Focus on the Fundamentals: Income, Not Investments
Felix Salmon comments on the stock market dropping below its November lows:
The fact is that prospects for the economy are much worse than they were in November. As such, it stands to reason that stock prices should be lower than they were in November: if they were much higher, and the Dow was still above 9,000, that would be the real news, since it might imply that the November lows were panic-driven rather than rational.
That’s right, but I think people’s Dow-driven anxieties point to a larger pathology that started at the policy level and has now infected the media and the general public’s understanding of how the economy works.
Historically, the route to higher living standards is higher wages and incomes. When productivity grows, and demand growth is robust enough to keep unemployment low, wages and incomes go up. Corporate profits should go up, too. All this ought to lead to assets increasing in price. If the income of people in the Boston area grows faster than the supply of houses in the Boston area, then housing in Boston is going to get more expensive. If profits grow, so will stock prices. And some people will make money off this growth in asset value. But it will be, more or less, a coincidence. The more expensive Boston area houses could lead to profits for some people who live there and want to sell their homes and move to Tampa. But for many people, it’ll make no difference—they might sell a two bedroom place and reap the benefits of homes increasing in price, but then buy a three bedroom place and suffer the consequences. And for people looking to move to Boston, the run-up in home prices is a bug, not a feature.
But ever since the 2001 recession, we haven’t really had growth in incomes. Instead, we’ve had asset-led growth. People who owned stuff already in 2001 saw the value of that stuff go up. Since they were now “richer” they were able to borrow more. And since they were able to borrow more, they were able to get more stuff. That had a similar result as if their incomes had gone up and they’d used the income to buy more stuff. But it was unsustainable. The lending based on higher asset values was based on the idea that the assets would keep going up in value. And the increase in value was driven by a combination of speculation, and buy the fact that consumption was creating economic activity. But now it’s all collapsed.
And with the collapse has come a powerful urge for action to prop the assets back up. To reinflate the housing bubble. To make the Dow go back above 10,000. But that’s all backwards. What we need is an increase in the amount of demand in the world. With, most likely, foreign countries actually being the main driver of this. And that demand can lead to jobs and income. And if people start earning more money, then soon enough asset prices will go up again. But that would be a consequence of growth, not a cause.
49 Responses to “Focus on the Fundamentals: Income, Not Investments”
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February 20th, 2009 at 4:41 pm
of course that’s correct, but it does leave out the intervening years: if the consumer will no longer be 70% of gdp, what picks up the slack? we’ve spent decades on a path of high imports and high debt-fueled consumption.
if we’re heading down a path of high exports and savings, that’s going to take years to see through.
which is why G has only begun….
February 20th, 2009 at 4:50 pm
“Demand” per se is always infinite. Who doesn’t want more of something even if that something is just leisure time? So insufficient demand just doesn’t work as an economic explanation.
What we need, perhaps, is more production of goods and services that the rest of the world values, so that they are willing to give us the goods and services we want in return–that is, increasing demand for our stuff. I’m not sure that’s the answer but at least it makes some kind of logical sense.
February 20th, 2009 at 4:53 pm
But ever since the 2001 recession, we haven’t really had growth in incomes. Instead, we’ve had asset-led growth.
Well, the difference between the 00’s and 90’s was that we had asset-inflation in the 90’s plus some growth, and then in the 00’s the growth went away, and all the investment went into lending.
if the consumer will no longer be 70% of gdp, what picks up the slack?
Consumers, on per head basis, have to make more stuff. Which then has to be sold. The net net here is that the manufacturing base (relative to the size of the population) went away and the growth went with it, with debt substituting for stuff. So the manufacturing (and farms and mines and non-financial services) has to come back up. Which won’t happen if there’s no demand.
Which means the USG has to spend a lot of money buying crap; not stimulus but out and out replacement of collapsed demand (cause by collapsed investment and collapsed debts).
