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How did Stocks Get So High?

Friday, September 21, 2012 1:51

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That’s the question asked by Business Week Magazine. The answer, I suggest, is money and by that I mean newly created money. The article notes that the S & P 500 average increased 25% over the past year. This seems surprising given the general economic stagnation during that time. In fact, over the previous 12 months ending in August, the True Money Supply, increased 8.4%. Such an increase in the money supply, made possible by credit expansion, reduces interest rates and increases asset prices including stock prices.

As Jesus Huerta de Soto explains in his Money, Bank Credit, and Economic Cycles:

In an economy which shows healthy, sustained growth, voluntary savings flow into the productive structure by two routes: either through the self-financing of companies, or through the stock market. Nevertheless the arrival of savings via the stock market is slow and gradual and does not involve stock market booms or euphoria (p. 461)..

On the other hand,when there has been monetary inflation in the form of credit expansion, it’s another story:

Only when the banking sector initiates a policy of credit expansion unbacked by a prior increase in voluntary saving do stock market indexes show dramatic and sustained overall growth. In fact newly-created money in the form of bank loans reaches the stock market at once, starting a purely speculative upward trend in market prices which generally affects most securities to some extent. Prices may continue to mount as long as credit expansion is maintained at an accelerated rate. Credit expansion not only causes a sharp, artificial relative drop in interest rates, along with the upward movement in market prices which inevitably follows. It also allows securities with continuously rising prices to be used as collateral for new loan requests in a vicious circle which feeds on continual, speculative stock market booms, and which does not come to an end as long as credit expansion lasts. . . .Therefore (and this is perhaps one of the most important conclusions we can reach at this point) uninterrupted stock market growth never indicates favorable economic conditions. Quite the contrary: all such growth provides the most unmistakable sign of credit expansion unbacked by real savings, expansion which feeds an artificial boom that will invariably culminate in a severe stock market crisis (pp. 461-62).

2012-09-21 01:44:23

Source: http://foundationsofecon.blogspot.com/2012/09/how-did-stocks-get-so-high.html

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