Can we have a booming stock market with economic calamity?

July 7th, 2009

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After the First World War, the Allies imposed punishing sanctions on the Central Powers. Germany had to pay gigantic war reparations and had their industrial base in the Rhineland occupied by the Allies. Austria-Hungary was broken up into Austria, Hungary and the other states. They also lost millions of their citizens to the newly formed successor states. The former imperial capital, Vienna, was left as a vast city without any hinterland to support it. Without Czech coal and Hungarian food, the Austrian economy was hardly self-sufficient. There was political and economic chaos in Hungary, Austrian and Germany. Hyperinflation and hunger reigned. Life was miserable then.

In the midst of such widespread economic despair, as this book, When Money Dies: The Nightmare of the Weimar Collapse described,

Speculation on the stock exchange has spread to all ranks of the population and shares rise like air balloons to limitless heights … My banker congratulates me on every new rise, but he does not dispel the secret uneasiness which my growing wealth arouses in me … it already amounts to millions.

In other words, the economic was a disaster, but the stock market roared. As we pointed out before in Zimbabwe: Best Performing Stock Market in 2007?, Zimbabwe too had a roaring stock market.

Today, the mainstream often associate economic calamity with collapsing stock markets and price deflation, and booming economy with booming asset prices and price inflation. As we wrote in Are improving consumer sentiments ?good? news?, if the masses’ sense of financial well-being depends on asset prices, then the past 3 months of rising asset prices had done wonders for improving the masses’ confidence. But as we stressed many times in this journal, it is possible to have economic calamity with booming asset prices, especially stock prices. As we wrote before in Harmful effects of inflation,

With inflation, there is less incentive to be productive and more incentive to hoard, speculate and gamble. This in turn will reduce productivity and increase price inflation, which further increase the incentive to be less productive. In addition, as we said before in How to secretly rob the people with monetary inflation?, inflation re-distribute wealth unfairly and exacerbate the divide between the rich and the poor.

As time goes by, the economy will be structurally damaged one step at a time. This process can take many decades to completely play out. Of course, with economic mismanagement, it can be accelerated, as in the case of Zimbabwe.

It is this speculation in asset prices that brought about the ‘booming’ stock market. In times of hyperinflation, the prices of everything (including everyday stuffs) rise in nominal terms, company profits included. Therefore, stock prices have to rise too to accomodate the hyperinflating profits.

Unlike the mainstream, we see any sustained rally in the stock market with a very suspicious eye.

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