Use access key #2 to skip to page content.

rfaramir (29.26)

Would the aggregate stock market rise with fixed money supply? Answer

Recs

6

June 12, 2013 – Comments (18) | RELATED TICKERS: CEF , GDX , SIL

Valyooo asks (http://caps.fool.com/Blogs/would-the-aggregate-stock/837014):

With a fixed money supply, would the aggregate stock market rise, and if so how?


First let me stipulate a few other conditions, see what happens, then work back to just your question.

Assume perfect forecasting of everyone's needs and wants and perfect forecasting of weather and other such natural events. Eventually we'd reach the Austrian theoretical state of the Evenly Rotating Economy, where there are no profits beyond the natural rate of interest, which is equivalent to the prevailing Time Preference (desire for present goods over future goods, all else equal). Read up on Austrian Theory if you don't get this or we'll have a *long* discussion!

Results: with no profits beyond the natural rate of interest, there would be no difference between investing in the bond market or the stock market. But then again, with all future events and needs known now, there would be no need for money at all! We would contract for what we know we would need in the future in exchange for whatever we produce ourselves, i.e., barter would actually be efficient with perfect knowledge. But assume we still use money as an artifact of when we were imperfect, plus the fact that it makes economic calculation possible (we may have future knowledge, but totalling the 'value' of heterogenous capital goods is still impossible without a unit of account). The market cap of the whole stock market would eventually be constant relative to population. If you assume no expansion into space, we would eventually find (or quickly since we have perfect knowledge) the Earth's capacity and stop population growth there, so the aggregate stock market value would stop, too.
 
But this ERE is not reachable. First, we have human limitations, so our knowledge is limited, and our needs and wants change a lot. So entrepreneurs make profits as they fulfill our needs (losses when they guess wrong), ever smaller profits as we approach the ERE, but long before we arrive, our wants (at least) change, so the equilibrium point changes, and entrepreneurs have new opportunities to make profits serving us.


In this process of meeting our needs, our wealth is increasing absolutely in total. Just look at how we live relative to 50 years ago. People in 1963 would be amazed at our electronics, at least (though wondering where our flying cars are--I blame 'free' government roads crowding out the need for them), people in 1913 would be amazed at 1963's aircraft, people in 1863 would be amazed at 1913's automobiles, people in 1813 at 1863's trains. The poorest among us in 2013 live with better hygeine, better diet, better longevity, better conveniences of all kinds than kings had in 1763.


Creating those convenience takes a lot of capital, most of which is probably owned by public companies. So my guess is that even with a fixed money supply, yes, the fraction of the economy's whole money supply invested in those public companies (i.e., the stock market) has grown to meet our desires for a better life, which we have achieved.


Will it continue to rise (in real terms)?


Unknown. In the future, we may reach a point of satiation, where we feel we no longer need the next newest thing (stimulated by smellovision?), or want to live even longer, but I think that is a long way off. So, we have quite a while of *potential* rise ahead of us.


But in the near term, our upward rise in quality of life is leveling off as liberties are lost. We may degenerate into oppressive police states that make the Iron Curtain countries look like libertopia. When it is no longer your choice how much health care you want to pay for, but are forced by taxes to pay and the decision of whether and how much you receive are left to death panels, our quality of life in that area will be lower. The profits of the health care industry will disappear and their market cap with them. Rising national debt means our children are born with government having already promised to wring from them hundreds of ounces of gold worth of their future production. Slavery is not conducive to prosperity.


Will we stop hiring thugs with guns to enslave our fellows, and thus enslave ourselves? If so, we may regain our upward march. If not, with nothing left over to save after government has wasted it, there will be nothing to invest. We will spend our income on desperate immediate needs and not invest in future comforts. Capital will be consumed in the process. We will find ourselves with a lower standard of living, and a lower aggregate stock market.


I didn't even have to refer much to a fixed money supply to see this. In part, that just makes the measurement easier. In part, flexible money supply is just a symptom of our flexible morals. Promises to repay in the future are changed in value by the whim of the central bank. When people are robbed by inflation there is less outcry than when they are robbed by taxes, which is less than when they are robbed by an individual. The criminals are getting smarter. The more they win, the more we lose. But if we can go back to honest money, we will thrive with honest contracts, and we will have honest growth in our living conditions.

