Why Stock Markets Are Not an Indicator of the Economy

In a free unhampered market economy based on a sound monetary system – this is to say a market-chosen monetary system with a free banking industry and no central planning institution that is manipulating interest rates and determining the size of the money supply – the gains and losses of shares prices in the stock market will simply be a reflection of entrepreneurial profits achieved in the past, plus embedded expectations of profits likely to be achieved in the future.

Nicolas Maduro, the hapless president of socialist Venezuela, here seen hung with all sorts of bling supposed to testify to his achievements.

Photo credit: Prensa Presidencial

Under the assumption that such a free market money system would be largely non-inflationary, this mixture of “historical record” and expectations would primarily be expressed by the relative prices of shares. The bulk of the returns achieved by investors would come from dividend payments, as a general inflation of “the market” would be nigh impossible.

And yet, although the stock market as a whole would barely appreciate in price in nominal terms, the gains achieved in real terms as well as real economic growth, would be far stronger than they are under our current, centrally planned system of constant inflation. Moreover, economic progress would be far more equitable as well, as the reverse redistribution of wealth caused by inflationary policy wouldn't exist.

This is why a rising stock market tells us absolutely nothing about the state of the underlying economy in the present inflationary system. In fact, we once again have a real life example providing ample empirical confirmation of this assertion. Venezuela's economy is in free-fall. Its desperate socialist government, in an attempt to satisfy the masses of voters who have voted for it in order to receive handouts, is resorting to ever more repressive economic policy and money printing on a truly gargantuan scale to at least keep up theappearance that bread and circuses will continue. It has long lost the last shred of credibility, as shortages of basic goods have become the major hallmark of the country's economy.