Focus on the Fundamentals: Income, Not Investments

Felix Salmon comments on the stock market dropping below its November lows:

The fact is that prospects for the economy are much worse than they were in November. As such, it stands to reason that stock prices should be lower than they were in November: if they were much higher, and the Dow was still above 9,000, that would be the real news, since it might imply that the November lows were panic-driven rather than rational.

That’s right, but I think people’s Dow-driven anxieties point to a larger pathology that started at the policy level and has now infected the media and the general public’s understanding of how the economy works.


Historically, the route to higher living standards is higher wages and incomes. When productivity grows, and demand growth is robust enough to keep unemployment low, wages and incomes go up. Corporate profits should go up, too. All this ought to lead to assets increasing in price. If the income of people in the Boston area grows faster than the supply of houses in the Boston area, then housing in Boston is going to get more expensive. If profits grow, so will stock prices. And some people will make money off this growth in asset value. But it will be, more or less, a coincidence. The more expensive Boston area houses could lead to profits for some people who live there and want to sell their homes and move to Tampa. But for many people, it’ll make no difference—they might sell a two bedroom place and reap the benefits of homes increasing in price, but then buy a three bedroom place and suffer the consequences. And for people looking to move to Boston, the run-up in home prices is a bug, not a feature.

But ever since the 2001 recession, we haven’t really had growth in incomes. Instead, we’ve had asset-led growth. People who owned stuff already in 2001 saw the value of that stuff go up. Since they were now “richer” they were able to borrow more. And since they were able to borrow more, they were able to get more stuff. That had a similar result as if their incomes had gone up and they’d used the income to buy more stuff. But it was unsustainable. The lending based on higher asset values was based on the idea that the assets would keep going up in value. And the increase in value was driven by a combination of speculation, and buy the fact that consumption was creating economic activity. But now it’s all collapsed.

And with the collapse has come a powerful urge for action to prop the assets back up. To reinflate the housing bubble. To make the Dow go back above 10,000. But that’s all backwards. What we need is an increase in the amount of demand in the world. With, most likely, foreign countries actually being the main driver of this. And that demand can lead to jobs and income. And if people start earning more money, then soon enough asset prices will go up again. But that would be a consequence of growth, not a cause.