Power & Market

What matters for the stock market is not the state of the real economy as such, but the state of monetary liquidity. In fact, bad economic conditions can actually be good for stocks. This is because monetary liquidity is determined by the interaction between the demand for money and the supply of money, the latter of which is associated with a looser monetary stance during crises.

As economic activity slows down, the demand for the services that the medium of exchange provides in the real economy declines. As a result, for a given pool of money a surplus of money emerges. As a rule, this surplus is put to work in financial markets, including the stock market.

Consequently, the prices of financial assets and stocks are pushed higher. (A deep economic slump also tends to be associated with a strong loosening in the central bank’s monetary stance, which further supports the growth momentum of the money supply.)

This was observed in the 1970s. The yearly growth rate of industrial production fell from 3.5 percent in January 1974 to –12.4 percent in May 1975. The yearly growth rate of the Consumer Price Index (CPI) declined from 12.3 percent in December 1974 to 9.4 percent by June of the following year.

As a result, the yearly growth rate of surplus money climbed from –7.7 percent in March 1974 to 7.6 percent in May 1975. In response to the increase in liquidity—i.e., the surplus money—the S&P500 climbed from 68.6 in December 1974 to 95.2 by June 1975—an increase of 38.8 percent.

Now if the pool of real savings is declining, it is possible that this increase in surplus money will not be employed in the stock market. Instead, investors may prefer to put it in safer assets such as Treasury bonds. This is something that was observed during the Great Depression.

For instance, the yearly growth rate of industrial production fell from 15.3 percent in January 1929 to –24.6 percent in October 1930. The yearly growth rate of the CPI also fell significantly, from –1.2 percent in January 1929 to –6.4 percent in December 1930.

In response to these large declines, the yearly growth rate of surplus money increased from –16.6 percent in May 1929 to 25.5 percent by November 1930.

Despite this strong increase in monetary liquidity, the S&P500 fell from 24.15 in October 1929 to 15.34 by December 1930—a fall of 36.5 percent. The index in fact continued to slide, falling to 4.4 by June 1932—an overall decline of 81.8 percent from October 1929.

I attribute the ineffectiveness of the increase in liquidity in strengthening the stock market between May 1929 and November 1930 to the possibility that the pool of real savings had declined significantly. The ensuing depression and massive unemployment forced people to stay out of any form of investment in stocks. As a result, the increase in liquidity was directed toward assets such as US Treasurys rather than stocks. During this period, the yield on the ten-year Treasury bond fell, from 3.71 percent in August 1929 to 3.19 percent by November 1930.

What is the current US economic background? Economic activity in terms of industrial production growth currently shows a visible weakening. After closing at 5.4 percent per annum in September 2018, the yearly growth rate fell to –1 percent in January 2020. The annual growth rate of the CPI, after having settled at 1.5 percent in February 2019, had climbed to 2.5 percent by January 2020.

The growth momentum of liquidity has shown a visible strengthening since August 2019. The yearly growth rate climbed from –2.7 percent to 4.2 percent by February 2020. The S&P500, however, after closing at 3,231 in December 2019, had plunged by 20 percent by March 2020, closing at 2,585.

As grappling with COVID-19 has required rapid and difficult decisions by world leaders to protect the public, it has been easy to overlook some of the lessons basic economics can teach us about prices. I taught economics for several years, and this topic that we covered in the first few sessions of each semester comes to mind as I watch today’s events unfold.

Prices serve a far more important role than simply telling us how much cash we need to part with in order to receive a good or service. They form the backbone of the entire market system. Individual market actors deliver critical products around the world more effectively than any third party–directed effort ever could. And they can do that only because of prices.

Prices act as signals to entrepreneurs of what value society is placing on particular resources at any given time. So, if society wants more iPhones, then the prices of the inputs to make iPhones will increase, thereby allowing the raw materials required to be directed to that purpose. Industries creating products with less value to society can’t pay as much for those raw materials, and thus they don’t get them. In times of crisis, our focus shifts from studying how prices direct resources to iPhone production to the more critical function of rationing—who does and doesn’t get food, fuel, and medical supplies.

The political consensus is that prices should be prevented from fluctuating in times of crisis. Although these policies are often well intentioned, they remove the critical signals needed by those on both the supply side and the demand side to make decisions in the best interest of society.

