For Every Debit….A Credit (somewhere) – Accounting For Stock Gains

I always get a kick out of this type of article “Dow Will Hit 60,000 In 20 Years“. Hooray…we’re all saved right….all you have to do is keep pouring 5-10% of your income into your 401k, and we will all retire like kings…say the current kings…happy to get rich skimming a bit off the top.

So…let’s imagine for just a moment that we woke up tomorrow, and the DOW…along with the rest of the stock market pulled a clean quadruple…and we hit Dow 60,000. Hooray…we’re all rich. We can all hire maids, nannies, gardener’s, and best of all, a couple Bugatti Veyrons to park in the garage of our fancy new houses. Right??

That sound great, and kinda makes sense, but to the accountant in me…I’m always wondering…what’s the other side of the entry, because for every debit, there must be a credit. So let’s think our way through it. We wake up in the morning, and the stock market has quadrupled, but nothing else has changed. We still have the same factories, machinery, buildings and shops. The stock of tangible assets is the same.

So….let’s look at two nearly identical families who have made different investment decisions. Family A has decided to invest their savings in real estate, owning free and clear a $250k home. Family B, on the other hand, has decided to invest their savings in the stock market…also $250k.

When these families wake up the next morning….they suddenly find themselves very unequal. Family A more or less feels the same….for now. Family B, on the other hand feels like they have won the lottery…just like every other owner of stock. Family B’s wealth is now 4X of Family A….all else equal. On this, I think we can agree. What may not be so apparent is that while Family A’s wealth…as measured in dollars appears to have stayed the same, the truth is, their wealth has been severely diminished by the rise in the stock market.

Lets step back and look at the economy as a whole. Assume that before the stock market quadrupled, there was $20T of wealth…$10T tangible (physical assets), and $10T intangible (stocks) After the event, the measured wealth is $50T…$40T intangible, and $10T tangible. At least…measured in dollars. But currency is…as a measuring tool, a pretty piss poor device. Over time, a secondary reallocation event will occur, making it crystal clear that no new wealth has been created. The spike in the stock market simply results in a transfer of real wealth to stock owners, at the expense of non stock owners.

Let me present another similar example…lets go back to the 2003-2008 time period…where the price of oil went from $30-150 (and ultimately back to $30) Economists and pundits screamed as each milestone was broken. $40, $50, $100, $125…. They would go on and on about how this hurt the consumer, and was hurting the economy. They obviously hadn’t been to Houston. I was in oil and gas at the time, and while the pain the consumers were seeing were real….there is a debit for every credit. As the price of oil rose…consumers saw their wealth decreasing….it took more hours of work to pay for the same amount of fuel. The oil business saw the other side of the equation….Our work was suddenly valued more…the one bbl of oil that used to only buy a dinner at Chili’s with the missus….could now buy dinner and booze at the nicest steakhouse in town. Wealth had been transferred from one large diverse population…consumers, to producers of oil. Ignoring the international aspect and looking globally….I would say that more or less…no wealth was created or destroyed. Wealth remained the same, but was reallocated among the”winners” and “losers”

Now, our two examples have used very large divergances…the price of oil going from $30 to $150 and a theoretical quadrupling of the stock market to illustrate the mechanism of what is going on at a much smaller scale all day every day….prices of everything are constantly in flux….both against the dollar (which itself changes), and more importantly, against each other. All of these result in small, and typically invisible transfers in wealth from the losers to the winners.

So…let me wrap this up and try to make my point. I guess I am saying that from a global perspective….it makes absolutely no difference what the stock market does….certainly not in the short run, and probably not in the long run. Today…the stock market is up about 0.5%. So owners of stock are obviously a little bit richer, and not so obviously non stock owners are a little bit poorer. If tomorrow stocks are down 0.5%…the exact opposite will happen. This is a completely different reality than the market myth that has been perpetuated for nearly a century….that a rising stock market creates genuine wealth for all. It doesn’t, it never has, and it never will. Economists, like most homo sapiens are quick to count the debit they can see while ignoring the credit just out of sight. The truth is, the stock market is just like the horse track, only the race never ends. Every day, there are winners and losers, but they all net to zero.