Dow’s High but Demand’s Still Low
Earlier this week, the Dow Jones Index hit a historical high. Other market indices while not setting records have also gone up sharply, signaling a strong recovery for the stock market and possible growth ahead. Good news for investors and people with 401Ks but what about the rest of the economy?
According to conventional wisdom a rising stock market is good for everyone, even people who are not participating in the market. The stock market is considered to be the major source of capital for businesses looking to gown in our economy. Rising wealth in the economy should spur overall growth and thus benefit everyone, right?
However, the stock market is not the only source of investment capital for businesses. For most businesses the first source of investment capital comes from its own profits. This surplus is usually kept in very safe investments like bank accounts, low interest bonds and securities, referred to as corporate cash reserves.
As Minnesota 2020 has pointed out, cash reserves in the US have grown sharply in the last decade, as shown in this chart. The huge cash reserves indicate that business leaders do not want to spend the money because they are not expecting any growth. In fact, right after the recession of 2007-2009 corporate leaders chose to increase their already historically high level of reserves rather than invest.
When capital is readily available a lack of investment indicates a lack of demand for goods and services in the market place. A rational capitalist will not invest if he or she doesn’t expect to have demand for the company’s product or service. Merely increasing supply of capital (via higher stock prices or tax breaks) will not change the mind of a rational capitalist. In a demand limited economy, surplus capital does not translate into growth.
Unfortunately in the US growth is demand limited. This is a just another effect of the dismal statistics of middle class income stagnation. And the Dow reaching historical highs does not change that.