Wednesday, 9 April 2014

QUOTE OF THE DAY: On the Source of Today’s Inequality

“Capital in the form of credit is normally and, certainly, properly, extended out of previously accumulated savings. In sharpest contrast, credit expansion is the creation of new and additional money out of thin air, which money is then lent to business firms and individuals as though it were a supply of new and additional saved up capital funds…
    “The truth is that credit expansion is responsible not only for the boom-bust cycle but also for another major negative phenomenon for which public opinion mistakenly blames capitalism: namely, sharply increased economic inequality, in which the wealthier strata of the population appear to increase their wealth dramatically relative to the rest of the population and for no good reason…
    “The [
counterfeit capital] created in credit expansion shows up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.
    “Since it’s so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices…
    “The new and additional funds injected into the economic system also soon show up… in an additional demand for consumers' durable goods, such as houses and automobiles. The purchase of these latter goods, like the capital goods purchased by business firms, depends largely on credit and is encouraged by lower interest rates. It is also fed by the capital gains being reaped by wealthy individuals, which results in an especially pronounced increase in the demand for luxury housing and for luxury goods in general.”
            - George Reisman, “Credit Expansion, Economic Inequality, and Stagnant Wages


  1. So true. And so well explained.

    As evidenced by the year-on-year M2 monetary aggregate column on the RBNZ website, the New Zealand covet-mint is inflating the money supply by 15-20% annually at present:

  2. I wonder if Mr Reisman has done much investing in the stock [sic] market.

    A company needs to make and sell 'real' things, to real customers, get paid real money and make real profits before its share price rises - let me assure everybody of that.

    If it were as simple as buying shares in a company selected at random, and by next Monday the share prices rises automatically - there would be a hell of a lot more billionaires around (myself, for instance).

    Also, those of us who are professional investors would not need to spend lots of money employing researchers and other staff to help weed out the rubbish on the various sharemarkets of the world, from the good investments.

    There are a relatively few occasions in history, which if you add it all up actually comprises a very short period of time, when credit expansion meant share prices automatically rose (regardless of what you invested in) -

    1. London in 1720 during the South Sea Bubble (yes, yes, I know - but it is relevant)
    2. New York 1928/29
    3. Australia 1969 (most famously with the Posiedon bubble)
    4. London 1971 -73
    5. NZ 1986/87
    6. The NASDAQ boom of 1999
    7. 2005 - 08

    These handful of occasions spring to mind, but let me assure you they all lasted for a far shorter time than you may think, and the remaining 99% of the time share prices have been based on 'proper' profits and healthy balance sheets and optimistic prospects for the future of a company.

    As an aside - and this is probably the sort of thing Mr Riesman means - I remember when I really started to make a substantial amount of money investing in shares during the fag end of last century.

    Between September 1999 and February 2000 on the NASDAQ during the dotcom boom, I and my business partner at the time usually did the following - when we awoke around 6am we would ring our share broker (you had to ring up in those days) and buy a block of shares in a company listed on the NASDAQ; when we got to the office around 8am we would ring the share broker back and sell - and the shares would have gone up.

    This happened every single day - it made no difference what we bought; you bought the shares and they would go up.

    By November 1999 it got to the stage where we would quite literally write down the names of 100 or so companies, put them in a hat, and each, literally, pull names out of a hat and those were the companies whose shares we would buy the next day; without exception - the price rose and we made quick profits.

    The 'dotcom' boom was so out of control, everybody had gone so mad, that it really was that easy to make money (and we weren't the only chaps around town doing this, either)

    Needless to say this $2000 or $3000 per day gravy train didn't last (and the NASDAQ spectacularly collapsed in April 2000) - but it was enormous fun whilst it lasted HAHAHAHA!!

  3. "A company needs to make and sell 'real' things, to real customers, get paid real money and make real profits before its share price rises"

    Not true, Xero, Whatsapp, and several others are good examples of share prices rising on companies who do not make money. We are in the midst of another dot com boom, and like the 99 one it is fueled by credit expansion. What the company makes has little influence compared with "positive public sentiment" and excess cash going round.

  4. It looks like the Xero bubble has burst during the last month, but your post highlights the problem with Sharemarkets in that people single out 2 or 3 companies and think that represents everyone else.

    If you were to go to the sharemarket page in the NZ Herald this morning, and go through the list of companies on the NZX and ASX, you will find they all need to do just this - real income, real products or services, real profits.

    There are always a couple of exceptions on any sharemarket of companies which are hyped up, (eventually ending in tears for the shareholders), but in general share prices are based on merit.

  5. I agree with you last post, however the sentiment of your previous post is that Credit inflation does not lead to a jump in share prices. Then you yourself acknowledge that during 98-2000 (a time of massive credit expansion) you could pick a company at random and make money.

    Sharemarkets today are growing in value every day, as measured by all indexes. The Nasdaq, Dow jones industrial and FTSE are all at (or near) record highs.

    Therefore, statistically speaking, if you are "Buying the market" (a representative sample of an index) you will make money whether those companies make widgets or empty promises. And this is in an environment of massive credit expansion.

    Does this not go some way to proving the original hypothesis, ie: All other things being equal, credit expansion will inflate a share market?


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