February 07, 2018
It seems the world’s financial markets have stabilized for now, but we’re still seeing all the pieces that were written with the expectation of a further plunge that were already in the pipeline, such as this front page piece in the NYT. I don’t mean to mock all these writings. The market certainly could take another plunge since prices are high, but they do provide a useful way to see the extent to which people are focused on real versus imagined fears.
As I have noted elsewhere, the obsession with inflation is clearly overblown. Not only is it not visible in the data, it is not visible in people’s expectations. As investors were supposedly dumping stock because of inflationary fears, the gap between the interest rate on government bonds and inflation-indexed bonds barely budged. This gap should be a pretty good measure of inflationary expectations and presumably, there is considerable overlap between the people who invest in the stock market and people who invest in the bond market.
Apart from inflation, there is another aspect of the higher wage growth reported last Friday that did not get as much attention. Actually, there was not much of a jump in wages in any case. The year-over-year change in the average hourly wage was reported at 2.9 percent. Twice in the last two years, it has been 2.8 percent. The increase in the average hourly wage for production and non-supervisory workers, a group that includes more than 80 percent of the workforce, was just 2.4 percent.
But let’s assume wages actually are growing more rapidly, which is what we would expect as the labor market tightens. While this could translate into inflation, it could also cut into corporate profit margins. There has been a large shift from labor to capital since 2005. It is reasonable to expect that this will be at least partially reversed as workers gain bargaining power.
This shift back to labor is good news for the vast majority of the population who get the overwhelming majority of their income from wages. However, it does mean lower profits and this is bad news for the stock market. In principle, the stock market is the value of future corporate profits. If profits over the next decade will be 10 to 20 percent lower as a result of a shift back to labor, then we would expect the market to be 10 to 20 percent lower, other things equal (yes, other things are never equal).
Finally, we have to calm down about changes in stock values. The stock market is not a measure of economic well-being and it generally is not especially important for the economy.
The major exception was the bubble of the late 1990s. During that period many new startups actually were financing investment by issuing stock. This is generally rare since the vast majority of investment is financed by retained earnings and borrowing on credit markets or from banks. There was also a consumption boom as people spent based on the stock wealth generated by the bubble.
When the bubble burst these sources of demand vanished. They were not easily replaced. From a labor market perspective, the 2001 recession was very bad. The recession officially ended in December of 2001 but we continued to lose jobs all through 2002 and didn’t start creating jobs again until September of 2003. It took until January of 2005 to get back the jobs lost in the recession. Until the Great Recession, this was the longest period without job growth since the Great Depression.
We shouldn’t have to worry about anything similar in response to a stock plunge now. Consumption is high and likely driven in part by a high stock market and also a high housing market. However, there is no investment boom that could vanish following a plunge. If consumption were to fall by one to two percentage points of GDP in response to a market plunge (a very large drop), it would be a drag on growth, but this is not recession material. It is just not a big disaster.
But what about people’s 401(k)s? Folks, get a grip. Even with a fall of 10 or 20 percent the returns over the last decade still would have been quite good by almost any standard. Yeah, it would be nice if stock prices would always go up, but that is not the way the world works.
We live in a country where Congress is looking to make millions of people with serious health or other problems work to get their Medicaid or piddling food stamp benefits. It’s hard to get too concerned because someone’s 401(k) only grew from $100k to $250k over the last decade, instead of $280k.
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