That’s where WWII comes into the picture, because that’s what we did. Think BIG.
max
['Of course, getting the political will to do what is needed to be done is hard. But then sin lays in seeing the right thing to do and refusing to do it.']
February 20th, 2009 at 4:54 pm
Bingo again. Your catching on YM. That said incomes are going to continue to fall for a long time. The money spent propping up asset prices is money down the tubes which could at least be used to add income and services to citizens. However with each passing day the administration is getting more involved in the prop jobs. Horrendous policy meet disastrous politics. It’s a nightmare.
February 20th, 2009 at 4:57 pm
It would be nice if income for workers increased when productivity rose. Usually it doesn’t anymore, but people keep talking as if that classically assumed relation is somehow intrinsically economic in nature rather than one of power and policy.
February 20th, 2009 at 5:04 pm
Krugman wrote a good article a couple of years ago called Two Cheers for Formalism . It addresses all the problems of this post and why journalists can’t understand simply arithmetic equations.
First the question of investments versus incomes is a false dichotomy. Real GDP, a measure of standard of living, completely ignores nearly every problem you’ve mentioned. Furthermore GDP is not a sum of investments and incomes. And profits are incomes. So, what exactly is your point and what does it have to do with investments and income?
It sounds more like you’re upset about improperly valued investments and how it changed peoples behaviour. But don’t get mad at investments, we probably need more of these given how much of our economy comes from consumption. That and exports.
February 20th, 2009 at 5:07 pm
No, demand isn’t infinite. It isn’t what you’d like without considering your ability to pay. It’s what you actually act on given your ability to pay, your view of what the future will bring (e.g., in the case of investments), etc.
February 20th, 2009 at 5:12 pm
“Historically, the route to higher living standards is higher wages and incomes. When productivity grows, and demand growth is robust enough to keep unemployment low, wages and incomes go up.”
So how do you grow productivity? With investment in real productive capacity rather than “investments” in speculative financial instruments fed by by an endless supply of cheap credit from idiot central bankers.
February 20th, 2009 at 5:13 pm
Where does Salmon end and Yglesias begin? Not the first time I’ve wondered this…
February 20th, 2009 at 5:28 pm
Am I the only one still confused by the title? I always thought investment and consumption where a trade-off but investments and income? That’s a pretty interesting concept I wish someone could explain it better.
February 20th, 2009 at 5:32 pm
The stock market was doing just fine until the music stopped. If they had invested more in truly productive investments than creatively packaged debt, then perhaps they wouldn’t be so glum right now. When Wall Street is as concerned with productivity as it is with making money for themselves I’ll care about their “panic”.
February 20th, 2009 at 5:35 pm
No, demand isn’t infinite. It isn’t what you’d like without considering your ability to pay. It’s what you actually act on given your ability to pay, your view of what the future will bring (e.g., in the case of investments), etc.
I agree with your definition of demand, but hold that it is still infinite. Another way of stating that demand is infinite is to say that whatever you have to spend, you will spend, either in current consumption or future consumption, and in the form of either goods services or leisure. Yet another equivalent statement is that people don’t just work and throw their money away, they do something with the wealth they obtain. Since demand is infinite (since everything a person makes is spent somehow), absolute demand can’t be increased or decreased through policy or mood swings. The policy implication is that, if we want to increase the amount people buy our goods, we need to convince them that our goods are a better use for their wealth than what they are currently spending it on.
February 20th, 2009 at 5:45 pm
A fan of Matt’s work I nevertheless would like to see a bit more ecological awareness in his analysis. I understand the economic point about needing to restore incomes, demand… but the planet needs this like it needs a biotic crash and new climate regime.
There is getting through this, but please don’t treat this as though going back to the way things were is either feasible or desirable.
February 20th, 2009 at 6:04 pm
“Am I the only one still confused by the title? I always thought investment and consumption where a trade-off but investments and income? That’s a pretty interesting concept I wish someone could explain it better.”
