Friday, January 02, 2009

The Benefits Of Lower Stock Prices

The issue of falling or rising prices is one of the subjects when most confusion exists. On the one hand politicians regularly denounces "price gouging", which is to say when they claim that companies keep prices too high, and that prices should be cut. In other contexts they depict price deflation as the worst possible calamity, a point where to quote one well-known Keynesian Telegraph columnist, we should "abandon all hope" (alluring to Dante's depiction of hell).

The reality is that falling prices is good for buyers, but bad for sellers. We all benefit when we have to pay less, but suffer when we are paid less. Whether or not particular or general price declines are good or bad for the overall economy is a somewhat complex issue which depends on exactly why and how prices are falling, an issue which I will not elaborate upon in this post ( I have however discussed this issue before, for example here, here and here). But the point in this context is that falling prices will produce both winners and losers-as will rising prices.

Note that this is not just true for consumer prices, it is just as true for asset prices. While people planning to sell their houses and stocks suffer from falling stock- and house prices, people who are planning to buy houses and stocks benefit from it. People who buy a home will have lower housing costs if they are able to buy their house cheaper. People who buy stocks will get the more dividends and other forms of positive future cash flow for any given investment if they are able to but stocks cheaper.

Yet the benefits of lower asset prices are even more rarely recognized than the benefits of lower prices of goods and services. When stock prices for example fall it is almost always referenced as "destruction of wealth", even though it should more appropriately be discussed as "redistribution of wealth". Even when it reflects deteriorating fundamentals (falling profits) due to malinvestments it is a symptom of "destruction of wealth" rather than being a form of wealth destruction in itself.

One exception to this to ignore the benefits of lower stock prices is this post from Dean Baker. Yet he focuses mainly on the benefits to people who don't trade in stocks, rather than the benefits to future stock buyers, which is somewhat misleading since not everyone eho abstains from buying or selling stocks benefits from lower stock prices. If current stock holders usually use their paper wealth to buy certain things, then this will lower the price of those goods, hurting the sellers of those goods while benefiting other buyers of those goods. Assuming for example that champagne are bought disproportionably by current stock holders, then falling stock prices will likely force champagne producers to lower their prices and so reduce their real income. But other buyers of champagne will see their real income rise as they pay less for their champagne.

In short, lower stock prices will hurt current stock owners, or more strictly future net sellers of stocks, as well as the people who disproportionably sell to these future net sellers of stocks. But future stock buyers, as well as other buyers of the things disproportionably sold by the future net sellers of stocks, will benefit from lower stock prices.


Anonymous newson said...

dean baker:"The loss of stock wealth means that stockholders have less claim to value of the country's output."

????? stockholders' paper wealth has decreased, but their entitlement to company earnings has not. unless for some strange reason listed companies' earnings fall off more than unlisted companies/partnership/sole-trader earnings.

12:59 AM  

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