Stock markets in power: The Tribune India


Aunindyo Chakravarty

Senior Economic Analyst

Economists often say that stock markets do not reflect the real economy, at least in developing countries like India. At first glance, this seems logical. Just over 6% of Indians have demat accounts, two-thirds of them were added in the last three years and half of them opened accounts in the two Covid years. This sharp rise is almost inexplicable, given that it came at a time when businesses were closing and the middle classes were facing their worst financial crisis in decades.

The economic recipes of traditional economists are primarily aimed at providing the best returns for equity investors.

One possible explanation is that households that had only one demat account holder obtained new accounts for other members to make the most of the large number of IPOs that took place over the past two last years. This means that no more than 2-3% of Indian households would have equity investments. If we were to double the number of those who have invested in mutual funds, without opening demat accounts, it will still be around the 5-6% of families who have a connection to stock markets.

This is reason enough to believe that stock markets do not affect the lives of 95% of Indians. Nothing could be further from the truth. Those who invest in the markets decide economic policies for all of us. And whether mainstream economists know it or not, their economic recipes are all geared towards delivering the best returns to equity investors.

There is no better example of this than the way authorities around the world are handling inflation. Mainstream economists have two main arguments about the causes of rising prices. The first is that the general price level is determined by the total amount of money in circulation and how quickly banknotes change hands. If governments borrow and spend too much, they end up increasing the money supply. The same thing happens when central banks print notes and allow businesses and individuals to take out easy loans. That’s when too much money chases the same amount of goods and services, causing high inflation.

The way to manage inflation is therefore for governments to spend less and for central banks to reduce the money supply. The quickest way to do this is to raise interest rates. When rates rise, consumers and businesses borrow less and spend less. This automatically reduces the demand for goods and services and staves off inflation.

The second argument has to do with employment and wages, and it is in a way a corollary of the monetarist thesis. If there is too much easy money available, companies borrow and increase production at a rapid rate. The more they invest, the more they hire. Soon, the economy reaches a stage of full employment. Now, if a company wants to create a new factory or increase its production, it must poach workers from other factories. Workers only come if they receive higher wages. They also demand easier working hours. Soon all businesses will have to pay their workers more and have them work fewer hours per week. This increases their costs, and this increased cost is passed on to consumers in the form of higher retail prices.

Workers soon find that inflation is eating away at their higher wages, and they demand even more. They also expect inflation to continue to rise, and this “expectation of inflation” drives them to demand even bigger wage increases. This becomes a self-fulfilling prophecy – high employment drives up wages, raises production costs, which in turn leads to higher retail prices, causing inflation expectations to rise among workers, who then demand more wages and cause even more inflation.

What is the remedy? Economists will tell governments to cut spending and implore central banks to tighten the money supply. They will say that the economy is overheating and the only way to cool it down is to urge new investment. This will reduce employment levels and force workers to accept lower wages. Lower payrolls will lower costs and retail prices will also fall, lowering the overall price level in the economy.

It is taken for granted that profits should not be affected to reduce inflation. The only reason to target wages to control inflation is to ensure that profit margins remain intact. If governments reacted to inflation by controlling prices and forcing businesses to maintain wages, it was the entrepreneur who would have to sacrifice his profits. And this would affect the value of companies’ shares, as their valuation depends on future earnings. So governments and central banks around the world are following everything mainstream economists prescribe to ensure that inflation targeting is done to the detriment of the worker and never the detriment of the capitalist.

But that too is only half the story. While individual capitalists are driven by the desire to maximize profits, the capitalist system as a whole is driven by accumulation. If governments and central banks tackle inflation by slowing investment, they are effectively harming the prospects for this same process of accumulation. If the rate of growth exceeds the rate of wage inflation, capitalist profits will not be affected by inflation at all. It is possible for inflation and wages to rise, but still grow at a slower rate than the rate of profit growth.

The real reason governments and central banks target inflation is because the world is ruled by finance capital. If inflation increases, the value of financial assets decreases. After all, a 10% return against 4% inflation is much better than a 15% return against 11% inflation. This is why inflation targeting has become the universal dogma in countries around the world, so that financial assets do not lose their value.

This is why, even if the stock markets do not directly concern 95% of the population, what happens there determines the economic existence of each one.


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