Home > Uncategorized > A stock market boom is not the basis of shared prosperity

A stock market boom is not the basis of shared prosperity

from Thomas Palley

The US is currently enjoying another stock market boom which, if history is any guide, also stands to end in a bust. In the meantime, the boom is having a politically toxic effect by lending support to Donald Trump and obscuring the case for reversing the neoliberal economic paradigm.

For four decades the US economy has been trapped in a “Groundhog Day” cycle in which policy engineered new stock market booms cover the tracks of previous busts. But though each new boom ameliorates, it does not recuperate the prior damage done to income distribution and shared prosperity. Now, that cycle is in full swing again, clouding understanding of the economic problem and giving voters reason not to rock the boat for fear of losing what little they have.

The Groundhog Day boom-bust cycle links with John Kenneth Galbraith’s observations on the phenomenon of financial fraud via embezzlement, which he termed “the bezzle”:

“To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there is an inventory of undiscovered embezzlement in – or more precisely not in – the country’s businesses and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle (Galbraith, J.K., The Great Crash 1929, New York: Houghton Mifflin, 1954, p.152-53).”

Galbraith’s bezzle captures perfectly the dynamics of Ponzi frauds in which existing investors are paid richly with inflows from new investors. Those rich rewards then attract new investors and the fraud continues until new inflows are insufficient to meet previous promises, at which stage the Ponzi scheme implodes. However, along the way all investors feel richer.

Galbraith’s bezzle also captures the dynamic of speculative bubbles, which are a form of fraud we collectively inflict on ourselves. Investors buy in believing they will be able to sell at a higher price, and their purchases drive up prices and attract new investors who hope to jump on the price appreciation band wagon. The bubble continues until belief in ever higher prices is punctured, whereupon buyers evaporate and the bubble implodes. Once again, all feel richer along the way.

Today’s stock market increasingly has the smell and feel of another bezzle. That smell is metaphorically reflected in President Trump who has the integrity of a con man and whose business history is marked by reliance on funding from suspect sources plus serial bankruptcies. Now, Trump has used the presidential bully pulpit to cajole the Federal Reserve into further inflating asset prices by enjoining it to lower interest rates.

In addition to directly impacting asset pricing, the Federal Reserve has given a green flag for speculative buying and strengthened beliefs that it stands ready to guarantee stock prices via the so-called “Powell put”. That put is an amplification of the prior “Bernanke put”, which was in turn an amplification of the “Greenspan put” which launched the Federal Reserve’s commitment to stock prices.

To be honest, it did not take much cajoling from Trump as the Federal Reserve has learned little from the past thirty-five years of serial asset price bubbles. Furthermore, the composition of its current Board of Governors leans strongly toward Wall Street, and all its Board members have a strong personal interest in higher stock market prices from which they each stand to gain.

The policy pyramid is supported by the mainstream economics profession (many of whom are also beneficiaries of higher stock prices) which has now embraced asset price inflation as the preferred tool for combating recession and sustaining economic expansions. The wheel has come full circle. Whereas in the post-War era economic policy aimed to provide a floor for labor, now it openly aims to provide a floor for capital.

So, why write this? First, caveat emptor. This time is likely no different. A bezzle is likely brewing somewhere within the system, and there are also risks brewing without.

Second, it is politically important to identify in advance the causes of the bezzle and the characters involved. That can help combat the false narratives which will inevitably emerge if a bezzle is eventually exposed.

Third, our addiction to stock price inflation is politically and economically toxic. It is rooted in an illusion promoted by Wall Street, the Federal Reserve and mainstream economists that conflates the stock market and shared prosperity. The reality is a stock market boom is not the basis of shared prosperity.

  1. ghholtham
    January 22, 2020 at 6:45 pm

    I agree. As long as the price of a tin of baked beans is stable and unit labour costs are not accelerating the Fed is happy to ignore any sort of bubble in the stock market – or indeed any asset market. The spread on corporate bonds, is currently absurdly low too. In 2007 there was no inflation in the consumer price index so the Fed let the housing market rip leading to a crash. Now it lets the stock market rip and an eventual crash is highly likely. When it arrives, we know from Minsky that some indebted holders will go bust with real-economy consequences. But the Fed will not take the political risk of inducing a slowdown to deflate the market in an election year – even if that would avert a more spectacular market collapse and recession later.

    The unspeakable consequence could be the stock boom continues and the President is re-elected. He more than anyone identifies prosperity with a booming stock market – and takes credit for it.

    • Meta Capitalism
      January 23, 2020 at 3:08 am

      As an American it is terrifying watching America descend into an elective despotism right before our very eyes.

