Striking Greek + US charts that *really* show why markets are disconnected from the real economy
It is often argued that financial markets are not like the real economy. But when Wall Street is opposed to Main Street it is mostly along the argument that greedy financiers are making money while real people struggle in lower paid jobs. And the world would a better place if bankers were not immoral greedy speculators constantly trying to cheat regulators.
The trouble with this line of argument is that it positions the issue on an ethical ground by actually implying that financial markets would somewhat be neutral by design and unfortunately corrupted by a few rogue agents. In other words, if those bad apples didn’t exist all would be good.
However it might be a bit simplistic to blame recurring scandals, from Madoff to the LIBOR fixing, for this perceived disconnect between financial markets and the real ’social’ economy. Indeed the current examples of the soaring Greek stock exchange and US corporate profits also confirm that the issue is more systemic than just a few fraudsters attracted by the amount of money at play.
THE FACTS:
1 – Greece has been brought to its knees, yet its Stock Exchange is flying like Icarus
The picture could not be starker. On 8 October 2012 the ASE index traded at its highest since September 2011. A ‘rally’ started in June 2012 meaning that investors who put €10,000 on the stock exchange that month, would have sold for €17,800 on 8 October, realising a 78% profit – almost double the sum.
In the meantime, the rest of the country has been on the receiving end of draconian austerity ‘in exchange’ of successive bail-out loans.
The Greek government is anxiously lobbying the “European Commission – International Monetary Fund – European Central Bank” ‘troika’ to agree a further vital €31.5bn cash instalment before November to prevent the coffers from going empty. This agreement is dependent of further cuts into public services, wages and pensions, exacerbating a situation where unemployment is already at 25%, and more than 54% for Greeks younger than 25 are out of a job.
2 – The US economy is said to be in a L-shape recovery (i.e. not getting traction), yet corporate profits have been enjoying a V-shape pattern
If you find the case of Greek stock exchange to caricatural to make the point, there’s always the US to look at. Counter-intuitively to the accumulation of negative news about the car manufacturing going bust, and entire industries needed support and bailout, US corporate profits have never been so big. Whether you look at them in absolute value or as a ratio of GDP, they have been going parabolic: they now account for significantly more than 10% of GDP: that have never happened before.
Yet, in the meantime poverty levels have been steadily rising, so has inequality ( link to Slate’s Timothy Noah ‘The Great Divergence‘ – PDF )
SO WHY IS THAT?
Firstly because of the inherent flaws of publicly listed companies
It is easy to get lost in the rhetoric of ‘ruthless’ financial markets and to miss what exactly makes them work at odds with “real life”.
The oddity of the Greek example is a reminder that publicly companies listed on the stock exchange are primarily exposed to speculation, as opposed to privately owned firms (such as family businesses) or state companies which are more focused on the revenue they get for the service they deliver.
Indeed the system is designed so that most investors totally disconnect the enterprise from the stock, which becomes an abstract concept destined to go up in value (the share price rises) or return dividends a couple of times a year: that is all that matters.
The physical reality of the actually company does not matter to most shareholders: whether costs are cut by sacking staff, or revenue increases thanks to better sales, is kind of nice to know, but the bottom line is that investors demand returns today and more importantly a promise of returns for tomorrow. And it is precisely in this future promise of growth that lays the perversion of the system that gets revealed in extreme cases like Greece.
In June 2012 after the accumulation of bad news Greece elected a pro-bailout pro-austerity coalition led by the centre-right New Democracy party. Mentioning the previous “accumulation of bad news” is important because it meant that the share market plunged and hit rock bottom until that month. In finance lingo, the bad news had been ‘priced’ by the market: enough shit had gone through the fan to the point that nothing could make it worse in the eye of the investors.
If anything, now that the new government had committed to oblige European banks, even more riots triggered by new rounds of austerity would actually be a ‘positive’ signal to the financiers indicating that their debt would be payed back. And this positive signal was exactly the promise of future returns that pushed the stock exchange to speculative heights: people rushing to buy on the calculated bet that even more investors will grab cheap assets, everybody betting that authorities will flood the system with liquidity. Even (especially) if that rally ends-up being a mini-bubble: Quick! While it lasts!
French economist André Orléan has been researching this imperfect market hypothesis and explains it in simple terms: instead of evaluating companies for their ‘fair value’, the game has become to buy before other buy, and to sell before other sell (detailed in this post)
It is precisely because of the inconvenience of such speculation that even the Economist (which you cannot really suspect of leftism) 
questioned the public company model which was invented to provide limited liability and access to public capital to develop the business, but comes at the burdening cost of making that business vulnerable to market fluctuations, outside of anyone’s control.
The soaring US corporate profits also give an insight on the inherent lack of redistribution caused by this financial system
In that case high corporate earnings are generated because the US economy has recovered (and actually better than Europe): the government bail-out followed by a couple of rounds of Quantitative Easing by the Fed have had an effect. The trouble is that those profits are not reinvested in the economy. It is sitting on corporations balance sheets as cash because they’re scared to invest by hiring and starting projects. Even with such low Fed rates, the Obama administration which has been shedding more public jobs that Bush and Clinton could – to quote journalist Felix Salmon ( @felixsalmon on twitter ):
“borrow at 1.45% in vast quantities, and invest that money back into the economy itself. Take a few hundred billion dollars and use it to fix our broken infrastructure, to re-hire all those laid-off teachers and fire-fighters, to provide some kind of safety net for the millions of Americans who have been out of work for more than a year. Even if the real long-term return on any stimulus package was zero, the nominal long-term return would be well over 1.45%, making the investment worthwhile.”
So why is it such a big deal to insist on the gap between finance Markets and the real economy?
After all, if cycles are part of capitalism – like we all have bad days and things become better after a while – shouldn’t we just accept them?
Unfortunately the answer is negative. Because whilst stocks and economic indicators can rise again after hitting the bottom of the pit, the social cost of those downturns is never totally reversible. The time lost by families whose parents are out of work, the youth of the Greek kids wrecked as their country descent into chaos while the banks keep reaping profits will never be given back to them.
To use a loose analogy, it would be like telling a bunch of soldiers about to die in Gallipoli in 1915 that the coming period was just going to be a rough ride and that all would be better in less than 20 years with a great new bridge in Sydney. You find this image absurd? Absolutely it is. But it is exactly the same bullying logic that pushes financiers to treat the social cost as mere variables to adjust, missing that the time wasted during those downturns is disproportionate on the time scale of an individual’s life.
For financiers, markets certainly are their ‘real’ economy, in the same way the fish market is the daily economy of a trawler’s crew. But to have succeeded in imposing them as ‘the’ one and only encompassing economy we all have to abide by is certainly an achievement even more spectacular than the profits they generate for themselves.
{ Sydney – 11 October 2012 }
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