So I was playing around with my spreadsheet and some numbers recently and decided to work out just how much money has been invested in the sharemarket as a proportion of GDP. Of course we remember the time when the Dow hit 10,000 and unemployment was low - but it's currently over 10,000 and unemployment is high. This should indicate something strange going on, not to mention question the idea that the Dow represents the economy.
I couldn't use the Dow index, though. Instead I decided on the Wilshire 5000, which is an index that a) encompasses all shares in all publicly traded markets in the US, not just the top performing ones, and b) comes up with an index number that also closely approximates the dollar value of the entire sharemarket. For example, the W5000 index for 2011-08-18 (last Friday) closed at 11806.16, which approximates $11.8 Trillion. Historical numbers of this broad index can be found at St Louis, as always. So what happens when you look at this index and compare it to GDP? This:
By way of comparison, throughout the 1970s this index averaged around 56% of GDP, and swung between 38% and 83% of GDP. The 1980s and half the 1990s thus saw a W5000 performance not too different from previous experiences. Then from 1995 onwards we have the tech boom, which peaks in 2000 Q1 at over 140% of GDP. Yet there was no decline back to the sub 80s for the long term but a re-inflating of the bubble from 2003 Q1 onwards (which, by the way, occurs around the same time as the Federal Funds Rate drops from 1.75% to 1.25% and then 1.00% for the rest of 2003). A second, lower, peak is reached in 2007 Q2 (108%), which then plunges back down to 58% in 2009 Q1 as a natural result of the 2008 credit crisis. Since then it has re-inflated back up to 92% of GDP in 2011 Q2. Of course, there is a huge chance that this number is going to crash down again.
What appears to have happened is simple - there has been a sharemarket investment bubble that has inflated since 1995 and which has yet to be properly dealt with. My belief is that the higher the sharemarket value to GDP ratio is (as demonstrated by the graph above) the more chance there is of a bust and a damaging recession. Either the sharemarket needs to crash down or GDP has to increase to ensure a more sustainable level. Anything below 50% of GDP should be a policy goal. This can be achieved through a Tobin Tax or a Market Capitalisation Tax imposed upon the sharemarket - with taxation rates increasing the higher the ratio gets in order to prevent runaway over-investment.
This issue also reveals shortcomings in monetary policy. While monetary policy affects the entire market, it affects the financial market and its behaviour directly through its operations. If the market is in the process of over-investing, then all monetary policy ends up doing is re-inflating the bubble, rather than mitigating liquidity issues arising from a deflating bubble. Ideally monetary policy in this situation should create a "soft landing" for the deflating bubble - but in practice it has simply re-inflated the bubble and, as a result, postpones the bubble bursting to a later date.
This issue also reveals shortcomings in fiscal policy. Tax cuts for the rich have not resulted in a substantial increase in money velocity but rather a further investment into the share market.
Finally it also appears that our current economic state is the result of the tech boom's bust. We're paying now for decisions made by the financial market up to 16 years ago. While it is true that the 2008 credit crisis had a more damaging impact upon the economy and upon unemployment than the 2001 recession, we can trace back the credit crisis to the tech boom.
Now the second graph to look at concerns personal saving. I've based this upon the St Louis Fed PSAVE series which measure the dollar amount of personal saving. I've then compared it to GDP. What has happened since 1981? This:
By way of comparison, between 1951 and 1980, the ratio of personal savings to GDP averaged 6.04%, with the lowest being 3.86% in 1951 Q1 and the highest being 9.28% in 1975 Q2. The average between 1980 and today has been 4.27%.
So since 1980 personal savings as a percent of GDP has dropped. In fact it dropped below the 4% level on a more or less continual basis since... 1995 Q2. Now where have we heard of that quarter before? Oh yes... that was when the sharemarket tech bubble started. In recent years the savings ratio has tried desperately to rise above 5% but has gotten no further than 4.84%
My belief is that too much personal savings is bad, but that too little is bad as well. If we assume that the 1951-1980 period was a better period for personal saving then obviously it should increase in these times. But it hasn't. Why?
The first is that we need to look at personal saving at the same time as we look at sharemarket investing. As sharemarket investing has grown so has personal saving dropped. This indicates that people are investing more in the share market than they are in cash.
