|By Chuck Thompson
Originally published in the November 2010 Socionomist
There they go again. For years economists and investors have been pining for and positing a single reliable, mechanical mover of stock prices. For a time it was the weekly money supply; then, the bond market; and after that, the near-term trend of the U.S. dollar. The price of oil had its time in the sun, too. Each of these indicators had a logical explanation that made it attractive. The problem was, however, that none of them were supported historically—as a quick study of the price record over time would have confirmed.
Another supposed mover of stock prices is the United States’ balance of trade. Many economists believe that a growing trade deficit hurts the economy and drives down stock prices. They also say a shrinking trade deficit is good for the economy and drives up stocks.
But as The Elliott Wave Theorist reported as far back as June 1988, the idea that trade deficits are bad for stocks “doesn’t fit the facts.” As Robert Prechter noted in the February 2010 issue of the Theorist, since 1974 the U.S. trade deficit and stocks have actually moved together, not conversely:
“… had these economists reversed their statements and expressed relief whenever the trade deficit began to expand and concern whenever it began to shrink, they would have accurately negotiated the ups and downs of the stock market and the economy over the past 35 years.”
The Wave Principle of Human Social Behavior (HSB, 1999) observed:
“The bigger has been the deficit, the stronger have been the stock market and the economy, and vice versa. Despite countless reports that ‘the trade deficit is slowing economic growth,’ statistics reveal the opposite experience for decades.”
Socionomists recognize the relationship because their studies begin with data. For many economists, though, the approach is to begin with a theory and a logical inference. As Prechter noted in the March 2010 issue of The Elliott Wave Theorist, “When you are brilliant, your mind is rational, your logic is sound, and yet your conclusions are continually wrong or inadequate, there is only one explanation: Your premise is false.”
Consider the following news stories from recent months, all published while the trade deficit expanded (emphasis added):
- “Rising trade deficit could drag down U.S. recovery” (USA Today, July 14, 2010).
- “Sagging exports and a rise in imports pushed the U.S. trade deficit up sharply in June—an unwelcome development during an already-weak economic recovery” (The Christian Science Monitor, August 11, 2010).
- “In the United States, the Commerce Department said the trade deficit had widened 18.8 percent, to $49.9 billion—a figure so large it sent economists scrambling to revise their growth forecasts for the quarter and predicting that unemployment may increase later in the year” (The Washington Post, August 12, 2010).
And, when trade figures for July showed a short-term decrease in the deficit, a September 9, 2010 Associated Press story proclaimed: “The lower trade deficit should give a boost to overall economic growth.”
In fact, while the trade deficit has been mostly widening this year, the stock market and the economy have been mostly recovering. Narrowing deficits have tended to have the opposite correlation. As Prechter pointed out in HSB, “the recessions of 1980 and 1982 followed a narrowing trade deficit. The next time the deficit began to narrow, in late 1987, it again led three years later to a recession, as the deficit shrank all the while. Those who followed the observations of economists and expanded their businesses in 1979 or 1989 on economists’ predictions that the newly shrinking trade deficit was bullish got caught in both recessions.”
The relationship between trade deficits and the economy begins with social mood. Thus, in August 1996, when investors were focused on “indicators” such as the trade deficit, the Theorist reported:
In contrast to these varying obsessions, The Elliott Wave Theorist focuses primarily on the market itself, its patterns and psychology, not on the background.
As mood waxes positive, stocks rise and consumers buy more. Because imports make up an increasing percentage of American goods purchases, and because non-U.S. providers of those goods are willing to hold U.S. debt, the trade deficit has risen as U.S. consumers have purchased more goods, which happens when social mood and the economy are positive, and vice versa. Stocks, spending, and the trade deficit are all impelled by mood and therefore tend to move together.
Economists have also attempted to link the trade deficit to declines in the value of the U.S. dollar. In an October 22, 2007 report, CBS News said, “The reason why the dollar is declining is very complicated with numerous factors going on. But a large one is the U.S. trade deficit.” An MSNBC.com article from October 18, 2009 also said that “[a]nother force driving down the dollar” was “continued U.S. trade deficits.” In a February 6, 2008 Bloomberg article, billionaire Warren Buffett, chairman of Berkshire Hathaway, said the biggest cause for the declining dollar was the U.S. trade imbalance. However, the chart on this page shows mostly the opposite relationship for a period of 25 years. When the U.S. trade deficit rose by $7.9 billion in June 2010—the largest month-to-month increase since goods and services were combined into a single data series in 1992—the buck actually increased in value.
Another point of note in the chart is that the dollar has been leading the trade deficit. The precipitous decline of the dollar that began in 1985 was ahead of the decline in the trade deficit. When the dollar began moving up, the trade deficit moved up. And, when the dollar declined again, the trade deficit followed.
The idea that rising trade deficits cause the economy to decline, the dollar to weaken, unemployment to increase and stock values to decrease is part of a continuing effort by the cognoscenti to link events to exogenous causes. Their explanation sounds plausible: Trade deficits are bad for our country’s balance of payments, so they’re bad for stocks, the dollar, and employment. But this explanation is not verified by either data or sound theory.
Perhaps, once again, there is another explanation: social mood increases the availability of credit, which produces inflation, making the dollar fall in value while also allowing more consumer borrowing, thereby prompting spending on foreign-made goods, therefore driving up the deficit.
“Conventional analysts try to reason from economics and political policy, which they call ‘the fundamentals,’ to mood,” Prechter wrote in HSB. “This approach is backward, which is why it consistently fails at the most critical times.”■
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Most economists, historians and sociologists
presume that events determine society’s mood. But socionomics hypothesizes
the opposite: that social mood regulates the character of social events. The
events of history—such as investment booms and busts, political events,
macroeconomic trends and even peace and war—are the products of a naturally
occurring pattern of social-mood fluctuation. Such events, therefore, are not
randomly distributed, as is commonly believed, but are in fact probabilistically
predictable. Socionomics also posits that the stock market is the best available
meter of a society’s aggregate mood, that news is irrelevant to social
mood, and that financial and economic decision-making are fundamentally different
in that financial decisions are motivated by the herding impulse while economic
choices are guided by supply and demand. For more information about socionomic
theory, see (1) the text, The
Wave Principle of Human Social Behavior © 1999, by Robert Prechter;
(2) the introductory documentary History's
Hidden Engine; (3) the video Toward
a New Science of Social Prediction, Prechter’s 2004 speech before
the London School of Economics in which he presents evidence to support his
socionomic hypothesis; and (4) the Socionomics Institute’s website, www.socionomics.net.
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