This recovery is fake

Dow Jones down 179 yesterday. Let’s see, to make the maths easy, that’s about 1% of the stock market’s value, and the total value of the stock market is about $17trn. So, yesterday erased about $170bn worth of ‘wealth’. By our reckoning, there’s about $7trn left to go.

It’s too early to call a top, but we wouldn’t want to be sitting on the uppermost branch of this tree. The higher up you go the more dangerous your perch. From where we stand on the ground, the whole thing looks scary.

There are too many people in that tree already, all of them counting on calm, sunny weather and a longer growing season for their money. What a shame it would be if the tree fell over!

Everybody invests in stocks hoping to ‘beat the market’. But everyone is the market. Only a few outliers beat it – usually by accident. Of course, last year’s stock buyers were happy just to ride along with the market. Beating it wasn’t necessary.

As we reported, the rich saw their wealth rise by $3.7trn last year. Much of that came from the stock market, which hit new records. Investors are hoping for a repeat of this performance in ‘14. Even if it does half as well, they tell themselves, it will still be an impressive gain.

But we have some questions: against whom are they gaining ground? From whom are they taking the loot? Or, to put it another way, who’s on the other side of the trade?

The economy as a whole rose at a 2% rate. So, there was a grand total of about $340bn in real, extra wealth to divvy up. How was it possible for shareholders to get ten times as much as the value of the wealth the economy created? But wait. The mystery deepens.

Since the depths of the crash in ‘09, household wealth has gone up by $21trn. Roughly, it went from $50trn to $71trn. During that same time, real household earnings for the typical family have gone down. Wages have gone down. And the net worth of the typical family has also gone down. Growth rates have declined. And, as a proportion of the population, the number of people with jobs has also declined.

Look at a chart of real GDP and you’ll see that it is only about 6% higher than it was in 2007. So, household wealth went up nearly 20 times faster than GDP since ‘09. How could that be?

The Bernanke team was trying to goose up asset prices. They succeeded. The ‘wealth effect’ brought an additional $21trn to the nation’s balance sheets. This was supposed to increase demand, which would lead to more spending and investing,

Say’s Law tells us that you have to produce before you consume (more or less). But here we have about $20trn of excess spending power that seemed to come from nowhere. How could that be?

Wealth is either physical, as in owning a big house or a painting by Modigliani, or it is paper wealth. Now we have new claims on $21trn of real output and real wealth. If there is no increase in real wealth, that money just competes for the same goods and services that were already priced at $50trn five years ago. We’re not a dime wealthier in other words.

All paper assets are a claim against real goods and services. And you can’t get more goods and services than the economy can produce. Since the economy of ‘08 to ‘13 produced only a fraction as much real wealth as the claims against it, those claims will have to be applied to future output.

So, when will the economy produce $21trn of new wealth so that these new claims can be realised? Let’s see: “… the future looks sluggish”, wrote Financial Times lead economist Martin Wolf.

The FT editor joins Larry Summers who argues that US growth is stuck in the mud, and may not get out any time soon. “Since the start of this century”, writes Summers in The Washington Post, “annual US gross domestic product growth has averaged less than 1.8 per cent”.

Hmm… that’s about $300bn. How long do you have to wait – at $300bn per year – to cover $21trn in claims? Answer: 70 years!

Well, that’s not going to happen, is it? Long before 2084 rolls around, those claims will be marked down and written off.

In other words, the additional wealth is mostly a mirage.