Stocks prepare for new crash

I could have titled this “Stocks hit new high.” But “Stocks prepare for new crash” is more to the point.

Yes, the recent jump in stock prices was based on some good economic news. But “good,” these days, is relative. We’re more than four years into a freaking depression. Maybe, just maybe, some cautious optimism is warranted. But exuberance? New records? What’s going on?

The answer, of course, is that it’s not about the real world at all–the stock market is one place where rich people and rich companies park their money when they’re not spending it. And they’re doing fine (we’re in a depression, they’re not). So they buy up each others’ assets in a sterile bidding war that has nothing to do with the real economy. For a while, everyone in the market thinks they’re rich, but they can’t all be that rich–there’s just not enough wealth in the real world to go around, especially because the rest of us need some to stay alive (although this is less and less important). At some point, some rich people realize that only the people who sell their assets fast, before everyone else catches on, will get a good price for them. And then everyone else catches on. And then it all goes to hell.

An analogy: Think of the financial world as the snow on a mountaintop, with the mountain being the real economy. The snow can’t build up forever; when there’s more snow than the mountain can support, you get an avalanche.

And to extend the analogy: while you can look and say, damn, that’s too much snow on too little mountain, you can’t predict exactly when the avalanche will come, or what will trigger it.

That’s the situation we’re in today–the financial world, which has the collective memory of a fruit fly, has gone and reinflated the financial bubble whose collapse sparked the current depression. It’s not going to last. The only question is exactly when and how the crash will come.

The way I see it, there are two ways the latest burst of irrational exuberance can play out.

One is that everything goes to hell pretty quickly. Like, this fall or next fall (crashes tend to happen in the fall for some reason).

The other is that some of the money in the market finally bleeds over into the real economy. (For instance, rich people use their sterile money to buy up real estate as well as stocks, reinflating the real estate bubble. As real estate prices rise, the construction industry revives, paying money to people who actually spend it, improving the real economy.) That means more mountain to support the snow, letting more snow build up and staving off the crash for two or three years more.

This second option is of course how financial markets are supposed to work–they’re supposed to fund real-world investment, which creates real wealth, which is reflected in higher asset prices, leading to more investment, and everyone’s happy forever.

But today, real-world investment is a minor afterthought in a market focused on the sterile circulation of paper and electronic balances. In fact, as I point out in Economix (page 215 panels 1 and 2, for those of you following along) the stock market is often a negative source of investment–between buybacks and special dividends, real-world companies give more to the market than they get back. That’s money that could have gone to wages, or taxes, or lower prices.

In other words, the real economy subsidizes asset prices. But we can’t subsidize them forever. Hence the title of this post.

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