18 Comments – Post Your Own

#1) On June 12, 2013 at 2:58 PM, Valyooo (99.35) wrote:

I disagree with your concluson though.  I totally agree that we are better off today as  a society than we were 50 years ago.  What I am talking about is the price level of something like the S&P.  Japan is surely much better off today than they were 25 years ago....yet their stock market is still down from then.  Yes, WEALTH is increasing, I am not arguing that at all.  If in one year my company makes $5 in profit and I use that $5 to buy a house, then the next year I make $5 profit again and use that to buy a car, then the next year I make $5 profit again and use that to buy a car.  At the end of year 3 I have a house, a car, and a boat, which is more than just the house I had at the end of year 1, so I am wealthier.  But if the p/e of my company was fixed at 10, and clearly I made the same profit each year, the value of my company was fixed at $50, so it did not increase

Report this comment
#2) On June 12, 2013 at 3:05 PM, Valyooo (99.35) wrote:

Also, I don't see why population has anything to do with it...if anything, population growth  would make the stock market go DOWN

 

Kim is in charge ofa  running the factory, 7 other people work for her. They produce 8 chickens in total, which are to be sold for $2 each. Each worker makes $2 (kim also makes $2) and the workers each use that $2 to buy a chicken. Total profit in the economy: $2

Now lets say same amount of money, but twice the amount of people (16) 15 people produce sixteen chickens and kim manages them, the chickens now only sell for $1 (because there is the same amount of money but twice the amount of goods), and each earn $1 for their services (kims profit too is $1).

 

So an increase in population should move the total market cap down not up 

Report this comment
#3) On June 12, 2013 at 3:05 PM, Valyooo (99.35) wrote:

Also, I don't see why population has anything to do with it...if anything, population growth  would make the stock market go DOWN

 

Kim is in charge ofa  running the factory, 7 other people work for her. They produce 8 chickens in total, which are to be sold for $2 each. Each worker makes $2 (kim also makes $2) and the workers each use that $2 to buy a chicken. Total profit in the economy: $2

Now lets say same amount of money, but twice the amount of people (16) 15 people produce sixteen chickens and kim manages them, the chickens now only sell for $1 (because there is the same amount of money but twice the amount of goods), and each earn $1 for their services (kims profit too is $1).

 

So an increase in population should move the total market cap down not up 

Report this comment
#4) On June 12, 2013 at 5:12 PM, ChrisGraley (29.65) wrote:

I don't have a ton of time right now, but the question is unanswerable without a government that could function without ever increasing revenue. I don't think our government could ever adapt to that situation. Without that key requirement, government would eat the s&p faster than the prosperity of a secure money supply.

 Valyooo re-read your post above. You would have a house, a car and a car. LOL

Also, in your example you assume that everyone born would be hired to make those chickens, but that would probably not be the case. If we can only hire 12 people to make the 16 chickens, then 3 people would have to get subsidized chickens and the other 13 would effectively pay for those as well. That's not a big deal with an unlimited resource, but could cause problems with finite resources. If you have a limit to the supply side of the equation, then the demand side could overwhelm it.

 

Report this comment
#5) On June 12, 2013 at 5:20 PM, Valyooo (99.35) wrote:

Woops, I meant to say a boat and a car, lol.  But two cars is fine with me too!

 

Also, then, why does the s&p seem to outpace price inflation?  The natural chain of  what I showed is more money = higher price, level people = less price, more productivity = better well being but same price.  So how come the s&p has outpaced price inflation?  It should be that price inflation and s&p stay the same, since after all, the amount you pay for a share of stock is a price...so why is it that this good seems to outpace the price of other goods?

Report this comment
#6) On June 12, 2013 at 5:33 PM, ChrisGraley (29.65) wrote:

LOL, OK, you drew me back in for 1 more.  In our current economy you buy a business at a multiple of earnings. So in a perfect world with a fixed money supply if you were paying 5 times earnings you would just be looking at growth. In our imperfect world you would pay a multiple of both growth and inflation. It's easy to outpace inflation when you are paying a multiple of it. 

