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We're Talking Stock Market Bubbles (This One)

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May 13, 2009 – Comments (6)

We're talking stock market bubbles over at the Mises Institute thanks to Frank Shostak's attempt to graph liquidity changes and stock prices in a series of graphs covering the last 80 years and an attempt to logically deduce the results of fiscal planning:

The demand for the services of the medium of exchange is also affected by changes in prices. An increase in the prices of goods and services leads to an increase in the demand for the medium of exchange. People now demand more money to facilitate more expensive goods and services. A fall in the prices of goods and services results in a decline in the demand for the medium of exchange. Now, take the example where an increase in the supply of money for a given state of economic activity has taken place. Since there wasn't any change in the demand for the services of the medium of exchange, this means that people now have a surplus of money or an increase in monetary liquidity. Obviously, no individual wants to hold more money than is required. An individual can get rid of surplus cash by exchanging the money for goods. All the individuals as a group, however, cannot get rid of the surplus of money just like that. They can only shift money from one individual to another individual. The mechanism that generates the elimination of the surplus of cash is the increase in the prices of goods. Once individuals start to employ the surplus cash in acquiring goods, this pushes prices higher.

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Personally, i hate the title of this piece (Obama's Mini Stock Market Bubble). This has little to do with Obama, and a lot more to do with the traditional policy of "Apres moi, le deluge." (Did I spell that right? I'm not going to look it up. I'm lazy today.)  That was the policy of French monarchy. Inflate all you can. Don't worry, you'll be dead and the next generation will pay.  Nowadays, it's the next President who pays, and so he inflates (and the bankers cheer), hoping to buy 8 years of political capital.  Bush did it. Clinton did it before him. Reagan did it. Carter did it. Nixon, LBJ, etc... Or maybe you could say their Congresses did it, or both?

Some of you may recall that I've been speculating that we are in a mini-bubble, particularly in banking stocks in a few comments I've made over the past three weeks.  I'm not totally convinced by Shostak's arguments as I've never been one to rely on charts to make up my mind. I just think about things logically (or attempt to).  A glut of dollars on the market leads people to bid up prices.  It's the reverse process of production, where increases in production drive down prices.

Look, it's not great that the market is up 25-30% if the money supply has increased even more than that to make it happen.  That means you are poorer.  That means you would have been better off with the market at 666 and the money supply untouched.  Purchasing power measures wealth. If your PPM is eroding faster than the market is going up, you're getting poorer (albeit less poor than those with no portfolios.)

I'm sure we can all see the logical consequences of this.  The people hurt the most by inflation are the poor and middle class. This is why the Federal Reserve works against Social Justice, even though it is the prized institution of the Progressives. (As Naomi Wolf admits, nobody on the Left has a clue how the Fed works. This isn't really surprising, since the reactionary wing of the Left is more concerned with creating a money-less society and hypeinflation can bring that about, see: Lenin's purposeful hyperinflation at the beginning of the Revolution.) 

We'll be talking more about this in the future I'm sure, but here is an article by Thomas Woods, Austrian School Economist and author of Meltdown, discussing the Fed's role in this whole fiasco, from beginning to end.

I’ve written quite a bit about ABCT [Austrian Business Cycle Theory], both in my book and in numerous articles, so I won’t repeat the theory in any detail here. What matters for right now is that the theory, which won F.A. Hayek the Nobel Prize in 1974, exonerates the free market of blame for the boom-bust cycle. Instead, the culprit is the government-established central bank (in the American case, the Federal Reserve System), whose activities lead the economy into an unsustainable configuration that can seem like prosperity for a time, but which inevitably collapses in a bust when the accumulated resource misallocations reveal themselves. (Yes, the theory can also account for booms and busts that occurred in the absence of a central bank; see Jesus Huerta de Soto’s treatise Money, Bank Credit, and Economic Cycles.) Fiscal and monetary stimulus, in turn, are based on a juvenile misdiagnosis of the problem, and can only misdirect the economy still further.

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Meanwhile, Gary North, another Austrian School Economist, reports there are no green shoots. This is a sucker's rally.

David Rosenberg, the chief economist at Merrill Lynch, retired last week. He may still be bullish on America, as the old Merrill slogan went. He is not bullish on the present U.S. stock market. He calls the rally a sucker's rally.

From the beginning of this rally, he has maintained that it will not be sustained. He has not changed his mind.

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David in Qatar

6 Comments – Post Your Own

#1) On May 13, 2009 at 12:15 AM, russiangambit (29.24) wrote:

> Apres moi, le deluge."

After me, come hell or high water. Should be "apres nous", perhaps, these days.