The second reason is that GDP has grown substantially in response to sharemarket investment. While it has created a "virtuous cycle" for part of that time, it means that ordinary people have had less money in proportion to GDP for them to save.
But here's another graph: Public debt.
One rule of thumb that people over the years have believed in is that when the government goes into debt, the private sector begins to save. Yet this doesn't appear to be true when it comes to personal saving. Since 1980 personal saving as proportion of GDP has decreased, while US government debt has increased. If the rule of thumb worked, then why wasn't there an increase in personal savings?
Well in one sense there was an increase in personal savings - investing in the share market. Share market investing, because it became so attractive, took money away from cash investment.
And the fourth graph is interesting too: The balance on the current account.
By way of comparison, the period between 1960 Q4 and 1979 Q4 saw an average current account surplus of 0.26% of GDP, with a high of 1.06% of GDP in 1975 Q4 and a low of -0.87% in 1978 Q3. Since 1980 the current account has averaged around -2.58% per year, with a high of 0.05% in 1991 Q4 and a low of -6.11% in 2006 Q3.
The first thing to note is that the first drop in the current account between 1984 and 1988 occurred during a time when the US Dollar increased in value. The Plaza accord was signed in 1985 Q3 to reduce the value of the US Dollar. This eventually saw the current account reach a trough in 1987 Q2 and begin to rise again.
The 1997 Asian financial crisis then saw a rush of investment into the US Dollar, which began rising again. By 1998 Q3 the current account had dropped past -2% of GDP. Since then the current account has been deeply negative.
We need to remember that the world cashed in on America's sharemarket boom as well. The current account deficit hid inflation and prevented any meaningful tightening of monetary policy to rein in the asset-price bubble that had formed.
In light of this, what would OSO do?
I couldn't use the Dow index, though. Instead I decided on the Wilshire 5000, which is an index that a) encompasses all shares in all publicly traded markets in the US, not just the top performing ones, and b) comes up with an index number that also closely approximates the dollar value of the entire sharemarket. For example, the W5000 index for 2011-08-18 (last Friday) closed at 11806.16, which approximates $11.8 Trillion. Historical numbers of this broad index can be found at St Louis, as always. So what happens when you look at this index and compare it to GDP? This:
By way of comparison, throughout the 1970s this index averaged around 56% of GDP, and swung between 38% and 83% of GDP. The 1980s and half the 1990s thus saw a W5000 performance not too different from previous experiences. Then from 1995 onwards we have the tech boom, which peaks in 2000 Q1 at over 140% of GDP. Yet there was no decline back to the sub 80s for the long term but a re-inflating of the bubble from 2003 Q1 onwards (which, by the way, occurs around the same time as the Federal Funds Rate drops from 1.75% to 1.25% and then 1.00% for the rest of 2003). A second, lower, peak is reached in 2007 Q2 (108%), which then plunges back down to 58% in 2009 Q1 as a natural result of the 2008 credit crisis. Since then it has re-inflated back up to 92% of GDP in 2011 Q2. Of course, there is a huge chance that this number is going to crash down again.
What appears to have happened is simple - there has been a sharemarket investment bubble that has inflated since 1995 and which has yet to be properly dealt with. My belief is that the higher the sharemarket value to GDP ratio is (as demonstrated by the graph above) the more chance there is of a bust and a damaging recession. Either the sharemarket needs to crash down or GDP has to increase to ensure a more sustainable level. Anything below 50% of GDP should be a policy goal. This can be achieved through a Tobin Tax or a Market Capitalisation Tax imposed upon the sharemarket - with taxation rates increasing the higher the ratio gets in order to prevent runaway over-investment.
This issue also reveals shortcomings in monetary policy. While monetary policy affects the entire market, it affects the financial market and its behaviour directly through its operations. If the market is in the process of over-investing, then all monetary policy ends up doing is re-inflating the bubble, rather than mitigating liquidity issues arising from a deflating bubble. Ideally monetary policy in this situation should create a "soft landing" for the deflating bubble - but in practice it has simply re-inflated the bubble and, as a result, postpones the bubble bursting to a later date.
This issue also reveals shortcomings in fiscal policy. Tax cuts for the rich have not resulted in a substantial increase in money velocity but rather a further investment into the share market.
Finally it also appears that our current economic state is the result of the tech boom's bust. We're paying now for decisions made by the financial market up to 16 years ago. While it is true that the 2008 credit crisis had a more damaging impact upon the economy and upon unemployment than the 2001 recession, we can trace back the credit crisis to the tech boom.
