as a positive development but the contrary, as historically the prosperity coinciding with the phenomenon proved to be illusory and a precursor to financial crises, economic depressions, social instability, gov’t/political reaction, and war and mass destruction.

    The stock market is a zero-sum situation, concentrating financial wealth to those who already have a disproportionate share of financial wealth and thus the rentier claims imposed by the associated debt to wages and GDP become a structural drag on economic activity until the debt is deflated and labor share begins to increase.

    China’s historical precedent since the late 18th century has been to open up to western capitalists about once a lifetime, experience capital inflows, exploitation, co-opting of elites, bubbles, and then the inevitable financial and economic crises that create economic dislocation and hardship, social unrest, and then gov’t reaction and turning inward from the rest of the world for a generation or longer. In fact, this pattern has recurred four times since the late 18th century, including the White Lotus Rebellion, Opium Wars, Boxer Rebellion, and Mao’s civil war and revolution.

    Thus, China and the world is due yet another crisis in the Middle Kingdom and within her “sphere of influence”, social unrest, gov’t reaction, potential war with the West and allies in the Pacific, Central Asia, Africa, and parts of the western hemisphere, and then a forced turning inward from the rest of the world to deal with increasing domestic crises, and even a 1930s-like deflationary collapse and takeover by the emerging generation of PLA generals in Beijing.

    WRT institutions, social classes, and the historical evolution of capitalism, Schumpeter had something worthy to say in the context of imperialism, of which no doubt you are aware.

  8. August 27, 2015 at 10:37 am

    The heterodox perspective becomes dominant
    Comment BC on ‘Quick thoughts on the stock market and the economy’

    I agree with your analysis. My perspective, however is different. You say financial crises are the nature of capitalism. The Nature-argument implies — intentionally or unintentionally — that things have to be accepted as given like the law of gravity. This, however, is not true for institutions like the financial sector of any regional/national economy.

    We know that orthodox economics is a scientific failure. Therefore, the familiar explanations of how the economy works cannot be taken at face value. Heterodoxy has to do better. This implies that we do not ask: does the stock market work as the efficient market hypothesis assumes? but: do we need a stock market? And if so, how can we make sure that it functions without negative externalities?

    As you say, the market economy can only exist as growing economy. On the other hand, it cannot grow much longer. The core problem is how to achieve the transition to a stationary or even shrinking economy without a self-reinforcing downward spiral. This is the actual situation of China, but under the broader perspective this is the situation of the world economy.

    Neither Walrasian nor Keynesian theory can deal with the situation. My point is: we have a lot of good descriptions of what goes on in the world economy — and yours is one of it — but we still lack a comprehensive theory that includes some ideas for a soft transition of the world economy after expansion has run its course.

    China’s chance is that it invents the new sustainable economic order and the appropriate institutions. This presupposes to rethink theoretical economics from the ground up. Hence, Chinese economists are by nature Heterodox. Why are we still discussing local pseudo-issues like DSGE, rational expectations, Lucas’s mathiness, or McCloskey’s silliness. That has become rather boring, to say the least.

    Egmont Kakarot-Handtke

    • August 27, 2015 at 1:03 pm

      I am not an economist, but to me the statement ‘a market economy can exist only as a growing economy’ sounds like its making a statement like a physicial law, like the law of gravity. Possibly that is true.

      Its also possible that only market economies eventually will exist—sort of an inevitable evolution as some think about cosmology and biology: the big bang, infations, emergence of forms of matter, stars and planets, etc. or fish to monkees to humans. Others don’t think that is inevitable (and maybe in other universes there are entirely different sequences—martians, not humans).

      “Market economy’, like ‘capitalism’, seems ill defined—there are many I have seen in the literature.

      While it is common for people to make that standard claim (naomi klein…) others such as Proudhon , mutualists, market anarchists, cooperativists, market socialists, syndicalists etc. might or would say one can have a market economy which grows, is static, or shrinks. It all depends on human choices—how they use the market.

