By Donella Meadows

–February 19, 1987–

Why is the stock market shooting up while the economy is in the doldrums? As usual with questions about economics, you can find someone to give you any answer you want.

If you want to hear that the market is revealing the hidden economic strength of this great nation, listen to someone in the Reagan administration.

If you want to think the bull market still has plenty of oomph, read the financial pages or talk to your broker.

If you believe that greed is always punished and what goes up must come down, John Kenneth Galbraith is the man for you. He sees in the current market a “mass escape into make-believe”, like the one he wrote about in The Great Crash 1929.

Unfortunately, the evidence is on Galbraith’s side.

The Dow Jones industrial average has nearly tripled since mid-1982. It went up 14% just in the month of January 1987. But even by the most optimistic measures, production of real goods and services has grown by no more than 20% since 1982. Industrial production has been essentially stagnant for the past two years.

The farm, fuel, minerals, steel, and machinery sectors are in deep depression. Personal, corporate, government, and foreign debt levels are at all-time highs. The unemployment rate, after four years of recovery, is about 7%, which used to be the recession high, not the recovery low. About the only booming activities are the defense industry and the business of raiding, merging, divesting, and leveraging companies.

In short, no perceivable improvement in the productive capacity of the real economy justifies the current rise in the stock market.

Then why is it rising?

Because people who have more money than they need have to put it somewhere; they prefer to put it where it will generate more money; these days the stock market is about the only place for it to go.

Since taxes were cut in 1980, there are more people with more excess money than there have been since — I hate to say it — 1929.

When the real economy is growing, that money can go into real investments — factories, machines, farms. But this is a time of glut. The world is producing more oil, wheat, shoes, steel, textiles, and automobiles than people can buy. One-fifth of U.S. manufacturing plants are standing idle. Farmland prices are deflating. There’s little opportunity for real productive expansion.

Interest rates on bonds and Treasury notes are going down. Gold and rare art and second-home lots in the country can only absorb so much dough. Therefore much of the money that’s sloshing around is going into stocks.

The stock market always has the potential to go into a boom. Stock prices go up a little, people earn interesting returns. More loose money comes to the market, prices go up even more, attracting still more money. Rumors about a bull market begin; more money comes in. How can you beat 14% per month?

Usually the market doesn’t become completely unhinged from the underlying value of the shares. The last time it did, in 1929, the real economy was also overbuilt; the rich had just received tax cuts; financiers in Wall Street had become objects of public admiration (and then objects of scandal); many clever devices to leverage debt with no underlying assets had been invented; and government officials were acting primarily as cheerleaders and weren’t paying much attention to what was really going on.

You can draw your own conclusions. I have drawn mine, and Galbraith has drawn his. He attributes the periodic appearance of senseless stock booms to two basic flaws in human character: the desire to get rich without effort, and the shortness of the public memory.

I guess I’m not as misanthropic as Galbraith is. I think that market booms and crashes, along with many other ills of our age, come simply from a false, unnecessary, and changeable way of thinking — our strange belief that wealth should grow naturally at 3% or 5% or 7% per year.

Nothing real can grow like that for very long. If our production of steel and food and haircuts increased steadily at 3.5% per year, within a century we would have 32 times more of everything. If real growth went on for a century at 7% per year, we’d be producing over a THOUSAND times more. Some poor countries could use that kind of growth for awhile, but a country as rich as ours wouldn’t know what to do with all the stuff, even if we let the poor in on the distribution.

The real material economy cannot, should not, and will not grow continuously. If the money economy tries to keep growing in the absence of real investments, it will create fake ones. Money assets will boom ahead of real assets until their disconnection from each other becomes obvious. At that point money assets will crash back to the level of the real economy, or, in a crisis of confidence, below that level for a period of depression.

I know how hard it is for our society to loosen its grip on the concept of Ever More and to contemplate the idea of Enough. But I recommend trying it. Not only might it release us from cycles of boom and bust, it might even bring us to an economy designed around real human welfare instead of constant growth. Maybe we could even learn what life might be about, when it isn’t about making more money

Copyright Sustainability Institute 1987