Now the second graph to look at concerns personal saving. I've based this upon the St Louis Fed PSAVE series which measure the dollar amount of personal saving. I've then compared it to GDP. What has happened since 1981? This:
By way of comparison, between 1951 and 1980, the ratio of personal savings to GDP averaged 6.04%, with the lowest being 3.86% in 1951 Q1 and the highest being 9.28% in 1975 Q2. The average between 1980 and today has been 4.27%.
So since 1980 personal savings as a percent of GDP has dropped. In fact it dropped below the 4% level on a more or less continual basis since... 1995 Q2. Now where have we heard of that quarter before? Oh yes... that was when the sharemarket tech bubble started. In recent years the savings ratio has tried desperately to rise above 5% but has gotten no further than 4.84%
My belief is that too much personal savings is bad, but that too little is bad as well. If we assume that the 1951-1980 period was a better period for personal saving then obviously it should increase in these times. But it hasn't. Why?
The first is that we need to look at personal saving at the same time as we look at sharemarket investing. As sharemarket investing has grown so has personal saving dropped. This indicates that people are investing more in the share market than they are in cash.
The second reason is that GDP has grown substantially in response to sharemarket investment. While it has created a "virtuous cycle" for part of that time, it means that ordinary people have had less money in proportion to GDP for them to save.
But here's another graph: Public debt.
One rule of thumb that people over the years have believed in is that when the government goes into debt, the private sector begins to save. Yet this doesn't appear to be true when it comes to personal saving. Since 1980 personal saving as proportion of GDP has decreased, while US government debt has increased. If the rule of thumb worked, then why wasn't there an increase in personal savings?
Well in one sense there was an increase in personal savings - investing in the share market. Share market investing, because it became so attractive, took money away from cash investment.
And the fourth graph is interesting too: The balance on the current account.
By way of comparison, the period between 1960 Q4 and 1979 Q4 saw an average current account surplus of 0.26% of GDP, with a high of 1.06% of GDP in 1975 Q4 and a low of -0.87% in 1978 Q3. Since 1980 the current account has averaged around -2.58% per year, with a high of 0.05% in 1991 Q4 and a low of -6.11% in 2006 Q3.
The first thing to note is that the first drop in the current account between 1984 and 1988 occurred during a time when the US Dollar increased in value. The Plaza accord was signed in 1985 Q3 to reduce the value of the US Dollar. This eventually saw the current account reach a trough in 1987 Q2 and begin to rise again.
The 1997 Asian financial crisis then saw a rush of investment into the US Dollar, which began rising again. By 1998 Q3 the current account had dropped past -2% of GDP. Since then the current account has been deeply negative.
We need to remember that the world cashed in on America's sharemarket boom as well. The current account deficit hid inflation and prevented any meaningful tightening of monetary policy to rein in the asset-price bubble that had formed.
In light of this, what would OSO do?
- Institute a Tobin Tax or Market Capitalisation Tax to dissuade over-investment in the sharemarket. Rates would be increased the more the market over-invests. This money would, at the moment, be useful in paying off government debt.
- Create a currency board to control US currency. This would not be an abandonment of a floating currency and nor would it be a return to Bretton Woods. Instead a currency board would act to ensure a balanced current account by entering the Forex market and either buying or selling US dollars in response to current account fluctuations. The US would also take the lead in creating a new world trade agreement to ensure that all major industrialised nations would institute currency boards to do the same thing for their own currency zones: ensure balanced current accounts (rather than current account deficits or surpluses). I go into more detail on this idea here.
- Create more broad-based monetary policy to ensure a wider scope for its effect: Quantitative easing needs to do more than just buy back government bonds - it could also be used to directly fund treasury, to create banks or even be used in Keynesian stimulus programs.
- Regulate the financial industry to dissuade the ponzi-like nature of modern financial investment. More details here.
- Expand government services with a commensurate increase in taxation to create another "New Deal". A minor "Total War" economy needs to be examined again, though with money being spent on growth (and obviously the environment and global warming) rather than on military equipment and wars. More details here.
1 comment:
Just wanted to say how much I enjoy your blog, having recently discovered it. I've no time for cogent commentary at the moment, but I'll be back.
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