Report this comment
#7) On June 12, 2013 at 5:45 PM, Valyooo (99.35) wrote:

I don't think that's right...otherwise p/e would be constantly expanding.  If I am buying a stock index (so aggregate, no profit growth in fixed supply) then you add in 3% monetary inflation, it should lead to the stock increasing 3%, as well as all other things increasing 3%.  If production lead to decreased prices, everything would fall 1%, including stocks which also have a price.  So in effect everything should be the same....monetary inflation of 3%, goods price increase 2%, stock price increase 2%

Report this comment
#8) On June 12, 2013 at 6:36 PM, ChrisGraley (29.65) wrote:

p/e would stay exactly the same. Stock price would increase and earnings would artificially increase, but what you would pay for those earnings would be the same multiple unless your criteria changed,

Report this comment
#9) On June 12, 2013 at 6:52 PM, Valyooo (99.35) wrote:

yeah, exactly....stock price increases, but so does the price of everything else...but it seems over the years, that stocks outpace inflation of other things.  This could be wrong, but it is what I was lead to believe.

Report this comment
#10) On June 12, 2013 at 7:09 PM, ChrisGraley (29.65) wrote:

Yes it does. You are right. If I pay $5 for $1 in earnings and 20% of those earnings were because of inflation. Then without inflation I would have paid $4 for 80 cents in earnings. I outpace inflation because I pay a multiple of it.

Report this comment
#11) On June 12, 2013 at 7:20 PM, rfaramir (29.26) wrote:

Your chicken example conclusion looks wrong. With twice as many people and chickens, but half price, the average price is down but the "total market cap" is constant. Instead of 8 2-dollar chickens it is 16 1-dollar chickens, isn't it? The total market cap measured in fixed dollars is constant, while measured in chickens has doubled. The prosperity measured in chickens per person is still 1 per person, so that is constant, but per capita prosperity in dollars *appears* to have gone down by half. But really, the dollar has gotten stronger by a factor of two, so the truth is everyone is as well off as before.

 

If your picture of Japan is complete, it makes sense. The people are getting wealthier in material terms, but the producers are valued at a lower level than before because the owners of stock see less future profits being distributed to them as the whole structure of production is weakened. Sounds like capital destruction and high consumer spending. The Japanese may be putting their cash into undebasable assets (material wealth) and investing less. A natural reaction to monetary shenanigans.

 

"price level of something like the S&P" is rather problematic. Like the chickens example, if the average goes down, it does not imply that the total goes down. If a company on the S&P 500 splits itself in two and both halves remain on the list, then one small company (the former 500th) gets bumped off, resulting in a lowering of the total S&P market cap and a lowering of the average, but no change in the whole market's market cap. If it is small enough that both halves fall off the list, then a new company joins the list (smaller than the combined company) lowering the former S&P 500 market cap and lowering the average, but again, no change in the whole market's cap.

In fact, any good that suddenly is marketed and sold in smaller (cheaper) units, but in the same amounts, changes nothing for real in the market, but the "average price level" lowers. Your measuring stick is rather meaningless.

Report this comment
#12) On June 12, 2013 at 10:42 PM, ElCid16 (95.85) wrote:

#4 - I don't have a ton of time right now.

2 hours later...still posting.

http://24.media.tumblr.com/tumblr_mcrqsrU0yp1riom23o1_400.jpg

Report this comment
#13) On June 12, 2013 at 11:53 PM, Valyooo (99.35) wrote:

Chris , 

 

in your example price inflation went up 25% and stocks also went up 25%....so in percentage terms they went up the same amount, no?

elcid, that picture is awesome haha 

Report this comment
#14) On June 13, 2013 at 12:00 AM, Valyooo (99.35) wrote:

In my chicken example yeah 16x 1 of course equals 8 x 2. But 16x1 with 16 workers means all 16 workers make $1, whereas before 8 people each made $2. So if each worker was its own company selling 1 chicken, then each persons profit went down to $1

Report this comment
#15) On June 13, 2013 at 1:49 PM, rfaramir (29.26) wrote:

But the profit did *not* go down. Due to falling prices, each dollar purchases twice as much in real (chicken) terms. A measurement half as large with a measuring stick twice as large is no change at all. It *appears* to have gone down only.

 

The measured value of the chicken-producing companies gets cut in half, but their actual value does not. Their price in stronger dollars goes down, as does the income of the workers/owners, but there is no essential change. A day's wage still buys a day's food (assuming you feed your family on 1 chicken per day).

