Stock markets have power: The Tribune India


Aunindyo Chakravarty

Senior Economic Analyst

Economists often say that stock markets do not reflect the real economy, at least in developing countries like India. At first glance, this seems logical. Just over 6 per cent of Indians have bank accounts, two thirds of them were added in the last three years and half of them opened accounts in the two years of Covid. This sharp rise is almost inexplicable, considering that it came at a time when businesses were closing and the middle classes were facing their worst financial crisis in decades.

The economic recipes of leading economists are primarily intended to offer the best returns to capital investors.

One possible explanation is that households that had only one demat account holder obtained new accounts for other members to take full advantage of the large number of IPOs that have occurred in recent years. That means no more than 2-3 percent of households in India would have stock investments. If we were to double the number of those who have invested in mutual funds, without opening bank accounts, it would still be around 5-6 percent of families that have a connection to the stock markets.

That is reason enough to believe that the stock markets do not affect the lives of 95 percent of Indians. Could not be farther from the truth. Those who invest in the markets decide economic policies for all of us. And whether mainstream economists know it or not, all of his economic recipes are meant to bring the best returns to equity investors.

There is no better example of this than the way authorities around the world deal with inflation. Orthodox economists have two broad arguments about what causes prices to rise. The first is that the general level of prices is determined by the total amount of money that is in circulation and how quickly bills change hands. If governments borrow and spend too much, they end up increasing the money supply. The same thing happens when central banks print banknotes and allow companies and individuals to take out easy loans. That is when too much money goes after the same amount of goods and services, and this causes high inflation.

The way to deal with inflation, therefore, is for governments to spend less and for central banks to reduce the money supply. The fastest way to do this is to raise interest rates. When rates go up, consumers and businesses borrow less and spend less. That automatically reduces the demand for goods and services and controls inflation.

The second argument has to do with employment and wages, and is a kind of corollary to the monetarist thesis. If there is too much easy money available, companies borrow and increase production at a rapid rate. As they invest more, they hire more people. Soon, the economy reaches a stage of full employment. Now, if any company wants to set up a new factory or increase production, they have to steal workers from other factories. Workers only come if they are paid higher wages. They also demand easier working hours. Soon, all companies will have to pay their workers more and work them fewer hours a week. This increases your costs, and this increased cost is passed on to consumers as higher retail prices.

Workers soon discover that inflation is eating into their higher wages and demand even more. They also expect inflation to continue to rise, and this ‘inflation expectation’ leads them to ask for even higher wage increases. It becomes a self-fulfilling prophecy: a high level of employment raises wages, increases production costs, which, in turn, leads to higher retail prices, leading to higher inflation expectations among workers, who then they demand more wages and cause even more inflation.

What is the remedy? Economists will tell governments to cut spending and implore central banks to tighten the money supply. They will say that the economy is overheated and the only way to cool it down is to squeeze out new investment. This will reduce employment levels and force workers to accept lower wages. The fall in the wage bill will reduce costs and retail prices will also fall, which will lower the general level of prices in the economy.

It is assumed that profits should not be touched to reduce inflation. The only reason to target wages to control inflation is to ensure that profit margins remain intact. If governments reacted to inflation by controlling prices and forcing companies to maintain wages, it is the employer who would have to sacrifice profits. And that would affect the value of companies’ shares, because their valuation depends on future profits. Therefore, governments and central banks, all over the world, follow what leading economists prescribe to ensure that inflation targeting is done at the expense of the worker and never at the expense of the capitalist.

But this too is only half the story. While individual capitalists are driven by the will to maximize profits, the capitalist system, as a whole, is driven by accumulation. If governments and central banks deal with inflation by slowing down investment, they are effectively damaging the prospects for this very process of accumulation. If the rate of growth exceeds the rate of wage inflation, capitalist profits will not be affected by inflation at all. Inflation and wages may rise, but still grow at a slower rate than the rate of increase in profits.

The real reason governments and central banks target inflation is that the world is ruled by finance capital. If inflation goes up, the value of financial assets goes down. After all, a 10 percent return against 4 percent inflation is much better than a 15 percent return against 11 percent inflation. This is the reason why inflation targeting has become the universal dogma in countries around the world, so that financial assets do not lose their value.

Therefore, although the stock markets do not directly involve 95 percent of the population, what happens there determines the economic existence of all.

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