Fairy Tales: Stock Market

The Fairy Tale goes something like this…a rising stock market is good for the economy. As the market goes up, people have more money, spend more money, and the cycle continues. Sounds believable enough. Taking a step back in time back to the 90’s… I was in high school, and according to the news, everyone was getting rich investing in stocks. I recall one friend telling a story about an uncle or 3rd cousin or something who had gotten into day trading…apparently he could make $30k a day. It probably wasn’t true (or was only half true…he also lost $30k a day), but it just didn’t make any sense to me. I understood how companies made money…they produced a product and sold it. But when a stock goes up, where does the money come from? It just didn’t make any sense…it seemed like money was just being created out of thin air.
It wasn’t until much later, armed with the tools of the accounting trade that I was able to work my way through this logical fallacy. So let’s imagine that on a particular trading day, the entire stock market is complately flat, with the exception of one stock that pulls a clean double. It starts the day at $50 a share and a market cap of $1B, and ends the day at $100 a share and a $2B market cap. Hooray right? Without a doubt, the fortunate owners of this stock are ~$1B better off. But….back to accounting 101… for every debit…there exists an evil twin….a credit…somewhere. The reason the fairy tale persisists is because the credit is not as obvious as the $1B debit the owners of the doubling stock, but it exists nonetheless. The credit manifests itself as a type of inflation….while the owners of the stock are $1B better off….after this trading day, the owners of all the other stocks in the universe, and generaly every other person in the world, is just a tiny bit poorer.
The day before, anyone could have purchased the stock for $50…..now it costs $100. Nothing has physically changed in the economic universe. It is the same company, same employees, same manufacturing facility, same revenues, same cash flow….If the price of gasoline doubled, you would immediately recognize this as inflation, and feel a bit poorer, and while the mechanics in the stock market are identical, we tend to categorize this differently.
So I guess what I am getting at is that changes in the stock market do not create wealth, they simply reallocate wealth. We can see this in the clearly by looking at price fluctuations in a single commodity. When the price of oil rises, the relative wealth of owners/producers of oil goes up, while the relative wealth of consumers of oil goes down. These more or less wash, though I won’t pretend the economic system is so perfect that they wash to the penny. The exact same thing happens with individual stocks, or the market as a whole. So as we sit here in April 2013 with the DOW and S&P500 pretty close to “record” high’s (unadjusted for inflation of course), there is no doubt that for owners of stock, this is a good thing. But for the economy as a whole, it’s pretty much a wash. High stock prices are only good for the economy in the same sense that high oil prices are good for the king of Saudi Arabia. If you are the King…it’s not so bad at all. If you aren’t the king, and your tank is empty, it can kinda suck.
You probably are not convinced…a 5 minute blog post isn’t going to change decades of stock market mythology….all I’m saying is think about it. If the entire stock market doubled tomorrow…..would anything really change? Or would the rich just be richer and the poor that much poorer? let it marinate…I’ll probably bring this up again some day.
For bonus points…think about the inverse…the stock market instead tanks…90% tomorrow. Nothing else is changed. The factories, the infrastructure, profits revenues ect…. are all the same, but nobody wants stock anymore…Is it the end of the world, or just a reallocation event? What if it happens over a 10 year period instead of overnight. Write in complete sentences 🙂