Tuesday, December 21, 2004

Another Lump of Coal Dropped On Kinsley's Newcastle

By the scrivener (who, the FLUBA Intelligence Committee has learned, has been reading the Becker-Posner blogging on pre-emptive warfare) as an early Christmas gift:

...for argument's sake let's assume a new full $200 billion is invested in stocks through privatized Social Security accounts each year.The market capitalization of the New York Stock Exchange is $12 trillion. ....

But that's just one stock exchange. The capitalization of the world's major stock exchanges combined exceeds $33 trillion (if anything in this world is globalized the financial markets are, and return isn't going to plunge in one without doing so in others -- and, of course, diversified private investment accounts can invest anywhere).

Moreover, their capitalization is growing at a long-term average rate of about 4%, over a trillion dollars a year.

Now, $200 billion equals less than 0.6% -- six tenths of one percent -- of total stock market capitalization (and that percentage will decline as time passes).

So hurdle-to-jump #1 is:

How is it plausible that increasing demand for stocks by all of six tenths of one percent will produce an historic change in the pricing and yields of stocks? For that matter, how will it produce one big enough for anyone to even notice?

2) The economy is not static, no matter what one assumes.

For argument's sake again, let us assume that some measurable increase in the price of stocks does occur to measurably reduce the yield on them, due to the increase in demand for them arising from new private Social Security accounts.

But we can't stop there! How will businesses react to that?

Well, since they now can sell shares for more -- for a higher price, while paying lower dividend yields on them -- they will sell more shares. This is just the law of supply and demand: increase in price brings an increased quantity of product to market. If you increase the amount that companies can get for selling stock shares, they will be happy to print and sell more.

Lower yields on stock shares make it less expensive for companies to issue new stock to finance new productive investment -- just exactly like lower yields on bonds make it less expensive to issue new bonds for the same purpose. Thus, with higher stock prices and lower yields on them, productive investments that were uneconomic for firms previously become profitable, and so will be financed with new stock issuances. Real economic investment increases.

This is exactly the benefit of increased savings that Kinsley assumes isn't supposed to exist when he makes the assumption: "If the economy doesn't produce more than it otherwise would". Yet with rising stock prices and declining stock yields it is unavoidable that investment increases! Real investment and the real productive economy grow faster.

Hey, this is exactly why economists of all political stripes are constantly saying the US savings rate is too low -- because they want to produce this effect to spur the productive economy!

Moreover, of course, this very increase in the supply of stock shares due to increased demand for them will offset much of that increase in demand for them. And this in turn will act as a contervailing force to check and prevent any dramatic increase in the price of, and decline in the yield on, stocks. This is why the term "equilibrium" is important in economics.

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