    • Meta Capitalism
      January 23, 2020 at 10:38 am

      This book provides a critique of the neoclassical explanations of the 2008 financial collapse, of the ensuing long recession and of the neoliberal austerity responses to it.

      The study argues that while the prevailing views of deregulation and financialization as instrumental culprits in the explosion and implosion of the financial bubble are not false, they fail to point out that financialization is essentially an indication of an advanced stage of capitalist development. These standard explanations tend to ignore the systemic dynamics of the accumulation of finance capital, the inherent limits to that accumulation, production and division of economic surplus, class relations, and the balance of social forces that mold economic policy.

      Instead of simply blaming the “irrational behavior” of market players, as neoliberals do, or lax public supervision, as Keynesians do, this book focuses on the core dynamics of capitalist development that not only created the financial bubble, but also fostered the “irrational behavior” of market players and subverted public policy. (Hossein-zadeh, Ismael. Beyond Mainstream Explanations of the Financial Crisis: Parasitic Finance Capital. (Routledge Frontiers of Political Economy) . Taylor and Francis. Kindle Edition., Emphasis Added.)

      I was trained as a corporate accounting with a focus in forensic accounting. This book is one of the better ones (besides Michael Husdon’s “Killing the Host” and “Finance as Warfare”) that I have read on finance.

    • Meta Capitalism
      January 31, 2020 at 11:20 pm

      The unspeakable consequence could be the stock boom continues and the President is re-elected. He more than anyone identifies prosperity with a booming stock market – and takes credit for it. ~ Gerald Holtham
      That view was now challenged. When he began to grasp, along with the rest of the world, what big American firms had done—rigged credit ratings to make bad loans seem like good loans, created subprime bonds designed to fail, sold them to their customers and then bet against them, and so on—his mind hit some kind of wall. (Lewis, Michael. Flash Boys: A Wall Street Revolt (Kindle Locations 528-530). W. W. Norton & Company. Kindle Edition.)
      The market-led model of globalization ultimately depended on the idea that, left to their own devices, increasingly internationalized markets could generate outcomes that were both in every body’s self-interest and in societies’ collective interests. Yet, following the financial crisis, it was no longer obvious that this idea was in any way credible. Indeed, Alan Greenspan, former Chairman of the Federal Reserve and for much of his life a cheerleader for market forces, was forced to admit as much while giving evidence to the US House Committee on Oversight and Government Reform in October 2008: ‘Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.’ Markets cannot function in a vacuum. They need to operate within some kind of institutional framework. But which one? (King, Stephen D. Grave New World [The End of Globalization, the Return of History]. London: Yale University Press; 2017; p. 79.)

      Anyone who thinks the stock market represents real wealth and is not rigged should read Flash Boys. Just as the GOP has rigged the DOJ with Trump’s cronies and sycophants, so to the Senate has just completed a sham trial with on witnesses and will surely acquit Trump of his attempts to bribe a foreign government to interfere in a US election, the very kind of thing the Founders feared most. America is now an elective despotism with a King and dictator with the willing help of the GOP. The Senate trial is nothing short of a cover-up of Trump’s crimes.
      Welcome to the new American Empire and the Grave New World!

  2. Craig
    January 23, 2020 at 6:03 pm

    Galbraith, Hudson and Keen all bring insight to the fact that the problem is in finance/money. It’s just that they don’t see that the even deeper cause is its paradigm of Debt ONLY, that is, Only as in a monopoly on the form and vehicle for the distribution of credit/money. Integrate monetary gifting intelligently and strategically into the economy and the supposedly thorny problems of the current/old paradigm go poof. Too simple for the intellectual vanities of the erudite, too freeing of every economic agent for them to opt out of such policies.

  3. Ken Zimmerman
    February 6, 2020 at 1:02 pm

    I wrote this earlier on another posting. “Wall Street is about investing. To get a large return on money invested. There is no shortage of theories on what makes the markets tick or what a market movement means. Some of which influence investor decisions. The two largest factions on Wall Street are split between supporters of the efficient market theory and those who believe the market can be beaten. Although this is a fundamental split, many other theories attempt to explain and influence the market, as well as the actions of investors in the markets.”

