The Problem with the Stock Market
blogmaverick.com
blogmaverick.com
Not really worth reading...
When monetary inflation is running higher than the interest rate on bonds, the Nash equilibrium for stock prices is infinity. More precisely, the Nash equilibrium is for there to be a currency run. It can be somewhat rational to buy stocks even at obscenely low dividend yields, because it is better than holding on to a rapidly depreciating dollar. But if the currency run does not materialize, you are out a lot of dough. We are all victims of an out of control monetary system.
I can see that being the case when the universe of goods consists solely of stocks and bonds (i.e., no other products are available for purchase) and you expect the current situation (interest rates, inflation, etc) to persist into perpetuity.
But, if either of those conditions is untrue I don't see how infinite price is the equilibrium (which isn't to say it isn't just that I don't see how it is).
Mind explaining?
Also, the fact that some prices were increasing doesn't necessarily mean there is inflation. Rising prices could be just as easily explained by real increases in real total wealth while the quantities of some good remained fixed, or at least grew slower than the overall economies rate of growth.
The Nash equilibrium is for the market to select some good other than Federal Reserve Notes to use as a store of value. People can just keep borrowing money, investing it in something like gold, and the price will continue to appreciate in terms of dollars. As everyone start to do that their is a full fledged currency run. The price of everything in dollars heads towards infinity as the dollar becomes worthless. (perhaps worthless is an overstatement as the government might still create some demand by taxing in dollars. But effectively worthless compared to its value now).
This article illustrates more clearly how the scenario can play out: http://www.safehaven.com/article-5205.htm (note that the author's prediction did not happen, because monetary inflation came to an abrupt stop in 2008. Not coincidentally, the stock market proceeded to crash).
Rising prices could be just as easily explained by real increases in real total wealth while the quantities of some good remained fixed, or at least grew slower than the overall economies rate of growth.
The price of good X is simply the ratio at which market actors are willing to exchange X for dollars. For the price to rise, one of four things must happen:
- The supply of X can be decreasing
- The supply of dollars can be increasing
- Demand for X can be increasing
- Demand for dollars can be decreasing
Changes in the supply and demand for dollars we call "monetary inflation".
So if you say the rising prices are some other cause, it can either be the supply of X is decreasing or the demand for X is increasing. Now we know that the supply of gold or real estate is not decreasing. So that leaves us with the possibility that demand is increasing. But the price increase is happening in every category of good - gold, oil, farm land, downtown skyscrapers, copper, stocks, etc. When demand for every good denominated is increasing, that's basically synonymous with saying that demand for dollars is falling.
For further evidence, note that MZM and total credit creation were also rising at ~10% a year. These are both a more direct measure of monetary inflation.
He bolded the main takeaway:
"The beautiful thing about this country is that we like to work hard, and we like to take chances. Unfortunately, over the last 15 years, the incentives have been to take chances as a financial engineer rather than as an entrepreneur. We give far more money to people who play games with financial instruments than we give to people who come up with ideas for the next big thing. That needs to change if we want to remain a leader in this world."
Under the current tax structure, the author believes that investors are encouraged to engage is overly risky behavior. It is not obvious that reducing taxes on a subset of financial instruments will make the rest of the instruments less appealing. The flexibility of the taxed instruments is not necessarily made up for by an increase in the rewards of the untaxed instruments. Massively increasing taxes on the instruments you dislike seems like a more straightforward incentive system.
(I'm not convinced that choice of instrument divides investors into "good" and "bad" categories, but the author's proposed solution seemed like an easier target.)