Article in Economics / Economic Theory
Understanding the economic reasons why Obama’s wealth effect bubble is popping.
 
 
 

Back on May 10, 2011, I wrote an investment advice column that it was time for investors to follow the evacuation routes to safer investment ground. (Technology Stock Advisor Issues Investor Alert, May 10, 2011, BestThinking.com).

This recent piece of advice followed my November 2010 investment column that the stock prices had taken leave of reality, and that investors should begin taking their gains and prepare their portfolios for a stock market decline. (Technology Stock Advisor Issues Investor Stock Market Warning, November 8, 2010, BestThinking.com).

Here is a graph of the Standard & Poors® 500 Index, which describes how the 500 biggest company stock prices have performed for the past 12 months, which includes the time period for my May 10, 2011 warning.

The graph is created on GoogleFinance, and readers are encouraged to go to that website and experiment with the different graphs and time horizons to verify my account of the stock market performance.

Of particular interest for investors is the recent period of the last 60 days, from the time the stock market peaked around April 29, 2011. The big question for investors is if this down trend in the stock market will continue.

My column today gives an economic answer to the question based on standard neoclassical supply and demand theory, updated slightly with a little economic evolutionary theory tossed in.

Another Look at Why Both Aggregate Demand and Aggregate Supply Both Matter At The Same Point In Time

In his daily economic blog, Tyler Cowen (June 15, 2011), offers a cogent and pungent analysis of what is wrong with the U.S. economy, deploying standard neoclassical marginal analysis.

Cowen has picked a type of philosophical fight with other neoclassical economists, who Cowen suspects are simplifying their economic analysis of the U.S. economy.

“I suggest a slightly more complex model,” says Cowen, in his understated opening gambit.

“During the financial crisis the American economy took a big AD (economic slang for aggregate demand, a downward sloping curve that economists love to fantasize about) hit due to debt overhang, falling asset prices, unemployment, imperfect monetary policy, credit contraction, and several other factors. After the peak of the crisis there were massive layoffs, largely because of these AD problems, toss in an increase in the risk premium and perhaps higher fixed costs of employing people. A lot of the labor market problems from this hit still have not been cleaned up, and furthermore with lower net wealth many of these jobs are never coming back, with or without monetary stimulus,” Cowen explained in the best shortest explanation of the U. S. economy in recent memory.

Cowen’s main idea is that AD is made up of several different sub-components of demand, and that his economic brethren are not giving due consideration to the underlying components of economic demand in the U.S. economy.

The U.S. economy is very weak in terms of aggregate economic demand, explains Cowen. The weakness in demand occurs at the same moment in time as weak aggregate supply factors, and both supply and demand must be considered at the same time, as the mythical economic parrot in your introductory economic class was fond of saying over and over again. (Teach a parrot to say “Supply and Demand” and he gets a Ph.D.)

A Little Economic Evolutionary Theory Tossed In

Neoclassical economists fervently believe that the economy will revert to a prior point of equilibrium where supply intersects with demand.

Evolutionary economists believe that the economy evolves, and that prior points of equilibrium are not relevant to economic analysis once the economy has slipped through an economic bifurcation point. As Henry Ford used to say about listening to his customers, “If I listened to them, what they would tell me is that they want a faster horse.”

The horse did not matter any more, after the technological evolution of the car had occurred, just like the former economic structure of the American economy did not matter any more, after the wizards who ran the economy shipped all the American innovation and jobs overseas beginning around 1985.

The reason the Obama stimulus was such a colossal failure was not simply that it was based on defective neoclassical Keynesian theory, but that the economy that Team Obama had in their minds did not exist anymore. The prior economy has evolved through a downward economic ratchet that some pundits are calling the “new economic normal.”

The Obama economic Keynesian geniuses managed to piss away $800 billion of imaginary aggregate economic demand. There were no U.S. income or employment multiplier effects because all the economic linkages are now over in India and China.

Those national economies are doing great, and the CEOs of the Big Corporations who sit on Obama’s economic council could not be more delighted with his economic policies.

The Obama Asset Wealth Effect Bubble Is Popping Just Like The One Under George Bush

Where, you may ask, did that $800 billion go? It went into a speculative commodity marketplace and an asset bubble stock market.

Take another look at the S&P 500 graph, especially around October 2010. That sharp upward rise in the stock market is where the Obama stimulus money went.

For all of his anti-corporate, anti-Wall Street talk, Obama did exactly the same thing as his nemesis George Bush did: He fed the Wall Street money machine, and then he appointed all the Wall Street CEOs to serve on his economic advisory council to give him advice on job creation.

Here is a graph from the George Bush asset bubble popping in real estate around 2008, caused by the Federal Government’s mishandling of the mortgage industry, along with some political malfeasance in the Bush administration.

The Obama asset bubble wealth effect bubble in the stock market is a mirage, just like the real estate asset bubble. Neither bubble was based on authentic credible economic activity, and the Obama bubble is popping, just like the ones before it in 1987, 1999 and 2008.

What To Do Now?

The U.S. economy is very weak economically, just as described by the AD/AS curves that Cowen talks about. His analysis of the economy is just about perfect, and his neoclassical theory is really good at describing economic activity in any 5-year period.

After that five years, neoclassical theory provides some misleading ideas about the economy, and a newer, better economic theory is needed to explain where the economy is headed.

That newer evolutionary theory suggests that the U.S. economy has passed through a downward economic ratchet point. There are two Americas, as John Edwards liked to say, but not for the reasons he said them.

One part of the U.S. economy is integrated into the global economy and that part of the economy is going gang-busters. Buying stocks in corporations that are benefiting from this part of the economy continues to make good economic sense. These stocks will decline as the asset bubble pops, but the best investment idea is to hold on to them if you already own them.

The other part of the U.S. economy is suffering badly. Having any type of investment relationship with that part of the economy does not make good economic sense.

Beyond the investment advice, I have another piece of economic advice for readers: There is a clear compelling economic growth strategy for America that will push the economy through a higher future economic bifurcation point.

That future point is based on capital investments made today in small business technological innovation, not on more government spending or more socialistic regulations.

About Thomas Vass

Vass is an investment advisor in Raleigh, N.C., and publishes the Technology Stock Advisor, an online investment newsletter for stock investors.

 

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