    Allow me to simplify. Stock, equity, real estate, and all the other so called ‘speculative’ options for betting money in so called ‘serious investment’ are all Frankenstein monsters. Invented hit and miss over 500 years, mostly in the west by people who wanted the excitement of wagering along with the veneer of ‘sound business.’ There is no clear understanding by anyone of how these monsters operate in the various places and times in which they exist presently or existed in the past or might exist in the future. They are like Frankenstein’s monster stitched together from hundreds of rotting corpses and newly born manias and hysteria. People are always involved with uncertainty; thus, they invent, and reinvent, and reinvent, etc. coping processes. Rules of thumb. For these monsters, people have invented thousands of such processes, to ‘defeat the monsters.’ Only two have remained constant, however. Don’t get caught flat footed in a crash. And, always profit from bubbles. Those holding greater wealth are more successful in achieving these tactics than poorer investors. So, they win more often that their poorer fellows. And what’s the sources of this greater wealth? Any source is permissible. As John D. Rockefeller said, in what is often labeled an ‘inspirational quote,’ “The way to make money is to buy when blood is running in the streets.” Thus, all these Frankenstein monsters are, like the original monster violent, dark, and not to be trusted. Yet, in the US and elsewhere millions of peoples’ lives are at the mercy of these monsters and their attendant wealthiest investors. During the 1970s, Nelson “Bunker” Hunt believed there would be inflationary pressures that would destroy the value of any investments denominated in or tied to paper currency. Consequently, Bunker foresaw at least a tenfold increase in the price of silver as a result of the plummeting real value of the dollar, so he and his brother began to buy up physical silver as well as future contracts. They stockpiled over $1 billion in silver, driving up the price of silver beyond $50 per ounce. Until the Hunts’ original $1 billion investment was valued at over $4.5 billion on commodities markets. This, of course placed hardships on all those using silver for such purposes as minting and electronics manufacturing. Federal regulators finally stopped the scheme, resulting in the bankruptcy of the brothers. I’d call this “blood in the streets” opportunism. And a clear example of how these monsters can harm or destroy an entire economy.

    • Meta Capitalism
      February 7, 2020 at 3:20 am

      Does anyone know of a study if the history of stock market crashes that shows the human elements of manipulation by wealthy individual and institutional investors?

      • Ken Zimmerman
        February 8, 2020 at 2:51 pm

        Try “Manias, Panics and Crashes: A History of Financial Crises.” It’s much more lively than most such studies. Which are in my view stiflingly dry and dull.

        This is one of my favorites. South Sea Bubble, 1720.

        In the early 18th century, Britain’s economic situation was battered by waging two wars simultaneously, the Great Northern War and a war with France. The government became more and more dissatisfied with the service it received from the Bank of England, which had the authority to arrange loans to the government. So, the newly appointed exchequer to the government, David Harley, suggested creation of a new company called the South Sea Company. Britain’s debt was transferred to the company and in return, the company issued shares. Also, the government agreed to pay a fixed amount annually which the company will use to distribute as the dividend. The company’s operations involved trade to South America, which was under the control of Spain at the time.

        Despite its efforts, the company remained largely unprofitable. The founders decided to keep this fact a secret and between 1711 and 1720, the company issued stocks several times for consolidating its debt. Also, they spread rumors about the company’s profitability to make the share price boom. Meanwhile, observing the ‘success’ of the South Sea Company, several other companies were created, and stocks offered to the public. But it all came crashing down in 1720.

        Many ordinary investors were ruined, and the House of Commons ordered an inquiry, which showed that at least three ministers had accepted bribes and speculated. Many of the company’s directors were disgraced. Including King George I. The scandal brought Robert Walpole, generally considered to be the first British prime minister, to power. He promised to seek out all those responsible for the scandal, but in the end, he sacrificed only some of those involved in order to preserve the reputations of the government’s leaders. The South Sea Company itself survived until 1853, having sold most of its rights to the Spanish government in 1750. By size of its losses the South Sea Bubble is the 2nd largest crash in western history.

        What lessons ought we take away from the South Sea Bubble and the dozens of other bubbles and crashes we could discuss here? This is Adam Smith’s assessment. “They had an immense capital dividend among an immense number of proprietors. It was naturally to be expected, therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs. The knavery and extravagance of their stock-jobbing operations are sufficiently known [as are] the negligence, profusion and malversation of the servants of the company.” This is the assessment of Charles P. Kindleberger and Robert Z. Aliberin in the sixth edition of their book, Manias, Panics and Crashes: A History of Financial Crises. “The common structure behind all manias and crashes is revealed in this historical study. In simple terms, beware when monetary policy is easy, banking regulation is lax, and the masses fall in love with a specific asset, often with leverage (think stocks in the 1990’s, real estate until 2007, and bonds up to 2013). What is self-reinforcing on the way up will be self-reinforcing on the way down, but with greater speed and ferocity, as bad debts have to be liquidated. Learn the pattern so you can recognize when you are living it… or pay the price.”

      • Meta Capitalism
        February 8, 2020 at 11:43 pm

        Thank you Ken.

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