Real Wealth

What happens when Wall Street profits divorce Main Street earnings...

(Source: Getty Images)

Bill Bonner, reckoning today from Youghal, Ireland...

The gap between the real world of Main Street output…and the fake world of Wall Street prices…narrowed slightly yesterday. Prices on Wall Street fell.

How that gap will close further is the major financial theme of the coming decade …and our primary focus here at Bonner Private Research.

Both Wall Street and Main Street are, of course, ‘real.’ Nvidia makes computer chips. It sells them…at a profit. And if you own Nvidia, you can sell your shares and convert the money into real things – a boat, a car…a six-pack of Bud Light.  

The difference is that the real economy of products and services gives you ‘wealth’ that is more or less tangible and reliable. An automobile, for example, is something you can see…touch…and use. It may go up or down – in price – but its utility is fairly stable and predictable; it degrades slowly, as the machine wears out. 

That’s why the Fed’s ultra-low interest rate policy was not only bad economics; it was unfair. It raised asset prices for the top 10%...but it did nothing for those who didn’t own them. The price of labor, sold by the hour, barely budged. The rich were not just richer ‘on paper.’ They could sell assets to buy other peoples’ boats.  

Unlikely Scenario

Shares of Nvidia are real, too…but speculative. You can exchange a share now, for $391 worth of real stuff. That price is not guaranteed. And since it represents only $1.95 of earnings, you’d have to hold the stock for 200 years to get your money back, assuming the company paid out 100% of earnings in dividends (which it won’t). So, the price represents something other than today’s reality. It suggests things about the future that might not actually happen. In fact, they’re rather unlikely.  

That gap – between what might be…and what probably will be – is the measure of the reckoning that lies ahead. It is the chasm between hope and reality…between illusion and brutal truth…between two tenses, the future conditional, subjunctive mood and the future as it will actually turn out. The wider the gap, the more difficult it is to bridge it. 

And this is not an academic or theoretical matter. According to Gillian Tett, writing in the Financial Times, there is a monstrous hole to be filled:

A new report about the state of the world’s balance sheet (that is, its assets and debts relative to growth) contains a startling finding. Number crunchers at the consultancy McKinsey believe that, since 2000, the world’s stock of paper wealth (the speculative, unrealized price of all its financial assets) has jumped by $160 trillion.

Doing The “P” Dance

World GDP stood at $50 trillion in 1999. It’s now closing on $90 trillion. That’s a gain of $40 trillion. If the profit margin on the extra GDP (services and products rendered) were 5% (which it isn’t; GDP includes government spending…the biggest item on the ledger…on which the profit margin is zero) that would be a total of $2 trillion of earnings, which the markets have capitalized at a p/e ratio of 80 (to get to $160 trillion of new, speculative gains) about six times what is considered ‘normal.’

At a ‘normal’ p/e ratio, the value of that $40 trillion in extra output, with $2 trillion of extra earnings, would be about $25 trillion. The rest ($160 minus $25)  gets the future conditional, subjunctive mood – it might work out that way, if we were to get very lucky. More likely, $135 trillion of the world’s ‘paper’ wealth will never exist in tangible, reliable form.  

What we see, in other words, is a lot of P and not much E.   

The laws of the universe – at least, as intuited by your editor – admit to only one reality. One of those numbers must be wrong. And since E is much less likely to move rapidly to the upside, and much harder to manipulate, we presume that P will have to take the hit. 

Downside Adjustments

It is the Fed that will decide the matter. It must ‘inflate or die.’ If it were to continue raising rates, putting them back into the ‘normal’ range, which is 2% or 3% above inflation, asset prices would fall. And they would probably keep falling until they are back to where they should be – a rough measure of the earnings the company is likely to produce.

In this ‘die’ scenario, there would be a lot of gnashing of teeth among the upper classes, as asset prices make the necessary adjustments to the downside.  

If, on the other hand, the Fed gives up the fight against inflation…and goes back to its bad habits of printing money and lending it out below the inflation rate …the gap will still close, but more slowly…and more painfully.

Recently, the ‘inflate or die’ trap was outlined to Robert Kennedy, Jr. candidate for president. He asked:

“What can we do about this?”

He wanted to know what could be done to avoid the hurt of a major correction.  Inflate or die – neither will be much fun.

The answer, alas, is: all you can do is to get through the correction as fast as possible.

When you have a toothache, you go to the dentist. You know it’s not going to be pleasant.  But if you don’t undergo the necessary remediation, the rot will deepen.

Regards,

Bill Bonner