 

Of course, if you have a debt denominated in dollars, you are quite dismayed at this rise in the value of a dollar! It effectively doubles your debt! If you owed $2 before the population change (say it takes 10 years for the population to double and the debt is a 10-year note and you paid the interest as you went along like a bond), instead of owing one chicken (day's wage) you owe two. Instead of tightening your belt one work week to make 4 chickens make do for 5 days' meals, you have to spend 2 weeks doing so (or make 3 chickens last 5 days).

If you're the lender, you're quite happy with the rise in value of the dollar! Say your family went a little hungry for a week 10 years ago so you could lend your neighbor $2 to buy his 6-year old daughter a bike, in return for interest (his mowing your lawn 4 times a year) plus principal returned in 10 years. You had planned on using the principal repayment as a down payment on a used car for your 16-year old daughter. But you find that instead, it buys half the car! Nice!

 

In summary, your economy got twice as big, both in terms of producing companies and consumers. Everyone is exactly as prosperous as before (works for one meal a day of the same quality: one chicken). The former S&P 8 (the first 8 companies) is now measured at half as large, but the whole market, the new S&P 16, has the same total market cap as before, just an average price of half the former average. This lower average (same total) really represents twice the productive capacity (16 chickens/day instead of 8), but you have twice as many consumers, so per capita income is still 1 chicken per day per person. A measurement that looks like half as large, but is worth the identical amount.

So, the fixed money supply does not affect the total value of the productive companies, nor the total wealth nor the income of the consumers. Just prices change.

Report this comment
#16) On June 13, 2013 at 2:20 PM, Valyooo (99.35) wrote:

You're missing my point.  I am fully aware that if the profit goes down by 1/2, and the purchasing power goes up by 1/2, the value is still exactly the same in real terms.  But I buy stocks for NOMINAL reasons.  If I bought a stock and it went down 50% but my purchasing power went up 70%, I wouldnt say "woohoo, I am richer in real terms!"  I would say "wtf, I should have just stored my savings in the form of gold rather than buying stocks".  Because gold would have stayed the same while its purchasing power increases, while stocks would go down even if their purchasing power increases, so I would be better off with gold, so I would just stash gold rather than buy stocks.

 

You also said "just price changes".  Is the price of a stock not a price? 

Report this comment
#17) On June 13, 2013 at 2:58 PM, rfaramir (29.26) wrote:

Valyoo: 'If I bought a stock and it went down 50% but my purchasing power went up 70%, I wouldnt say "woohoo, I am richer in real terms!"'

Of course, not, because you'd be POORER!

Your purchasing power has to go up 100% to match a 50% decline in asset nominal value. 70% instead is a loss.

 

"I should have just stored my savings in the form of gold rather than buying stocks"

True. But holding a dollar is as good as holding gold, with fixed money supply (assuming fixed gold supply and demand). And you can't eat money, whereas you can eat a chicken a day. So, you'd probably be better off living on the profits of the company you purchase than trying to live as long as the dollar amount would last you.

 

"Is the price of a stock not a price?"

Of course. But you weren't clear about (or I didn't hear) what you meant by "aggregate stock market rise". The stock market is not a single company. You did not specify whether average price or total market cap should be used (which I covered). You also did not specify what measuring stick to use to determine whether it rose, dollar (nominal) or chicken (real).

 

But even with these clarifications, this is not like most people's questions about a fixed money supply. When they complain that there is "not enough money" (or specifically "not enough gold"), they seem to think that the fixity of the money supply will hurt the stock market or the economy or the well-being of the people. It does not.

Report this comment
#18) On June 13, 2013 at 6:40 PM, Valyooo (99.35) wrote:

Well it doesn't hurt the stock market, but it doesn't help it either. Nominal is the only thing that matters. If my decision is hold gold (btw I've been assuming gold = money) or hold an asset which is likely to go down in value, the decision becomes purely nominal. And in the example above (well In the first one I got profit being halved) stock market either goes nowhere in aggregate (if you're right) or down (if I'm right) 

keep in mind I am NOT advocating for fed inflation just to boost the stock market, I'm just trying to figure out if money supply is all that moves the agreggate 

Report this comment

Blog Archive

2013
June (1)
2011
October (1)

Featured Broker Partners


Advertisement