At the conclusion of his article, he writes:
While Standard & Poor's downgrade of US government debt has triggered the plunge in the stock market, the underlying cause behind the stock market's sharp decline is loose monetary and fiscal policies that have badly damaged the ability of the US economy to generate wealth.I could not disagree more strongly.
Let us examine Shostak's article point by point. He begins:
On Monday, August 8, the S&P 500 stock-price index fell 6.7 percent to close at 1,119.46. The index fell 13.4 percent from July, and this was the fourth consecutive monthly decline. It has fallen 17.9 percent from its high of 1,363.61 in April this year.I believe it is an error to look at the S&P downgrade as even a short-term cause of the market decline. The market had been declining since late July. On July 22, the S&P500 stood at `1344 on August 3, it was down to 1254.
Also, the index's growth momentum has fallen visibly. Year on year, the rate of growth declined to 6.7 percent from 17.3 percent in July.
The trigger for the plunge in stocks was Standard & Poor's lowering of the US Treasuries' rating from AAA to AA+. But while the trigger may have been this downgrade, the key factor that set in motion the plunge in stocks is the sharp deterioration in the state of the pool of real savings as a result of loose monetary and fiscal policies.
Before this break, on July 18 in the EPJ Daily Alert I wrote:
The hikes in interest rates that have been put in place by theA crash in the eurozone was taking shape, with, or without, the S&P downgrade. Further, on the Monday that Shostak refers to, Treasury securities actually went up in value. The interest rate on the 10-year Treasury fell on Friday from 2.58% to 2.40% on Monday. Bottom line there wasn't even a short-term panic out of Treasury securities. The panic was developing out of Europe and started long before Aug.8.
European Central Bank appear to be having an impact.
Italy's euro money supply plunged as has the euro money supply in France.
Real M1 deposits in Italy have fallen at an annual rate of 7pc over
the last six months, faster than during the build-up to the great
recession in 2008.There have also been sharp contractions in Austria
and Belgium. The Netherlands and Germany are negative.
This signals a likely stock market crash in the eurozone and
recession. It will also make it near impossible for the PIIGS to come
anywhere near meeting their austerity goals. The euro crisis looks
like it is about to intensify significantly.
Any weakness in U.S. markets because of weakness in the Eurozone or
China should be considered a buying opportunity in the states. U.S.
monetary policy is falling out of lockstep with China and the
EuroZone. The accelerating U.S. money supply will overcome the
localized weaknesses of China and the Eurozone and cause serious price
inflation here in a manipulated upward stock market and economy.
Shostak also wrote in the above quoted paragraph:
the key factor that set in motion the plunge in stocks is the sharp deterioration in the state of the pool of real savings as a result of loose monetary and fiscal policiesLoose monetary policies never have a negative influence on the stock market. There may be countervailing factors resulting in a market going down, but adding money to the system always pushes markets in an upward direction, not downward.
Secondly, it is not the case that there is a direct correlation between loose monetary policy and a deterioration in the pool of savings. There are distortions in where savings end up as a result of money printing, but not necessarily deterioration. Indeed, it is clear that under many scenarios loose money has different impacts on real savings. For example, if money printing fuels a housing boom, then those buying houses may very well be using their funds for down payments which is a form of an increase in real savings.
Shostak also writes:
As economic activity slows down, the demand for the services of the medium of exchange that money provides in the real economy declines. Therefore, a surplus of money or an increase in monetary liquidity emerges. As a rule this surplus is put to work in financial markets, including the stock market."Economic activity slowing down" is not, as an Austrian, a term I would generally use. It is excessively aggregative and confuses the issue. I think what Shostak is discussing is a recession. During a recession, it is not a case that "the services of the medium off exchange that money provides in the real economy declines". It is that people are scared out of their wits and actually the demand for cash balances, i.e. money, increases. When cash balances increase, there is less liquidity---and there is no increase in "monetary liquidity" which puts "surplus" money to "work in financial markets, including the stock market."
I think Shostak is completely confused on this point. But Shostak claims this liquidity during a downturn, which I don't think exists, pushes "the prices of financial assets and stocks...higher."
Shostak then goes on to use some very aggregative data that I have always questioned, including the highly dubious aggregate, the industrial production number, to determine "yearly rate of growth of surplus money". Since this "surplus money" is going into cash balance, I find it a highly unusual to use this as an indicator of stock market strength. It would seemingly be the opposite.
It is true, as Shostak points out. that if the "real pool of savings" is shrinking, this will have a negative effect on the economy and stock market. But Shostak also readily admits that "we cannot quantify whether the pool of real savings is currently expanding or stagnating."
There is probably a long-term decline in the real pool of savings, given ever expanding government, growing oppressive regulations, etc. But I see no correlation with this decline and increasing money supply. Thus, I see Shostak's warning about the decline in the real pool of savings as a result of increasing money supply to be misplaced. Real savings are declining, but that has been going on for a long time, no new major drop in real savings is indicated by current Fed activity. Thus, unless there is a new increase in the demand to hold cash balances, always possible, but it doesn't appear likely at present, current acceleration in money growth is most likely to result in a manipulated economic boom and a strong stock market.
Robert Wenzel,
ReplyDeleteDo I get a finder fee for this article? J/k
Thank you for your thoughts.
Which money supply figure do you prefer; M1, M2, or TMS (now AMS?)?
@Zach Bush
ReplyDeleteYou get a free subscription to this blog.
I prefer M2, but I consider it a very rough guide.
Is it not the case that when you increase the money supply and spend it, you are essentially taking purchasing power from savings and therefore decreasing the supply of savings? Thank you for your time.
ReplyDeleteI think there are some misconceptions about Shostak's article. It think they originate from a misunderstanding of what Shostak means when he uses various phrases. I can say this because I myself got misled the same you did about an article he wrote last year or the year before, and I was corrected.
