Why It Feels Like Stock Markets are at All Time Highs

Published by Matthew Tae at October 16, 2020

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A Narrative History of How Strange it Feels That Stock Markets are at All Time Highs

Today, JP Morgan reported corporate earnings and guess what… banking deposits were up 28%!!! It was so much money they had to park all that new cash into T-bills (i.e. short term Treasury Bonds… the banking equivalent of a low interest savings account).

There’s a narrative (mostly on the left IMO) we need more stimulus! There’s people unemployed! People are HURTING! That is true for 30-40% of the population (and that’s a wild unsubstantiated guess). Please search “K shaped recovery” for a mountain of thoughts on this. But to sum it up… some people are one leg of the K going up, and some are the other going down. The data is there, stock markets (of which is an upper class good like designer handbags and fancy cars) are up, banking deposits are up, new business formation is up, and a general feeling by some that they have more money, opportunity, and as a result, courage and agency to go forth into the world and thrive.

I want to use this as an opportunity to explain a portion of the “Economy” as we’ve made it: https://shared401k.com/blog/deleveraging-the-us-economy-modern-monetary-theory-in-action/

The K-shaped recovery is more pronounced than past bubbles because our machine has been running a long time, and this machine’s “bug” (i.e. mechanical glitch) is that it is ultimately a “trickle down” mechanism that doesn’t trickle down. To paraphrase Reagan, if you create prosperity, “all boats rise with the tide”. How this prosperity is created is by giving created money to the richest corporations / people / job creators. However, when combined with the Friedman doctrine that claims that the sole moral duty of a business is to maximize returns/profits to shareholders… a paradox occurs. They are mutually exclusive doctrines.

How to create prosperity from the top down

The Federal Government (i.e. The Treasury… Steve Mnunchin) can create government bonds and sell them… taking the equivalent of an IOU note written on a bar napkin, can sell that napkin and thereby convert it to cash when sold. The magic happens when The Federal Reserve (i.e. The Fed… Jerome Powell) purchases these bonds. Where does the Federal Reserve get the cold hard cash to purchase bonds from? They can print it, or nowadays, just add zeros on a computer screen. That is the awesome power of the Fed. Jerome Powell can even purchase an IOU note written on a cocktail napkin from YOU!!! The Federal Reserve is a non-profit entity created a little over 100 years ago to stabilize the US economy and the banking system. It was created mainly to be a buffer in the power struggle between centralized government vs de-centralized state’s rights. That much central government power was unthinkable in the 1800’s and early 1900’s. That family history is why Jerome Powell and the Fed doesn’t purchase an IOU written on the back of a cocktail napkin from you. This is why The Federal Reserve stood by and did nothing during the Great Depression. Remember what happens when shit hits the fan:

People / companies cut spending (i.e. tighten belts to pay debt… good ole’ Suze Orman stuff)
However, when people cut spending, incomes fall because your spending is my income and visa-versa. Everyone has less revenue, income, profits, etc.
With less income we all become less creditworthy, so credit dries up
With less credit there is even less spending because we take credit (debt) to spend it
This is all deflationary because less money going around means less money to buy things so prices must decrease… and asset prices drop.
Because borrowers have lower valued assets, they are less creditworthy. They can no longer “roll over” debts (this is a function that happens with companies more than with people) and they must sell assets to raise funds to service their existing debt because they cannot obtain new debt to pay off the old debt. This further depresses asset prices.
There is a vicious circle… less spending -> less income -> less wealth (lower asset prices) -> less credit worthiness -> less borrowing -> less spending

During the Great Depression, those with money to lend could charge loan shark 14% interest rates to people & companies desperate to keep the lights on. The Fed could probably have stepped in and helped here. But back then, the country leaned towards preserving the power of State’s.

Let’s forward to Reagan… who said in a nutshell, “if the Federal Reserve will purchase any IOU’s written by the central government, then let’s saddle up!” (The President appoints the Federal Reserve Chair… so the President gets to pick the person who agrees you purchase the cocktail napkins, and if they don’t, they can appoint someone else). This is a simplification for literary license… but let’s run with this thought, with the end result being, the President / central government has the ability to create unlimited amounts of cash for the Central Government.

*A side note that the STATES do not have this power… unless The Fed also purchases state municipal bonds written on the back of bar napkins, which The FED sometimes does. What an interesting power dynamic if Steve Mnuchin creates cash for the government by selling bonds to Jerome Powell, only to have Donald Trump refuse to fund “blue state” governments… who in turn create their own state municipal bonds and sell them to Jerome Powell (who was appointed by The President).

