Our economy presently faces by far the greatest collapse in the lifetime of most people alive today. Indeed, long after the Covid-19 scare passes, we are likely to remain mired in a high unemployment trap for an extended period. The U.S. economy has lost over 40 million jobs in the past four months, even if several million have been temporarily recovered as a result of the federal government’s Paycheck Protection Plan. Consumption fell by record amounts in April and May before recovering modestly, as expected, in June. Economists anxiously await the second quarter GDP numbers, which are expected to provide further evidence of a historically unprecedented collapse.
Yet, although the major stock indexes dropped over 20 percent in mid- to late- March, the stock market has since rebounded impressively. What can we make of this? Aren’t a collapsing economy and a bourgeoning stock market inconsistent, contradictory even? I would submit that they once were. In the distant past, a well-performing stock market was a fairly reliable signal of economic strength. Stock prices tended to reflect the performance of private companies. As the companies prospered, prices rose. But prosperous companies also grew, hired people, and produced stuff. In short, when the economy grew the stock market tended to rise.
But the link between the stock market and the economy has, over time, weakened substantially. As described by economist Mariana Mazzucato, the financial industry in the early 1970s lobbied the government to revise the national income accounts to give more importance to financial activities, most of which are speculative instead of productive. What the change signified was that the economy could “grow” even if production and employment were not keeping pace, as long as the financial sector continued to expand in relation to the rest of the economy. Widespread financial deregulation starting in the 1980s, extending beyond the Clinton Administration’s appalling repeal of the Glass-Steagall Act, ensured that this would happen.
Today, nearly all (i.e., more than 99 percent) of stock purchases occur on the secondary market. What this means is that rather than, for example, giving my money directly to Apple for ten shares of its stock, I simply buy existing Apple shares from their previous owner. Speculators today “bet” on short-term increases in the stock price, and the trajectory of stock prices is in no small part determined by non-economic factors – fear, psychology, appetite for risk, etc. Yet the stock market still impacts the economy in a meaningful way. With a growing percentage of the U.S. population having a stake in the stock market (even if mostly through retirement accounts), changes in stock values often significantly impact wealth and therefore consumption and savings decisions.
Even today, many confuse rising stocks with a strong economy. While the so-called recovery from the financial crisis of 2008-2009 has been exceptionally weak by historical standards, this is not been the prevailing narrative. Economics reporting has instead focused on the robust performance of the stock market, as well as on the historically low but highly misleading unemployment rate.
Never, however, has the disconnect between the economy and the financial sector been as stark as at present. It is as if buyers on Wall Street were entirely heedless of what is happening in the world of production, spending, and work. Something highly unusual, to say the least, is happening. We might liken it to the 2008-09 financial bailout on steroids. Then, “too big to fail” justified the Treasury’s and Federal Reserve’s rescue of reckless banks. Since that crisis, the apparent importance of finance to our economy has increased unabated. Evidence is that today the Federal Reserve is doubling down on the previous bailout by providing all manner of economic stimulus to the big corporate players, even those only indirectly tied to the financial sector, by buying corporate debt in addition to Treasury bonds.
Will there be a market correction? While I have been wrong before, a large one seems inevitable. Stock traders are clearly “pricing in” a perpetual bailout, meaning that they believe that the government will stop at nothing to save the financiers. It is an extreme case of socializing risk while allowing gains to remain in private hands. The crucial question is for how long such a policy can be maintained.
Comments 1
This is fascinating.