      It may be that actually people do not use the market—the market uses them, and it wants to grow. But that is at best a hypothesis, not a law or fact.

      To me a market is basically a tool or mechanism—-humans use it to exchange, or buy and sell things. It can be a farmer’s market, street market, corner market or the stock market. (Also, to me China is more or less following a variant of standard capitalist devlopment—though more of the pre-industrial revolution model because of history. Its state capitalism.Robber barons, lots of growth, depressions…)

  9. graccibros
    August 27, 2015 at 1:04 pm


    It seems we’ve reached the same conclusion: China has exhausted Keynesianism conventional infrastructure spending as the means to keep the downturn, which is structural, from deepening, and the attempt to use the stock market as a “remedy” (or even a diversion) looks like it has failed as well…so how else can China keep its people employed with useful tasks (since it does not have a deficit/debt problem as far as I can see with all its deployable reserves built up over the years – maybe Austerians have a very different take on this)?

    Of course the “logical” answer from my distance and perspective is to throw itself into solving the nation’s horrendous environmental problems, especially global warming, but also air and water and soil pollution. I know certain Chinese academics would be receptive, but it doesn’t look like this pathway is on any of the other policy makers’ “menu.” No more than Syriza’s in Greece. Instead they’re going to deploy tools selected out of the US Fed’s and Japan’s tool kit…whose efficacy is increasingly in doubt, even more so since China is at a very different place in “capitalist evolution…” …maybe, as I have previously suggested, undergoing a fundamental transition crisis as well as a more conventional “slowdown.”

  10. graccibros
    August 27, 2015 at 1:19 pm

    Wanted to mention this as a general comment to all here: has anyone else noticed the lack of commentary – relative to what has been going on – at Naked Capitalism, and also from Nouriel Roubini…strikes me as rather strange. Roubini’s been talking about a China slowdown for years… is he consulting with them and taking himself out of his usual role?

    And of course it’s August, vacation time, but Yves usually has a system of delegation…

  11. graccibros
    August 27, 2015 at 2:23 pm

    I found this interesting analysis by Roubini from the end of May, 2015, here:


    It is silent on the China causes, on the fundamentals in economic structure that may be behind the market volatility he talks about: his conclusion: the new market technologies in trading (Flash Boys!) plus the new boxes created for traders by the regulatory responses to the 2007-2008 crisis make a larger crash possible.

    I see something else dated August 26, 2015, “more turbulence, no free-fall” is the gist, but the Roubini piece is reserved for “subcribers.”

  12. August 27, 2015 at 4:45 pm

    Pygmy economics
    Comment on graccibros and Ishi Crew on ‘Quick thoughts on the stock market and the economy’

    (i) I think your perspective is wrong. The issue is not about fixing the Chinese stock market by kicking out some Flash Boys. That is Roubini pygmy economics. What is needed is to find out what financial institutions China needs for the transition to a full-employment economic future in a stationary world economy. My hypothesis is that she is better off without a stock market.

    (ii) I agree with you that in economics almost everything and the exact opposite has already been said sometime, somewhere, by somebody. There is an abundance of opinion and a dearth of knowledge. In other words, economics is a failed science.

    “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

    The true theory is not to be found in the history of economic thought. Heterodoxy either develops a new paradigm or it goes down the opinion-drain like Walrasianism, Keynesianism, Marxism, Austrianism, Ishiism and all the rest.

    Egmont Kakarot-Handtke

    • JdeV
      August 28, 2015 at 3:53 pm

      Mr Kakarot-Handtke. How do we implement a new paradigm (e.g K-H ism)?
      If we were to “see sense” & convene a latterday (but pre cataclysm) Bretton Woods what sort of consensus would need to be arrived at in your opinion ? I will leave aside the issues as to who should be invited or whether any sort of consensus would actually be achieved.
      All that appears certain to me is that we’d be better off not starting off from where we are now.

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