The Speculator Republic
Short term movements in the stock market don’t tell you much, and one of the main things they don’t tell you is how to make public policy.
The idea that a given policy can be justified by its impact on the stock market, or that movements on the stock market in and of themselves call for (usually pacifying) public policy is one of the great fallacies of our time.
The “fiscal cliff” farce is a prime example, with lawmakers urging a deal on the grounds that stocks would fall if one was not forthcoming and analysts nodding their heads approvingly when news of the deal, at best a temporary balm, was met with a sharp rally in stocks on Wednesday.
This is a bit like doing your grocery shopping, or better yet your retirement planning, entirely at the behest of a four-year old. You will get an interesting basket of food or investments but the sugar buzz will eventually wear off.
The stock market will never, at least in the short term, react positively to good long-term decision making, nor will it greet happily the debt reduction which will ultimately have to happen in the US
Not only is the stock market not a very good oracle of what is good for the country, it is often not even a very good predictor of what will be good for the stock market. The stock market, you might remember, loved subprime mortgages and the housing bubble. For a time too, back in the last millennium, it loved high cash burn rates in internet stocks.
It is also, generally, pretty positive on a steady march upwards in company earnings, even if, as so often is the case, this is done by hollowing out the franchise of companies by skimping on research and investment. That’s not good for companies, the economy or the country, but don’t look to today’s trading news for a clue about that.
The stock market will never, at least in the short term, react positively to good long-term decision making, nor will it greet happily the debt reduction which will ultimately have to happen in the US This is not a comment on the fiscal cliff deal, such as it is, or for that matter an argument for more or less austerity, taxes or government investment.
A Cosmic Joke
There are two main problems with using the stock market as a guide to policy. The first, obviously, is that it what is in the best interests of higher stocks today is so often not in the best interests of the wider population. This isn’t simply due to some kind of class conflict between equity owners and the rest, but results from a deep short-termism among investors, executives and policy-makers.
The second problematic mismatch is the stark fact that the stock market is being kept aloft by policy, namely loose monetary policy, but also a raft of other government incentives and guarantees. A given rally might tell you a lot about what Federal Reserve Ben Bernanke is thinking, but it is, compared to 30 years ago, a lot less reliable an indictor of the future health of the economy.
While over the very long-term stock markets might be one judge of policy, and will certainly tell you who wins the wars and who better adheres to the rule of law, over the short term they are dangerous guides to what to do.
This conflation of the stock market with the health of a nation is a legacy of a mix of trends, forces and policies having their roots mostly in the 1980s, many of which have had, at best, mixed results.
One is the move to individualize risk by creating incentives for individuals to invest in the stock market. While that has allowed many companies to get rid of the risks inherent in pensions, the decade or more of low returns has left many staring at a bit of a black hole when it comes to retirement income.
Alan Greenspan also bears a lot of responsibility here, as a man whose instinct as Federal Reserve chief was always to support the market when it fell but never to puncture it when it became un-moored from reality. Bernanke has carried on, though arguably with better cause, propping up the market as a way of staving off depression and deflation.
So if we can’t trust the stock market to tell us how to run the country, perhaps we’d be better off looking at bonds, which at least lack the get-rich-quick spirit.
The great cosmic joke, however, is that if the stock market is light on useful information the bond market is, if anything, even worse. It is a market dominated now by the Fed, which buys to goose growth, and foreign central banks like China’s, which buy to manipulate currencies.
Speculation has its uses, especially if real risk is taken, but a government of speculators, by speculators and for speculators is not a good thing.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com)