Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

328 Money, Bank Credit, and Economic Cyclesgoods. Only securities which represent the property of thecompanies closest to consumption will undergo a temporary,relative decline in price, as a result of the immediate, negativeimpact of the decrease in the demand for consumer goods thatis generated by the upsurge in saving. Therefore it is clearthat, contrary to popular opinion, and in the absence of othermonetary distortions we have not yet touched on, the stockmarket does not necessarily reflect mainly companies’ profits.In fact, in relative terms with the capital invested, the accountingprofits earned by the companies of the different stagestend to match the interest rate. Thus an environment of highsaving and low relative profits (i.e., with a low interest rate)constitutes the setting for the greatest growth in the marketvalue of securities representing capital goods. Moreover thefurther the capital goods are from final consumption, thehigher the market price of the corresponding securities. 48 Incontrast, growth in relative accounting profits throughout theproductive structure, and thus in the market rate of interest,other things being equal, will manifest itself in a drop in thevalue of securities and a consequent fall in their market value.This theoretical explanation sheds light on many generalstock-market reactions which ordinary people and many“experts” in finance and economics fail to understand, sincethey simply apply the naive theory that the stock market mustmerely reflect, automatically and faithfully, the level ofaccounting profits earned by all companies participating inthe production process, without considering the stages inwhich the profits are earned nor the evolution of the socialtime preference (interest rates).48 The ceiling price will be reached when the effect of the reduction inthe interest rate subsides and is counteracted by the larger number andvolume of securities issued in the primary stock and bond market,which will tend to cause the market price per security to stabilize at alower level. In the next chapter we will see that all prolonged marketbuoyancy and in general, all sustained, constant rises in stock-marketindexes, far from indicating a very healthy underlying economic situation,stem from an inflationary process of credit expansion which sooneror later will provoke a stock-market crisis and an economic recession.