Most readers have by now already heard the news. The stock of Meta Platforms, aka Facebook, crashed over 25% after reporting shockingly dismal financial results and projections after yesterday’s close. Only yesterday it was a trillion dollar company, and when a trillion dollar company loses a quarter of its market value, you’re talking about a quarter trillion dollar loss to the stock market.
Yet you could listen to hours of coverage of the horrific numbers and read endless analysis without a glimpse of the bigger picture. A monster asset bubble is breaking.
As regular readers know, the purchasing power of world’s aggregate assets cannot be worth more than the aggregate of consumer goods and services available for purchase. The US stock market alone recently reached a valuation of over twice US gross domestic product. Now for technical reasons this alone doesn’t tell the whole story, but this figure is far higher than historical norms. Assets are indisputably overvalued relative to consumer goods and services. There are only two ways to resolve this discrepancy: Either consumer prices must rise or asset prices fall to meet them. Or some messy combination of both.
And we are seeing both. Some analysts suggest that the Federal Reserve faces a difficult task ahead in trying to slow consumer price inflation without tanking the stock market. Let’s be real. It’s an impossible task. Having inflated the bubble, best the Fed can do now is to try and engineer a soft landing for asset prices while consumer price inflation gradually declines. This is the difficult task.
The crash in Meta stock is just one pixel in a picture that we’re gradually seeing develop as as it joins many other pixels in painting this picture. To successfully navigate the investment landscape over the next year or so, investors must see the big picture.
Bill said: “the purchasing power of world’s aggregate assets cannot be worth more than the aggregate of consumer goods and services available for purchase.”
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A very thought provoking statement. This may take some time. I fail to see why the value of all assets in the world can not be worth more than the goods and services in the world. Is not the value of a field of wheat worth more than the current crop produced?
Thanks for calling me on this CB. Questions like yours help tell me where I haven’t quite connected.
Taking a step back from the details, ask yourself what people own investments for. Say you have shares of stock in ABC, or an index fund XYZ. Or government bonds, or even just plain old cash. What good are they to you? You can’t eat your stock. You can’t live in your bonds. You can’t wear your cash (or at least you would find it in bad taste!).
They’re all means for storing value for later use. We can call them “assets”. They have no intrinsic utility to you, but are tradeable for things that do. Ultimately you expect to trade your assets for things you can eat, live in, wear, or otherwise enjoy.
On a global level, at any given moment there is finite amount of such things; food, homes, clothes, etcetera. Since these are the things we ultimately expect to trade our assets for, how could the assets themselves be worth more? If everyone decided to redeem their assets for their ultimate purpose, this body of goods is all they could expect to receive.
This admittedly is a simplification, because assets also can yield income, but at current prices that yield is historically small. It also overlooks the fact that it’s not possible for everyone to redeem their assets at the same time; for every seller there must also be a buyer. It also doesn’t take into account the ability of capital to leverage labor to produce more goods, but those goods aren’t currently available; they only become available over time with further inputs required (such as the labor to get more wheat from a field). You can’t eat the wheat field. In the final analysis, it’s clear on a conceptual level that the purchasing power of assets can’t simply unmoor from the goods available for purchase, but are ultimately tethered to the same tangible reality.
It’s a bit like a game of musical chairs. The game can start with an equal number of people as chairs. Each person can claim a chair without conflict. But if you were to add more people to the room, without adding more chairs, you wind up with more claims on chairs than you have chairs available to be claimed. This circumstance can persist for a long time, but when the music stops, the claims are revealed to be worth less than the people thought.
This happens in markets too. The perceived value of assets – claims on goods – can grow far beyond the amount of goods available to be claimed.
This is the crux of inflation. Creating dollars is like adding more people to the room. The effect may be to increase stock prices, as people realize the dollars are losing value. So it spills over from cash into other asset markets. As stock prices rise, people believe their wealth is increasing proportionally. The believe there are many more chairs in the room than there actually are.
So what happens if asset values grow several fold over a period of time in which the body of goods only grows a few percent? The excess is illusory. So it’s still inflation, even if consumer prices haven’t yet caught up. But over time, they either must catch up, or asset prices decline to reflect their true purchasing power.
I’ve been making this point in one way or another for a long time, but it’s especially timely now, because we’re at the point where the music is fading. Consumer prices have begun to wake up, indicating that the perceived value of dollar claims is beginning to reflect the underlying reality. Stock and bond prices are beginning to decline, increasingly reflecting their intrinsic value.
“Let’s be real. It’s an impossible task. Having inflated the bubble, best the Fed can do now is to try and engineer a soft landing for asset prices while consumer price inflation gradually declines. This is the difficult task.”
Succinct and cuts out all the noise you get from the Bullhorn. A great read, thank you.