Consider hand sanitizer, the price of which has been increasingly scrutinized during this crisis. People around the world have been hoarding it, making it difficult or impossible to find in some areas. Nervous citizens quite naturally understand the importance of this product and want to make sure they have plenty of it. With prices forced to remain low, those who can get to the stores fastest have little economic incentive to not stock up. Those who aren’t as swift (who coincidentally make up a large portion of those who would be most at risk should they contract COVID-19) are left with empty store shelves. Once hand sanitizer is out of stock, those who really need it can’t purchase it—at any price. Even if a desperate person deems fifty dollars per bottle a lower cost than the cost of contracting the virus, they have no options. Our well-intentioned anti-price-gouging policies have left them with nothing.

And because producers who might currently be supplying ethyl alcohol for other, less needed uses (such as alcoholic beverages) aren’t able to be compensated for the expense of converting their plants or abandoning their existing customers, many of them aren’t able to shift gears—even if they might like to in the name of helping society in a critical time.

The inevitable outcome is the emergence of a black market as desperate buyers and sellers attempt to skirt the rules and transact anyway. A basic supply and demand graph shows us that black market prices are higher than those the market would have arrived at. Our attorney generals then run around making criminals out of people who were attempting to serve the needs of the community, and no one wins.

If, however, we allow the price to fluctuate freely, two good things happen. Those who are able bodied and make it to the stores first will have some challenging decisions to make. When faced with hand sanitizer at twenty dollars per bottle that was previously only two dollars, they will be a lot less likely to clean the shelves out. They will be much more likely to grab only the amount their families need, thereby leaving additional supply for those who come behind them.

In addition, producers of alcoholic beverages will quickly notice that prices of hand sanitizer are rising. They will find it more profitable to supply hand sanitizer than beverages and rapidly convert their production. This increase in production will not only increase the amount of hand sanitizer available in the world, but also mitigate the rise in prices. Even enterprising suppliers who might appear to be exploiting the situation at the consumer’s expense are sending vital signals to other suppliers that they need to start ramping up production.

The phenomenon has been proven time and again over many generations, and no product or service to date has been exempt—no matter how urgent the crisis. The invisible hand is still at work. Markets provide more products than any other delivery method and the most just form of determining who gets them. In a time of crisis, instead of abandoning their most beneficial feature, perhaps we should lean on them more.

A reader, A.B. Sterner, writes:

Toilet paper, for reasons I still can’t grasp, is experiencing a severe (in store) shortage in a lot of areas of the country. Yet in some areas price ceilings—in the form of "anti-gouging" laws—have been put in place to keep those prices artificially low, despite the unprecedented increase in demand.

Our family is one who gets a predetermined order of paper and other products delivered by Amazon monthly, through their subscribe and save feature. One of the items we receive monthly is toilet paper. This last delivery, Amazon was unable to fill the order. Thanks to our overestimation and failure to adjust our previous orders, we have been unintentionally hoarding toilet paper for years. When set up initially, we assumed we would use a package equivalent to 56 “regular” rolls of toilet paper each month. As it turns out, we have used an estimated average of 38 regular rolls of toilet paper per month. So even as we did not receive our shipment this month, we still had plenty of stock on hand, the equivalent of nearly 500 rolls, or enough to easily supply our family for at least a year.

We are now faced with a far larger than needed inventory of toilet paper. Our first thought is we should hold onto it, given the uncertainty of when we will be able to purchase more. Given we have more than a year’s supply, there isn’t a likely scenario where this would be necessary. It's a sunk cost, we have the room to store it without sacrificing the storage of other items. The do-nothing approach is the most appealing option right now. But what if we were to try and sell it? We paid roughly $0.30 for each regular roll. It’s $150.00 worth of inventory we are currently carrying. Our subjective value of this toilet paper is at least what our costs were, as of now. As laws to prevent price gouging are in effect, and if we were to try to sell any of our inventory for more than $0.30 per roll would be considered illegal, there is no incentive to let go of our current inventory.

As of now, our subjective value of each roll is probably $0.50, a 67% premium over what we paid for them. If we could receive more than $0.50 per roll, instead of hoarding them, we would put at least a couple of cases up for sale. If we could get $1.00 [per] roll, we would likely put most of my inventory up for sale. If we could get $5.00 per roll, we would sell every last roll and either purchase a bidet or two, or maybe even use warm wash cloths and do quite a bit of unpleasant laundry every day.

