A glaring paradox of modern economics

When the world economy is sinking due to the Covid19 pandemic shutdown, stock markets (capital markets) are booming thus allowing those at the top of the economic pyramid to make wealth when billions of people are losing theirs.

The global economy was facing its worst recession since World War II and that the growth was expected to shrink (i.e. negative growth) by 5.2% in 2021(as said by World Bank in its ‘Global Economic Prospects report of June 2020).

It should also be noted out that the major fraction of economies are experiencing a reduction in per capita output. The US economy is projected to shrink by 6.1% in 2020 and that of India by 3.2% in 2021. Yet the harsh reality has ignored stock markets, except for an initial blip in March.

Stock market booms while economy sinks

The analysis of stock market data says that the US billionaire wealth surged to $584 billion, or 20%, during the pandemic, between March 18 (rough starting date of the pandemic lockdown) and June 17, when most economic activities were restricted.

The US GDP registered negative growth of 4.8% in the first quarter, the first negative reading since Q1 of 2014.

Scrutiny of stock market data shows, between mid-March and mid-June the US’s NASDAQ (National Association of Securities Dealers Automated Quotations) Composite rose by 41.8% and the S&P 500 — the top 500 stocks — went up 27%.

A similar situation is evident in India

Business Today magazine’s latest issue (July 12, 2020) provides startling information. Describing the market rallies during the pandemic lockdown as “a lot of bull”, drew attention to three things:

⦁ India’s economy is projected to shrink (negative) 6.8% in FY21, according to the SBI’s projections (World Bank projected a shrink by 3.2%)

⦁ growth in Q4 of FY20 was slowest in 11 years at 3.1% and

⦁ early corporate results showing sharply shrinking top lines and bottom lines.

Just as it happened in the US, the Indian stock market has rallied through the lockdown after an initial dip in March, driven by a handful of stocks. Between March 23 (national lockdown started from midnight of March 24–25) and June 12, 10 stocks accounted for 75% of the rise.

The current stock market rally is not an isolated incident. Sensex hit an all-time high of 42,063 on January 17, 2020, while the quarterly growth rate had consistently been going down since Q4 of FY18 when it touched 8.1% and went down to 3.1% in Q4 of FY20.

The stock market rally until Q4 of FY20 is all the more perplexing since the GDP numbers are known to be grossly exaggerated due to multiple downward revisions of previous quarter numbers, thereby making subsequent numbers look better than what they are.

Such downward revision goes all the way to the UPA era (FY05 to FY14). Yet, the Sensex reached an all-time high of 42,063 on January 17, 2020.

The Post-March rally has happened even though the lockdown has hit the economy hard and growth for at least the next two quarters is expected to be negative (first-quarter numbers will come out in August).

What is then driving the stock markets?

Disconnect from business fundamentals

Did the delinking happen now?

It has been pointed out that the Indian stock markets had discounted massive economic shocks of demonetization and GST that derailed the economy in 2017, and bank failures (PMC, Yes Bank), NBFC crisis (IL&FS, DHFL), and growing NPAs in the subsequent years that prevented the economy from bouncing back.

The upward trend in the stock markets continues amidst the trade war against China. Amid rising clamor to boycott Chinese goods, imports from China have been held up at Indian ports, which the Minister for Micro, Small and Medium Industries Nitin Gadkari objected to saying that this will harm local businesses that have already paid for these goods.

Far more critical is that such hold-ups may impact the production of key COVID-19 drugs redeliver and favipiravir and other life-saving drugs in India, leading to country-wide shortage and endangering the lives of millions of Indians. India imports two-thirds of its active pharmaceutical ingredients (APIs) and formulations from China.

Some economic experts suggest that the delinking of stock markets happened in recent times (2015). But this delinking was evident during the massive market crash of 2008 and earlier in 2000–01 when the dot-com bust happened. Historically, this breakdown has been evident since the 1929 Great Depression. That is nearly a hundred years of historical evidence.

It needs no elaboration that high stock market fluctuation comes up when the link with the real economy (macroeconomic and business fundamentals) is broken. Valuation of stocks reaches irrational highs, leading to an eventual crash (unless timely rescued with taxpayers’ money).

Reason for the market boom

Why stock markets are booming when economies are not performing well is not unknown. For one, it has a great deal to do with liquidity infusion. In the US, the Federal Reserve has not only reduced interest rate to near zero (0.25%) to create more liquidity but also decided, as part of its stimulus, to buy corporate bonds from the open market (quantitative easing).

There is more support waiting. Should there be a market crash, more taxpayers’ money would be plowed in to protect private investors, as happened during the Great Recession of 2007–08.

In India, it happens even without massive crashes of the 2007–08 proportion.

It is no secret that every time market falls sharply, the government instructs public sector undertakings like the LIC and SBI to step in quickly, buy stocks and boost “market sentiment”. That this rush job is potentially dangerous for these PSUs escapes attention.

For another, it is the lure of gambling. Making quick money through speculative activities (betting and gambling) is an old human vice.

But lowering the interest rate to near zero in the US further incentivizes people to borrow money virtually free of cost to invest in stock markets. This is one reason why the US stock market has made a swift recovery.

Stock traders know the Fed will protect the long-term profitability of big corporations with taxpayers’ money.

In India, the Reserve Bank of India (RBI) has been reducing interest rates. Though it has not reached near zero yet (the repo rate is 4%), it has generated additional liquidity of Rs 8.1 lakh crore. Most of it is being parked in the RBI’s reverse repo account, reflecting the futility of liquidity infusion. On June 26, Rs 6.35 lakh crore was parked in this account. On many occasions in May, the reverse repo deposits had crossed the Rs 8 lakh crore mark.

Nobel laureate Joseph Stiglitz has been stinging in his criticism of the speculative activities in stock markets.

In the book ‘People, Power, and Profits’, Stiglitz writes: “In many ways, the stock market is just a rich person’s casino.

And while gambling may afford some short-term pleasure, money simply moves from one person’s pocket to another.

The gambling — and short-term trading — don’t make the country richer or more productive, and it often ends in bitter tears on the part of one party or the other.”

To that extent, stock market activities are simply a tool to transfer money from the impatient to the patient or a zero-sum game in which some gain at the cost of others.

Why does the game never end at some point?

Apart from low-interest money, more people join the game, bringing in fresh money to keep the game going.