Stock Market (was: Re: Government Radio Propaganda)
George J. Lee (gjlee@uclink4.berkeley.edu)
05 Nov 1997 02:16:09 -0800
schoen@uclink4.Berkeley.EDU (Seth David Schoen) writes:
> George Lee writes:
>
> >For example, the extra money people would have to spend
> >could be invested in the stock market, which is experiencing an
> >incredible bull market. At the current rate of increase, someone could
> >easily double his (or her, of course) money in as little as 5 or 6
> >years.
>
> OK, but how much of this growth is real -- how much is sustainable? How
> much, on the other hand, is just speculative?
>
> For example, Ponzi schemes exhibit substantial growth in consequence of
> expanding interest in these schemes as an investment technique, but that
> doesn't mean that the return on investment could actually be realized
> by many people.
Actually, the return on investment can be realized by many people.
Doubling money in 5 or 6 years is being optimistic, but if you just
stuck your money in the S&P 500 about six or seven years ago, you
would have doubled your money. The difference between investment and
Ponzi schemes is that in Ponzi schemes, money just gets transferred
around as they get more people to fall for them. Investing is
different in that this money is actually purchasing part of a company.
> Sustainable growth in the stock market has to be bounded on average by
> the rate of growth of the economy. Of course, this is making some
> assumptions about how economic growth is tied to the stock market, which
> might be unrealistic (for example, a growth in barter markets, or
> drug deals, or transactions by privately held companies, is not reflected
> in the stock market) but there must still be some kind of bound set by
> the economy's rate of real growth!
Correct, the growth does have to come from somewhere. That "somewhere"
is the companies offering stock to investors. Most of the growth in
the stock market comes from small companies, and besides, the stock
market does not encompass all aspects of the economy.
> I do believe, contrary to the socialist position, that wealth is not a
> conserved quantity and is continually being created. On the other hand,
Correct.
> at what rate is it expanding? It is unlikely that the ordinary person
> with no more than average information could get long-term stock-market
> gains which substantially exceeded the rate of wealth creation, whatever
> that is. If this were possible, it would require a huge inflation rate
> which would wipe out all of these profits.
You are right in that wealth has to be created for people to gain it,
but investing is simply the act of letting your wealth create more
wealth for you. The money you put in directly helps the business make
more profits. The approximately 15% average returns on the S&P 500 in
the past five years or so is proof positive that it's a no-brainer to
get good returns in the stock market.
> Since the stock market is a genuine market, it's got an elasticity.
> The location of the market equilibrium is affected to some degree by the
> actual amount of demand. If stock prices are tied to some underlying
> value, rather than being speculative only, increased demand ought to produce
> a severe dilution of profitability.
>
> Otherwise, the stock market is either just a Ponzi scheme or a tool for
> manipulation by rich people to get richer without creating any underlying
> wealth (see Brian Harvey's reply in ucb.class.cs61a to my article
> "Re: Check Kiting"). I don't think it's either of these, but the
> potential is there; there are a whole lot of people buying because they
> hear there is a bull market and they know other people will also continue
> to buy. Remember Greenspan's "irrational exuberance"? Some trading
> doesn't have a lot to do with expectations of the actual performance of
> companies...
You are right. The P/E ratios of the S&P 500 have increased maybe a
bit less than 50%, so demand for stocks has increased. The P/E is the
ratio between the stock's price per share and its earnings per share.
Though P/E's have increased, earnings have also increased
dramatically, more than enough to make up for the higher P/E. The P/E
is what stock prices are tied to: historically, the S&P has always had
a P/E around 15 or so, though it fluctuates from time to time. This
means that increases in stock price in the long run have been
proportional to increases in earnings. If the only difference were a
sudden increase in demand, perhaps the rate of return for investors
today would decrease, but the amount of real wealth would definitely
increase if taxes went down.
> So even if stock market gains are sustainable, it doesn't mean that they
> would continue if taxation were eliminated and the current tax load
> invested in the market. Imagine if you could make 1000% returns delivering
> chocolate in the dorms here. (Hmmm, maybe you can.) Presumably, once
> a large number of other firms were attracted by the profits, your rate of
> return would fall off, because the population and hunger of the dorms is
> finite, or at least growing fairly slowly.
>
> Ending taxes would definitely hurt the instantaneous rate of return on what
> presently seem to be very sound investments. It would certainly spur
> longer-term economic growth, but I don't know how significant that effect
> would be. (Of course, judging the relative magnitude of these effects
> depends basically on whether you have a supply-side or a demand-side
> orientation... :-)
It would increase the rate of return by making businesses more
profitable and encouraging entrepreneurs to start new business,
further strengthening the economy. I believe these benefits far
outweigh the effect of increased demand. If government were scaled
down, the private sector would jump in to fill in the gaps left by the
retreat of government. This would consume much of the extra demand.
> So I think taxes paradoxically help investors in one way, by reducing
> competition in financial markets in the form of disposable income! That
> definitely raises interest rates and dividends. Of course, taxes _do_
> potentially also badly hurt the economy by depressing economic growth.
> But then there is government investment, which, while frequently more
> wasteful than private investment, still exists.
Taxes do nothing but harm to the economy in general. The government
doesn't help people in general by stealing their money.
Yes, taxes hurt the economy very badly: if the government taxes
people, they are in effect forcing them to invest in the government.
In the free market, people can instead make a fortune by finding the
most profitable companies. The money people lose in taxes today could
instead be invested in the private sector. Both businesses and
investors would profit immensely.
> So I really don't know whether you can objectively make a claim like
>
> >the extra money people would have to spend could be invested in the stock
> >market, which is experiencing an incredible bull market. At the current rate
> >of increase, someone could easily double his (or her, of course) money in as
> >little as 5 or 6 years.
My original point was that if the gov't takes $10,000 from someone in
income tax, that $10,000 could be worth $100,000 by the time that
person retires; much more than the original $10,000.
> (Could _all_ taxpayers double their money in 5 or 6 years? Wouldn't that
> require the whole economy to be doubling in production every 5 or 6 years,
> to avoid inflation?)
Not necessarily, since the taxpayers double the money they *invest* in
5 or 6 years. That's only a fraction of their total income. Still, if
you look at the rate of growth of the U.S. economy, you will notice
that real growth has slowed as goverment has expanded. (Sorry I don't
have the figures, but I will try to supply them if you are interested)
During the 19th century, the economy surged forward on the order of
about 10% a year, I think, which is leaps and bounds beyond the measly
3% we are doing now.
Inflation is another issue: if currency were tied to a fixed supply of
anything, then a dollar would have real value. I am in favor of a gold
standard. That would halt inflationary gov't spending.
> I think there are too many side effects and complications to reliably
> predict many actual overall effects to taxpayers of getting rid of taxes.
> As the critics of libertarianism like to say (irrelevantly), there's no
> free lunch in these matters; many advantages to individuals are subjectively
> balanced by new disadvantages.
I see no major disadvantages. If you agree that the private sector in
general does things more efficiently than government, then cutting
taxes will help both investors and businesses. Simply put, wouldn't we
be better off if the money given to government were instead wisely
invested in our economy? You're right, there is no free lunch. By
cutting taxes, we give up Welfare, Social Security, Medicare, the
Department of Education, and all the other waste in Washington.
George