I’m sure plenty are thinking that we should do the “right” thing and just donate them to others less fortunate. The problem with this is prices have remained unchanged, thanks to price ceilings put into place by the government. You may not think this would have any effect on our willingness to donate our inventory, but it has a large impact. Donations to a qualified non-profit carry tax benefits. Our $150.00 inventory, if donated, would generate a tax deduction of no more than $150.00, since this is the current artificial price. The actual tax savings to us would be less than $50.00, well below what we paid and far below our subjective value per roll. The incentive isn’t there. If we could deduct $500.00 or $1,000.00 worth of income by donating our excess inventory, because prices were not artificially restricted, there would be an incentive to donate our extra to those in need.

If the price system were allowed to work, even though we would gain more profit from selling them outright, we would more likely donate our excess, because the monetary benefit would be equal to or more than our subjective value. In addition, we would also profit from the psychic benefits we would get, from knowing we were helping those who are in need during this time. So even if we had the opportunity to be selfish, uncaring capitalist dogs, we wouldn’t.We are not the only ones in this situation. Others are have inadvertently overordered their supply of toilet paper and have inventories such as ours. Even more have purchased well more than they need in the short term and have subjectively valued theirs at more than they have paid. If prices were allowed to work, ask yourself, how many of just these rolls of personal inventory would be put back out into the market? The answer is an easy one. It would be more than enough to satisfy the current needs of every American. As we established, there is no shortage of toilet paper out there, just a shortage of toilet paper in the marketplace because of the price ceilings put in place by our philosopher kings. 

Cato Institute research fellow Patrick Eddington recently filed several Freedom of Information Act (FOIA) requests to find out if the Federal Bureau of Investigation ever conducted surveillance of several organizations dealing with government policy, including my Campaign for Liberty. Based on the FBI’s response, Campaign for Liberty and other organizations, including the Cato institute and the Reason Foundation, may have been subjected to FBI surveillance or other data collection.

I say “may have been,” because the FBI gave Mr. Eddington a “Glomar response” to his FOIA requests pertaining to these organizations. A Glomar response is where an agency says it can “neither confirm nor deny” involvement in a particular activity. Glomar was a salvage ship that the Central Intelligence Agency used to recover a sunken Soviet submarine in the 1970s. In response to a FOIA request by Rolling Stone magazine, the CIA claimed that just confirming or denying the Glomar’s involvement in the salvage operation would somehow damage national security. A federal court agreed with the agency, giving federal bureaucrats, and even local police departments, a new way to avoid giving direct answers.

The Glomar response means these organizations may have been, and may still be, subjected to federal surveillance. As Mr. Eddington told Reason magazine, “We know for a fact that Glomar invocations have been used to conceal actual, ongoing activities, and we also know that they’re not passing out Glomars like candy.”

Protecting the right of individuals to join together in groups to influence government policy is at the very heart of the First Amendment. Therefore, the FBI subjecting such groups to surveillance can violate the constitutional rights of everyone involved with the groups.

The FBI has a long history of targeting Americans whose political beliefs and activities threaten the its power or the power of influential politicians. The then named Bureau of Investigation participated in the crackdown on people suspected of being communists in the post-World War I “Red Scare.” The anticommunist crackdown was headed by a young agent named J. Edgar Hoover, who went on to become FBI director, a position he held until his death. Hoover kept and expanded his power by using the FBI to collect blackmail material on people, including politicians.

In the 1930s and 1940s, the FBI spied on supporters of the America First movement, including several Congress members. Two of the most famous examples of the FBI targeting individuals based on their political activities are the harassment of Martin Luther King Jr. and the COINTELPRO program. COINTELPRO was an organized effort to spy on and actively disrupt “subversive” organizations, including antiwar groups

COINTELPRO officially ended in the 1970s. However, the FBI still targets individuals and organizations it considers “subversive,” including antiwar groups and citizen militias.

Congress must hold hearings to determine if the FBI is currently using unconstitutional methods to “monitor” any organizations based on their beliefs. Congress must then take whatever steps necessary to ensure that no Americans are ever again targeted for surveillance because of their political beliefs and activities.