So, Reagan created money, slashed taxes, “deregulated”… and everyone in the “Economy” had more cold hard cash in their pockets. When folks have that much cash in their pockets… whew, what a party! Really that party has never stopped. Stock market returns under every President since then has been spectacular for the most part until the crash and hangover. Reagan, H.W. Bush, Clinton, W. Bush, Obama, Trump… they’ve all been spiking the punch bowl of corporate profits. Here’s the S&P market returns by president:

Reagan: 118%
W. Bush: 51% (one term)
Clinton: 210%
Bush: -40% (Note: W. Bush got the dot com crash AND the Great Financial Recession in his terms)
Obama: 182%

But here’s how the party goes on, bonds and debt. Everyone has more cash because the Fed is buying bonds… therefore giving the President the ability to cut taxes and give everyone in the Economy more cash. Everyone has more cash and we all need a place to “park” it… like JP Morgan reported this morning when its deposits increased by 28%. The parking place for cash is the bond market… institutions buy bonds, not stocks… people play stocks. When there’s A LOT of cash chasing too few bonds… those bonds are worth more (i.e. supply / demand). The bond issuers can ask you to pay more, for less interest. This pushes overall interest rates down throughout the Economy. If people can’t earn interest rates in bonds… they’ll seek it elsewhere. Stock markets, emerging markets, a new business venture in this dot com boom, new financial products & schemes… like credit default swaps that allow corporations / banks to put those mortgage back securities on steroids!

The Friedman Doctrine Walks Into A Party

Let’s imagine you are a consultant at Deloitte or PWC or whomever, and your corporate client is flush with cash without adequate means of “maximizing profits for shareholders”. The CEO says to you, “We have all this cash and we’re trying to maximize returns, but we can’t park the money in bonds because it sucks and if I do that… I’ll be fired because my competitors will be more creative!” So you float the idea of off-shoring jobs to lower labor costs to increase margins, buying back stock to increase the share price (which aligns nicely with the CEO’s stock based compensation package, and heck… stock markets have been ripping higher), and creating overseas markets to sell your products there to grow top line revenue.

We in the USA have cheaper TV’s, cheaper electronics, cheaper goods across the board. But those jobs that were off-shored… where did those people go? Those stock buy-backs to boost shareholder profits, done at the opportunity cost of being actually inventive and creative and investing in machines and R&D…and training the employee’s to execute those creative and inventive ideas… what did that lead to? The creation of overseas markets to share the game plan and the party… does that really fit the Japanese lifestyle? There’s a current Zeitgeist that praying at the alter of globalization and cheaper TV’s hasn’t brought true happiness. So, grab that yoga mat and let’s breathe for a minute.

The current K-shaped recovery and the disconnect between all-time stock market highs and the calls for more stimulus for suffering citizens occurring simultaneously is a symptom of Presidential / Congressional ambition to retain power, coupled with the Friedman Doctrine, without a good alternative narrative. Former Fed Chair Alan Greenspan saying “free markets know best” is naïve in the long arc of human emotional ambition.

Once upon a time there was “Fiscal Stimulus”… that during the 40’s thru the 70’s Congress & the President used the power of money creation to gain global power, employ people, create jobs, try to create the “American Dream”. The role of efficient government is to allow people to have meaning, a heroic bend to their lives, a driving instinct that orients one to proper action within the world. The “American Dream” got a bit of a shake up in the 60’s in the USA. The Friedman Doctrine came along in 1970, and by 1980… it was a new game plan, a new narrative that Reagan fully embraced. Milton Friedman was not wrong, there just hasn’t been a re-boot of a narrative when one’s been sorely needed for many years.

New Narrative

We live in an Economy with a strong central government that controls the money supply, and that created money supply primarily goes to large corporations. It’s how this USA economic machine is built and we can’t make major changes to the machine while we’re still in it (it’s very risky). Unless the power of the Federal Reserve is extended so they can grant micro loans to individuals, or Congress actually engages in fiscal policy (i.e. how to distribute money, and the opportunity that represents) that sends newly created money supply to people and not large creditworthy (i.e. rich) corporations, corporations will be at the center of creating de facto fiscal policy on behalf of Congress.

However, the Friedman Doctrine directs corporations to maximize shareholder profit. The Fed can already give money to large creditworthy institutions. If Congress cannot engage in fiscal policy & just chooses to “double down” in giving money to large creditworthy corporations (i.e. entities with wealth that makes them creditworthy) alongside the Fed, ultimately corporations accumulate all the newly created money (loans) & the opportunity that money represents.

The Friedman Doctrine is firmly ingrained in corporate America. By becoming a shareholder, you can influence this narrative. The American Dream was one of immigrant opportunity, then a house with a white picket fence, then one of growth & global dominance guided by The Friedman Doctrine. USA! USA! USA! Large corporations currently hold the football.

Since large corporations are the primary recipient of newly created money / opportunities, and their mandate is to “maximize shareholder profit”, the new narrative that ESG investing is requesting is “shareholder profit that is ethical and fair.” “Ethical & fair” can be seen as fair compensation & not exploiting labor, not strip mining & polluting the planet, having a CEO who isn’t a jerk… things our central government has the power to engage in as well. But this dance is as American as anything. Large public ownership of the corporations and requesting something other than the Friedman Doctrine, that is newer… or older if you like the 20 years post World War 2.