ReplyDeleteBy "increase/decrease in real savings," Shostak is referring to a growing/shrinking supply of consumer goods that sustain workers while they produce with an eye to the future.
By "demand for the services of the medium of exchange that money provides," he is referring to transactions demand for money, which in other words just means money spending on real goods.
So when he writes:
"As economic activity slows down, the demand for the services of the medium of exchange that money provides in the real economy declines."
what he is referring to is exactly what you tried to correct him on, which is that during a recession, the demand for money holding goes up, and spending on real goods goes down. The connection to ABCT here is that when the Fed engages in "money pumping" (to use his terminology), it diverts money and spending to projects which cannot be completed because there are not enough "real savings" (i.e. consumer goods) to enable a lengthening of the economy's productive structure to be maintained. The economy is not productive enough in real terms yet. So once the originally diverted resources to higher stages of production requires more complimentary resources, they are not available, because consumers are not able to be sustained with consumer goods while they are working towards the artificially created future orientation of the economy.
Shostak then writes:
"Therefore, a surplus of money or an increase in monetary liquidity emerges. As a rule this surplus is put to work in financial markets, including the stock market. Consequently, the prices of financial assets and stocks are pushed higher."
Here is writes that typically what happens with a relatively large increase cash holdings on the part of those who invest, is that this money is then typically used to buy financial assets (since most cash holdings take place within business firms, who tend to use their excess cash to buy financial securities, rather than capital investment in their own firms). Of course, not all the money holdings are then used in this way.
Part 2:
ReplyDeleteNext up, you quote Shostak as writing:
"the key factor that set in motion the plunge in stocks is the sharp deterioration in the state of the pool of real savings as a result of loose monetary and fiscal policies"
To which you replied with two points. Your first was:
"Loose monetary policies never have a negative influence on the stock market. There may be countervailing factors resulting in a market going down, but adding money to the system always pushes markets in an upward direction, not downward."
Now, Shostak isn't saying that money printing doesn't goose the stock market. You and him will agree with that. What he is saying is that previous money printing and fiscal deficits weakened the overall productivity of the economy, which reduces the production of consumer goods, which, as we have seen, is what he calls real savings. I am sure that you will agree that inflation and deficits distort the economy and make it less productive.
Shostak is just saying that a weakening economy on account of such government intervention in the past will result in a future declining real productivity of the economy, hence a relative decline in the production of consumer goods (what he calls "real savings") that are available to sustain workers as the structure of production lengthens (on account of Fed "money pumping") and fewer workers produce in the consumer goods industry relative to the capital goods industry. Thus, the "pool of real savings declines due to money pumping and fiscal deficits."
What you are talking about is the short term nominal goosing of the stock market on account of money printing. Shostak will agree with you on that.
Your second point was:
"Secondly, it is not the case that there is a direct correlation between loose monetary policy and a deterioration in the pool of savings. There are distortions in where savings end up as a result of money printing, but not necessarily deterioration. Indeed, it is clear that under many scenarios loose money has different impacts on real savings."
What Shostak meant was that inflation and fiscal deficits results in more money going to relatively less productive economic actors, and less money going to relatively more productive economic actors, in terms of economic sustainability (not necessarily individual talent). Loose money leads to real wealth being invested in unsustainable (i.e. anti-wealth generating) projects, which of course means less real wealth being invested in sustainable (i.e. wealth generating) projects. Fiscal policies does the same thing, because it also overrules the free market process of competition and optimal real wealth allocation.
He holds (correctly I think) that only the free market process of competition can maximize real wealth going to wealth generating activity and minimize real wealth going to wealth consuming activity. But inflation and fiscal deficits overrules this process, and leads to less resources being devoted to wealth generating activity, and more resources to wealth consuming activity.
Part 3
ReplyDeleteAs a part of your second point, you write:
"For example, if money printing fuels a housing boom, then those buying houses may very well be using their funds for down payments which is a form of an increase in real savings."
Shostak will disagree with you for saying "increase" in real savings. Shostak will argue that the loose money that leads to a housing boom will result in more scarce resources being diverted to non-wealth generating activity (in the long run, the context he always writes) which of course means fewer scarce resources going to wealth generating activity.
Yes, a housing boom could engender a diversion of real savings to housing, in the form of down payments, but that just means more savings are going to wealth consuming activity (since the housing boom was not created by real savings, but by money printing) and thus less savings go to wealth generating activity.
I, and probably Shostak as well, vehemently disagree with you that loose money will not necessarily deteriorate real savings (if by real savings we mean "consumer goods that sustain workers in a (quasi-permanent) lengthened, more capital intensive productive structure.") ABCT is a theory that loose money does just that. I'm certain you will agree that loose money has real effects on the economy, because money is not neutral.
Loose money and fiscal deficits lead to more investment redirected to unsustainable projects, or what Shostak calls "wealth consuming activity", and less investment to sustainable projects, or what Shostak calls "wealth generating activity." Shostak will definitely call the housing boom "wealth consuming activity" even if real savings are diverted to housing (down payments) and even if loose money raises the nominal incomes in housing.
Finally, when you write:
"There is probably a long-term decline in the real pool of savings, given ever expanding government, growing oppressive regulations, etc. But I see no correlation with this decline and increasing money supply."
I think that's just wrong. When the Fed System inflates, that leads to more resources being devoted to wealth consuming activity, and fewer resources to wealth generating activity. Real wealth was squandered during the housing boom. That means resources that could have been used to sustain workers so as to maintain a lengthened productive structure, are instead diverted to higher stage capital goods that cannot be completed. Time preferences have not increased, which means workers want more consumer goods, not more capital goods (i.e. future consumer goods). The end result is a reduction in real savings (consumer goods).