Because a huge amount of what was called investment during the era was speculation. The money being poured into the bailouts is speculation too and they are bad bets.
Income flows though good existing business and if there is need it will flow into real investment.
February 20th, 2009 at 6:05 pm
“The stock market was doing just fine until the music stopped. If they had invested more in truly productive investments than creatively packaged debt, then perhaps they wouldn’t be so glum right now.”
There are plenty of non-financial companies with strong balance sheets whose stocks have been demolished in this market. Here’s one example, Amtech Systems, a company in the solar and semi-conductor space. The company has $38 million in net cash and a market cap of only $27 million: i.e., it trades for less than its cash.
February 20th, 2009 at 6:18 pm
We don’t need more demand. We need more investment. But it is true that we do not need more speculation pretending to be investment.
What we need is to invest in technologies to increase our productivity.
February 20th, 2009 at 6:18 pm
To make the Dow go back above 10,000. But that’s all backwards. What we need is an increase in the amount of demand in the world… And that demand can lead to jobs and income. And if people start earning more money, then soon enough asset prices will go up again.
But the stock market is a leading indicator — its level reflects the present value of future cash flows, which is why it’s a useful proxy for the market’s expectation of future demand.
February 20th, 2009 at 6:18 pm
Also, the post tile is definitely confused. What I think you mean is “Income, not Asset Prices.”
We need more investment, as that can stimulate real growth and higher incomes, etc.
February 20th, 2009 at 6:47 pm
Boy, I must be from Mars, but I’ve never heard of a single economic theory that predicts this. Rather, it’s historically been the case that when incomes–or the cost of labor, if you are a member of the ownership class–go up, stock profits go down. After all, the more you have to pay the money-grubbing losers who do the actual grunt work of making your company go, the less money you have to buy vacation homes or yachts. And isn’t that what it’s all about in the end?
Of course, just because what’s good for the working class is bad for the stock-owners doesn’t mean that everything bad for the stock-owners is good for the working class. Which is why we’re where we are now.
February 20th, 2009 at 6:55 pm
Matthew fails to realize that the drop in the stock market since November is even greater in REAL terms, not just dollar terms. Dollar terms are misleading because they don’t reflect the ongoing fall in the value of the dollar. Look at how Gold has climbed from around $750 to $970.
And it is not just Gold. Usually Platinum moves in reverse to Gold — because while it is rare and a store of value, it’s value is driven by its use in industry. As a catalyst in auto emissions control, for example. SO Platinum plunged in price from early 2008 until Nov. But since then it has been rising along with gold — which indicates that the rise is Gold reflects a falling value in the dollar, not just speculation.
The falling value in the dollar is the market looking at almost $10 TRILLION being committed to this bailout –when you count the GUARANTEES for assets and acceptance of overinflated assets as collateral for loans by the Fed. Congress has not yet been forced to print money to pay for those guarantees –but that day is coming. Just as it came for those “not real guarantees” issued for Fannie Mae and Freddie Mac.
February 20th, 2009 at 6:56 pm
Forget about stocks. Stocks are done, for a long long time. Stocks are primarily a speculation. Investment means an expected return hopefully drawn from real earnings. That means bonds. There is no reason to buy stocks now. Maybe at DOW 3600 but it will still be a speculation. Existing business which needs investment will get it where they always get it, in the bond market.
It’s a pipe dream but the dream of capital gain from asset inflation has got to be discouraged. The entire boom of the last 25 years was founded upon inflating assets. Now they are deflating. What do we have to show for it. Households with record high debt and record low savings. Millions with negative equity in their home, the last ‘investment’ bubble of course. A stupendous infrastructure of retail space. Oh boy. I won’t go on. I am too depressed.
February 20th, 2009 at 6:59 pm
He rules everything out except demand.
So tell us what is stopping demand.
max, are you a supply sider when you say:
“Consumers, on per head basis, have to make more stuff.”
What stuff, in particular.
Glaivester counters:
“We need more investment. ”
Any particular machines you think we should invest in?
