Supply, demand . . . and an impending thud

Marketplace Staff May 30, 2007
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Supply, demand . . . and an impending thud

Marketplace Staff May 30, 2007
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KAI RYSSDAL: It’s almost as if you can take anything you like, throw it at the U.S. stock market and have absolutely nothing bad happen. Take your pick — whether it’s spillover from the Chinese markets that we talked about at the top of program or the housing market and its seemingly endless tumble. American investors keep on buying.

Commentator Robert Reich says if you really want to understand why the stock market continues to be bullish, you have to go back to Econ 101.


ROBERT REICH: When the supply of something decreases while the demand for it stays up, its price rises. Here, I’m talking about supply and demand in publicly-traded stocks.

In case you hadn’t noticed, corporate America and Wall Street are in the process of privatizing a growing portion of America’s stock market. It’s happening in two ways. First, cash-rich companies are finding they can boost their stock prices faster by buying back their shares of stock than by investing in new factories, equipment, or research and development. After IBM announced it was repurchasing another $15 billion of its stock last month, for example, the value of its publicly-traded shares rose.

Meanwhile, private equity firms are doing a record amount of leveraged buyouts — that is, taking publicly-traded companies private. That’s what Cerberus Capital did two weeks ago with Chrysler.

Now look at the big picture. Last year, corporate buybacks and leveraged buyouts totaled about $600 billion. That was roughly 3.5 percent of the whole value of the American stock market. At the rate buybacks and buyouts are going this year, the total is going to be close to about $900 billion. That’s another 4 .5 percent of U.S. market capitalization taken out of circulation.

With the supply of publicly-traded shares shrinking like this, and with lots of global money out there to buy the shares that remain, it’s no wonder the stock market is going like gangbusters.

Yet at some point, this bubble will burst. You see, the whole reason for companies buying back their shares, and for private-equity firms doing leveraged buyouts, is to put all these shares of stock back onto the public market at some point in the future at a higher price than before.

But if stock prices are now rising largely because the supply of publicly-traded shares is shrinking, and if companies aren’t really investing for the future what happens when all this stock comes back on the market? The loud thud you’ll hear will be the sound of shares falling back to Earth.

RYSSDAL: Robert Reich was secretary of labor for President Clinton. He’s now a professor of public policy at the University of California Berkeley.

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