Wednesday, March 20, 2013

We Should be Happy About Recent Stock Market Increases, Right?

"So, the stock market is at record highs, and you say that's bad?" asked a co-worker. I had just given a dour response to his exuberance about recent stock market gains.

I replied that it could be either good or bad, depending on one's position in the market. But I noted that the underlying assumption seemed to be that the recent gains meant that the economy was dramatically improving and that life would be getting better. Oh, it will get better for a few people that have a good sense of what is happening in the market, but ....

My friend was mystified by my pessimism. I asked if it seemed reasonable to think that the underlying value of the firms that make up the DOW or the S&P 500 actually increased so much over such a short period of time. Or was it that these highly watched firms were carefully hiding value that has only now come to light? No, none of that seems right. Value gains like that would have rippled throughout the economy driving massive employment gains, and real unemployment is still extremely high.

Then maybe one should consider the possibility that a bubble lacking real value is forming in the stock market. If so, that bubble will burst at some point, leaving many decrying their losses. For long-term stockholders this will mean losses of imaginary gains that never really existed. For recent buyers that bought stocks at inflated prices, the losses will be very real.

An economist that goes by the pseudonym Adam Smith does a fine job of explaining the impending stock bubble collapse in this article.

The Federal Reserve Bank and the U.S. Government have colluded to keep long-term bond rates very low (effectively 0%) for many months in an attempt to stimulate the flagging economy and fund government debt at artificially low prices. Those that used to rely on long-term bond yields for income (i.e. retirees) have had to move to the stock market to get any kind of income.

Smith doesn't mention this, but many people that got out of the stock market when it crashed in 2008 are just now feeling comfortable enough to get back in. The average stock market investor is a very emotional being that exits the market when confidence drops and re-enters the market when confidence is high. The result, however, is that they sell when stocks get cheap and buy when stocks get expensive; the precise opposite of a wealth producing strategy.

With no "great underlying fundamental driving real growth," the supply of business equity (i.e. stock) value is no higher today than it was a few months ago. When supply remains constant while demand increases, price must also increase. People are paying more for stock without getting additional value.

Smith explains that this is actually being done by design "to make people feel richer and hence spend more money and expand the economy." One can debate the ability of fake wealth to foster real wealth, but the Fed can't keep this up forever. At some point "the Fed is going to change policy and increase interest rates."

Trading professionals are keenly watching for this moment and will engage in a huge stock sell-off when it arrives, locking in their gains. Seniors, however, that have moved their savings from bonds to stocks will end up reaping the whirlwind as the value they thought they had purchased will evaporate. After the bubble bursts, emotional based investors will jump out of the market again, thereby, permanently locking in their losses.

The stock market isn't the bad guy here. It is just a tool that is being manipulated by big government actors, whose efforts will end up contributing to the impending retirement crisis.

As I noted in this post from a year ago, we cannot avoid the fact that retirees rely on existing workers to support them. This would be true even if Social Security did not exist and retirees were completely self funded. Retiree investments only have as much value as is imbued in them by current worker productivity. Also unavoidable is the fact that the ratio of productive workers to retirees is rapidly declining.

Some say that this isn't so bad, because per-worker productivity continues to increase. While this is true, it would require a highly skewed view of economics to believe that productivity increases can adequately compensate for decreases in human capital. The best measures we have of productivity do not appear to support such a conclusion.

To top it off, the Wall Street Journal reports that workers aren't adequately saving for retirement. A significant number quit saving when the economy went south in 2008 and many have less saved today than they did in 2007. Besides the current dismal economy, increasing life expectancy, expanding expectations of post-retirement lifestyle, the relative size of the Baby Boomer generation that is now entering retirement, the diminishing worker-to-retiree ratio, and the impending stock market bubble collapse lend to the forecast of a looming retirement crisis.

When the crisis hits, watch for large swaths of the populace—especially those that are retired or close to retiring—to clamor for more government mandated wealth transfers. They will cry for those that have been most productive and most prudent to be punished, along with the young and unborn future workers that cannot yet speak for themselves. One problem of moving from a republic to a democracy is that a majority or even a highly motivated minority can succeed in gaining benefits funded by those that are less politically connected. Even this game can only be played temporarily.

Last summer I posted about the dismal view taken by Mark Steyn of the future we can expect. He asserts that "we will work till we’re older and we will start younger — and we will despise those who thought they could defy not just the rules of economic gravity but the basic human life cycle."

If Steyn is right, the coming retirement crisis may be more than just a temporary dip that lasts a few years. It could be the start of longer careers, less prosperity, less leisure, and shorter retirements for almost everybody.

So, go ahead and celebrate the recent stock market increases, if that's what you want to do. But don't be surprised when the bubble bursts, deflating Americans' dreams of long, luxurious retirements.

We have spent ourselves into the position of necessarily thrashing from economic crisis to economic crisis. The solutions offered by politicians and their business cronies at this point are designed to create temporary bubbles of inflated well being in an effort to gain power and put off for as long as possible taking the medicine we know must take. People buy these ideas because being truly fiscally responsible sells poorly.

In other words, when the stock market bubble crashes, it won't be the last economic bubble we will experience. Taking steps to get your own economic house in order can help, but it may be inadequate to fully protect you from the coming series of crises.

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