The Ultimate Transparency for Capitalism
Barry Ritholtz is talking about the Bull market coming to an end. It is no surprise to me. My equations of effective demand may finally be cracking the code of the business cycle. But I want to say that knowing where the business cycle ends is the ultimate transparency in capitalism.
Barry, as usual, makes intriguing comments…
“Why the sudden shift, from excess bullishness and exuberant expectations of more double-digit gains, to a recognition that perhaps the party won’t go on forever? You humans seem to desperately search for a simple narrative that explains complex events of unknown causation.”
Yes, the question sounds forth… “What the heck is happening?” The answer is quite simple. The effective demand of the economy is showing its constraints. Labor share has fallen so much that we will not return to what used to be considered full employment. This limit could have been known years ago as the recovery was taking shape.
He concludes…
“Hence, a correction is not simply the random meanderings of a complex system comprised of the buying and selling activities of millions of participants, but rather must have been caused by stocks that were too pricey, or earnings that have not lived up to expectations, or the development of big trouble in China. The problem with these rationalizations is that all of these things were well understood by markets — and have been for some time. None are surprises, and none reflect information that is new or was especially unknown previously.”
Not everything was well understood by the markets. They did not understand the effect of a falling labor share. Economists don’t even understand it. Markets thought that lower wages would raise competitiveness and thus increase economic potential. No… they were wrong. Lower labor share constrains production. Economists haven’t even adjusted potential GDP yet.
If it was common knowledge where the business cycle ended, there would be less surprises, . Markets would be less volatile, less disturbing. Stock prices would be more reasonable.
The United States though is reaching the end of its business cycle. I have said that in 2014, stock markets will occasionally fall and then rebound some, until eventually they just keep falling. That is a normal pattern near the end of a business cycle, as many are led to believe there is a tremendous upside… when really there isn’t.
Society as a whole would function better if markets had a wisdom of when the business cycle ends. Actually it would be easier to maintain output at a sustainable level. So much craziness and delusion would go away.
A clear understanding of the effective demand limit upon the business cycle would be the ultimate transparency for capitalism…
and Dare say… capitalism itself would function better…
We haven’t completed the correction, so your bet is still on. If we do it smoothly, then the market has known about your theory all along, if the correction is chaotic, then you win.
Matt,
Smoothly? How can the market correct smoothly when most top economists still think that potential GDP is far far away… the implication is that the economy still has a lot of growth left, so that stock prices should still have plenty of upside. People will get hurt with that view. The correction will be an eye-opening process.
First, the fresh water economists expected high inflation. Many people got hurt. Now the salt water economists expect great potential to get back to full employment. Again many people are being deluded by incomplete economics.
Smoothly will come in the eye of the beholder, as people and economists realize lower economic limits due to lower labor share. … low labor share is a new phenomenon. Not understood yet.
There is no end to the business cycle coming. Corrections are corrections.
John C.
Above I wrote… “I have said that in 2014, stock markets will occasionally fall and then rebound some, until eventually they just keep falling.”
i see those as corrections, but in the long run, there is very little upside to the stock market. If it keeps going up much more from here, you will see an even bigger correction by the end of the year.
So I see weeks like this one as corrections nearing the end of the business cycle.
Where do you see stocks going?
Markets? That is part of the problem. There are pieces of the market, but there are not markets.
Stock market? With 81% of all the trades being computer generated, is it a market or is it simply a machine?
The effective demand limit has always been known, it’s just not been referred to in the way you have. Of course for your model to take hold within the profession, the profession has to come to see “markets” as the make up of people instead of using econo speak words that in English would be considered third person references. Words like “markets” as in:” all of these things were well understood by markets.”
But, then again, putting a human face on their mussing about 1 aspect of the human experience would undermine the decades push to be some Spock like science.
Hell, corrections? Even the game Monopoly comes to an end when the “markets” have no money as the “market” consolidated it all.
Edward Lambert,
Assuming that Mr Market is all knowing is nonsensical on its face. And I stopped trying to guess what the stock market would do next when stock prices went up on good, bad, or indifferent news. For all I can tell, it is tracking the number of virgins in the population.
Economists have fine tuned their models using the data from the period after 1945. Their models actually worked as long as some unstated and possibly unknown prerequisites were met. The more finely tuned their model became, the less likely that they could predict events which had never occurred after 1945. Thus they missed the approaching Great Recession. (We would recognize it as a great depression if there were no unemployment insurance, no social security, no Federal Deposit Insurance Corp, no medicare, and no medicaid .)
I believe that you have been documenting a previously unknown or severely under appreciated prerequisite to any realistic economic model.
Any economic model which assumes an ever present demand is seriously flawed.
Any economic model that assumes an ever present supply of credit worthy and motivated borrowers is seriously flawed. Thus any economic model that assumes that all savings will be borrowed and spent into the economy is seriously flawed.
Consumers can not spend what they do not have, and producers will not produce what they can not sell. Those are elementary truths and economists have been ignoring them.
Capitalism would function better if the effective demand limit was recognized. But the top 1%, their lobbyists, and our elected representatives like the system the way it is. So I don’t expect any change any time soon.
Agree Edward….but where can capital go when states are bankcrupt and interest-rates are down to 0-3%, globaly? How about pension-funds? Will they survive in this environment? No! The stockmarket can and will probably come back after a quick deep correction when centralbanks continues with their missallocations. Next time with negative interest-rates….and then later? Probably a global depression!
Jim H,
Agreed,.. we can’t expect any change soon. or ever… The idea of effective demand is a tough one for economists to get their heads around.
Christopher Kamb,
Agreed… money coming back from emerging markets is looking for a place to go, but the stock market itself is going to offer an up and down road over the next months. The best option is to save the money. Setbacks in stocks trigger those with capital to save their income more. That is a step to the next contraction.
With each setback in price, capitalists protect themselves more.