I agree with you, it is the liquidity induced rally. Not suprisingly commodities rally, oil is close to $60.  Dollar is falling. Bloomber interpreting it as a move to risky assets, I interpret it as a flight from dollar inflation.

The sad part, people who are not economists don't understand what is happening. They think things are getting better. Of course, it is the FEDs intent to mask the problems until the confidence returns and pulls everybody out of the hole. And the people will be no wiser, but poorer.

The only question, will the FED be able to inflate quickly enough to hide the effects of unemployment and falling production.

I see two possible scenarios: FED sucessfully inflates and we go for a couple of years trying to figure out what is exactly happening, and then crushing again. However, I think commodity prices will prevent the FED from inflating so much.

Then the second scenario, the house of cards falls apart in the fall.

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#2) On May 13, 2009 at 12:20 AM, JibJabs (91.88) wrote:

has that happened? if you think so, why?- what's your source?

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#3) On May 13, 2009 at 1:13 AM, whereaminow (< 20) wrote:

Here is the interview between Naomi Wolf and Lew Rockwell. It's 50 minutes long, but amazing.

David in Qatar

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#4) On May 13, 2009 at 1:39 AM, whereaminow (< 20) wrote:

The last President who didn't inflate the currency through the Fed was John F. Kennedy, who stated that he would rather issue dollars created interest-free through Congress instead (in order to bring the deficit down.)  He was assassinated shortly thereafter.

I'm not sayin..... I'm just sayin...

David in Qatar

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#5) On May 14, 2009 at 11:05 AM, nzsvz9 (< 20) wrote:

David,

Apres=after

moi=me

le=the

deluge=flood 

Good enough, c'est bon!

A couple times I've posted here that the increase in dollars from the Fed and Treasury, if it's 10T dollars, is offsetting the 10T dollars in losses from the market, business collapses and un-real estate deflating. If there is a balancing offset her, then there is no inflation, just re-distribution. If it's out-of-balance, then there's either inflation or deflation depending on which way the imbalance settles ...

I've not seen your reply to this, and don't see this taken into account in any of the links provided, so to me it's another missing piece of the puzzle unaccounted for.

If we repudiate the debt (which I'm in favor of), and the 10T dollars in debt vanishes, will that restore the balance? 

Please comment.

Oh, and Lincoln was assasinated just before his plan to issue new US Treasury backed money (green-backs, it's where the name came from) by ... not sayin' ... just sayin'

Known as nzsvz9 sitting on the grassy knoll

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#6) On May 15, 2009 at 7:56 AM, whereaminow (< 20) wrote:

nzsvz9,

It's an interesting discussion certainly. Let's imagine that $10T was lost in the crashes. Well, how does printing up $10T make up for that?  Is the money going to the same exact people in the same exact amount to have the exact same impact? Obviously no, so it's just redistribution of wealth, even if the perfect amount of money was created.

But why create money in the first place?  The demand for money derives from the increase in production.   Let's take it one step at a time. This is how wealth is created (Very Very Rough Sketch):

1. The economy becomes more productive.  It becomes cheaper to make things that people want.

2. Goods in production fall in price as productivity increases. This is good, not that dirty word (deflation).  Prices dropping from an increase in productivity benefits EVERYONE, especially the poor.

3. Capital is freed up to invest in new ventures. It costs less to make what we have. That gives us a greater opportunity to create things we don't have. (This is key!!)

4. An increase of goods on the market causes an increase in the demand for money. 

5. The money supply grows as the economy grows.

That's the way the market worked, for the most part, until the central banks stole the money supply (Note that prices dropped steadily for 150 years from the late 1700's until WWII - and nobody cried about deflation.) Now they increase the money supply in order to grow the economy. In other words, they have the process back-asswards.

We can't answer your question as to what the right amount of deflation/inflation is in order to stabilize the economy. There is no way to stabilize an economy. Economies are not supposed to be stable. They grow, they shrink, they stagnate, etc.,  These are normal things.  Intervention and attempts to stabilize the economy only destabilize it further.  They distort the market.

I hope this helps, but I don't think I've done my best work here, so please comment back and let me know if you feel I left something out.

In the meantime, there is a great deal of work on deflation done by Jesus Huerta De Sota and Jorg Guido Hulsmann that I think you should check out.  Here's a couple of quick links off my favorite list:

Deflation and Liberty - Hulsmann (pdf)

Financial Crisis and Recession - De Soto

Also, I recommend books by Thomas DiLorenzo and Thomas Woods discussing the history of Capitalism and the debunking of collectivist myths about the time of Liberty (late 18th century until 1913).

David in Qatar

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