Here is how I think the causality goes:
- Consumer, unexpectedly, changes his consumption model.
- Producer inventory undergoes adjustments to better reflect users change in consumption patterns.
- Goods flow no longer supports the aggregated balance sheets.
- Asset values undergo adjustment
- New asset evaluations allow producers to solve step one.
We are at the last step, ready to step into the new frontier.
February 20th, 2009 at 7:14 pm
Yeah, seriously, fix your indents, Matt.
February 20th, 2009 at 7:32 pm
We have to get better at making stuff and doing things that other people want to pay for.
February 20th, 2009 at 8:35 pm
Glaivester counters:
“We need more investment. ”
Any particular machines you think we should invest in?
I have no idea. I say let the market decide.
Forget about stocks. Stocks are done, for a long long time. Stocks are primarily a speculation.
Stocks are fine, I think, as long as you get into a stock for the dividends (for that, of course, you need to pick a stock that pays dividends) and not for price speculation.
February 20th, 2009 at 8:57 pm
Keep working ,great job!
February 20th, 2009 at 9:25 pm
glaivester, i’ve been a value investor my whole investing life, but when i read your last paragraph (and many similar comments from many people in many settings of late) and i am ready to become a growth investor as a pure contrarian play.
the intrinsic value of a business can grow, and is worth something on its own and not merely as a dividend generator.
February 20th, 2009 at 9:27 pm
DTM,
I think it does imply that demand is infinite. Perhaps it would invite less confusion to say that demand is insatiable. The point is that at an absolute level you can’t increase it or decrease it using policy.
It is true that if people become poorer then they will buy less. But Matt isn’t arguing that we try to make the rest of the world richer so they will be able to afford more of our goods.
February 20th, 2009 at 9:51 pm
The company has $38 million in net cash and a market cap of only $27 million: i.e., it trades for less than its cash.
If you know this then so presumably do others. So why isn’t the company being bought?
I don’t think the stock market is the enemy of the working class, but I do believe that in many ways it is an epiphenomena. Wall Streeters seem to regard it as the show, the purpose, but it’s utility is to be one means of raising and allocating capital so that others can do something useful with it. That’s no small feat (raising and allocating capital) but other countries do it successfully with a much smaller stock market and I really hate to see the implicit claim that “what’s good for the street is good for America, ergo policy should focus on what’s good for the street.”
February 20th, 2009 at 10:05 pm
But there you go: if public policies in the aggregate over time can make us richer or poorer, then they can have an affect on aggregate demand over time.
That is precisely the opposite ordering of events as that proposed in the post.
February 21st, 2009 at 2:26 am
“If you know this then so presumably do others. So why isn’t the company being bought?”
Let me flip that question around for you as an exercise. Why aren’t you buying this stock? You’d be getting your share of the company’s future prospects for less than nothing, since the price per share doesn’t even cover the company’s net cash per share.
“I don’t think the stock market is the enemy of the working class”
That’s mighty benevolent of you. I’m sure you’re aware though that not every stock market investor is a plutocrat wearing a top hat and a monocle. There isn’t a clear demarcation between the working class and the investor class.
“but other countries do it successfully with a much smaller stock market”
Other countries often raise capital for their companies in our stock markets. I own shares of small companies from Canada, Israel, China, and Australia that have all done their IPOs here.
“I really hate to see the implicit claim that “what’s good for the street is good for America, ergo policy should focus on what’s good for the street.”
I leave that straw man to you.
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February 24th, 2009 at 1:48 pm
well, sure, income is a great measure when you’re 30 and have 40 years of earnings potential ahead of you. But when you’re 55 like me, and have spent 30 years trying to build up a nest egg which is invested in various financial assets, and now wondering if you’ll ever be able to retire, the stock market indices–whichever ones are best, for sure–are more than just a fetish or an obsession. My income is fine, but it’s my assets that have been slashed by almost 50% in the last year.
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