The serious losses in major stock exchanges announced all over the world have been shocking. Is the bubble finally bursting in equities?
If so, it wouldn’t be without ample warning. Everyone, from former Reagan administration budget director David Stockman to the World Bank, has been warning of the unsustainable credit-fueled bubble caused by “quantitative easing.”
But of course, it wasn’t supposed to be this way. In theory, vast money creation and the associated zero percent interest rates favored by the US Fed and other central banks should have kick-started the global economy.
With industries using what was essentially free money, upgrading processes and plants, improving technology and developing new products should have been a no-brainer. Instead, firms hoarded capital or used the money for non-value-added activities like share buybacks.
What we have here is an interesting distortion of the meaning of markets, and maybe capitalism itself.
Wealth, as we think of it in the modern era, is assumed to be the result of processes that add value to end users. For example, steel mills add value to iron ore by making steel, then automakers add value to that steel by building an automobile with it.
Consumers then pay for this added value, exchanging something else of value (money) for that automobile.
The value of the steel mill or auto manufacturer was then measured by the firm’s assets, like factories and machinery combined with the company’s process knowledge, expertise and marketing power of their brands.
Unfortunately, the issuance of stock to generate capital caused a parallel measure of value, namely share price. In theory, the two are closely connected. For example, General Motors’ vast breadth and depth of manufacturing expertise made it a blue-chip “buy and hold forever” choice for two generations.
Today it’s different.
Look at Facebook. It’s a market powerhouse, but adds very little value to any process according to the conventional definition of the term. So why is it so valuable? Because equity markets believe it is, trading it at over 80 times its earnings.
Equity markets are places where perceptions and perceptions of perceptions drive pricing, rather than economic fundamentals. There’s no surprise here: all that liquidity sloshing around the world had to go somewhere, and there’s only so much luxury real estate in the world’s hottest cities to go around.
The result is a bubble far more dangerous than anything seen during the dot-com crisis or even the 2008 banking fiasco. It’s so serious, even Chinese government intervention has failed to avert the slide in Shanghai. They are especially ill-equipped to backstop their nation’s four big banks, who by themselves could bring down the global financial system if allowed to fail.
Ironically, down on Main Street where I live, the only thing that truly matters for the economy is consumer demand, which is essentially unchanged. Consumer demand for manufactured goods in all categories from textiles to transportation is perpetually latent and strong.
With the vast majority of equities held by a very small minority of the population, it’s reasonable to expect that a massive market crash should not affect the goods producing economy at all. The real risk isn’t that shares collapse in price, but that the vast quantity of money conjured out of thin air by global central banks haven’t been used to increase productive efficiencies and therefore lower the inflation-adjusted prices of things that people need; namely food, clothing, shelter and transportation.
The experts talk of a liquidity crisis and they’re right, except their thinking about the wrong liquidity.
It’s the lack of disposable income in the hands of the middle class that’s the real liquidity crisis. And that’s the key to sustainable economic growth and good middle-class jobs, particularly in manufacturing.
The assumption that handing hundreds of billions of dollars to banks who will in turn loan it to job creators like the manufacturing sector was clearly irrational. It’s simply easier and more profitable for banks to speculate with the money.
So here we are, on the cusp of a market haircut worse than 2008, having learned essentially nothing.
Until the actual goods producing economy is restored to dominance over the financial sector, we’re in for a perpetual roller coaster ride of boom and bust market cycles. To put real industry on top again requires real political will, and ultimately we control that at the ballot box.