Edward Renshaw
Professor of Economics
State University of New York at Albany
Former CEA Chairman Beryl Sprinkel (1964) was among the first economists to publicize a positive relationship between changes in the money supply and changes in stock prices. If one could have accurately predicted what would happen during the year to the real value of the conventional money supply that information would have sometimes been of considerable value in helping to identify good years to have been in the stock market. Since the beginning of World War II there have been 25 years when real M-1 increased by 1.6 percent or more on a December-to-December basis and in each of these years the financial return for the S&P index was positive. (See those cases marked with a double asterisk in column 4 of Table 11.1S.)
When the first differences in the growth rates for the real money supply in column (5) have been equal to four percentage points or more, the financial returns in the following year have also been positive. (See the ten returns in column 6 which are identified with a hatch mark.)
The stock market crash of October 19, 1987 shifted the attention of Wall Street to Washington, D.C. and quickly became an indictment of the economic policies of the US and some of its trading partners. While some economists assumed that large trade and budget deficits were a primary cause of the crash the historical data would suggest that the stock market debacle may have been more nearly a result of a rapid reduction in the federal deficit rather than an accurate reflection of its unconscionable level.
Since the beginning of World War II the financial returns associated with the S&P index have (so far) always been positive when the federal budget deficit in the National Income and Product accounts was equal to 3.25 percent or more of nominal GDP. This point can be verified by comparing columns (1) and (6) of Table 11.1S for the years 1942-45, 1975, 1982-87 and 1991-93. For the 15 years when the federal budget surplus as a percent of nominal GNP deteriorated by at least one full percentage point, the financial returns for the S&P index are also positive. (See those surpluses or deficits in column (1) which are identified with an asterisk.)
Before the enactment of the Economic Recovery Tax Act of 1981, which slashed tax rates while national defense expenditures were allowed to almost double, most large budget deficits occurred either during wars or during economic recessions. Many economists are of the opinion that large budget deficits in the midst of a recession are stabilizing and help to shorten the economic decline.
While stocks are not a very reliable hedge against inflation it questionable whether there is a better hedge. In 1990 the average value of the S&P composite stock price index was more than 75 times as great as in 1875. Gold and silver, on the other hand, were only about 19 and 4 times as expensive. Many stocks promise dividends as well as some protection against consumer price inflation.
In twelve of the 15 years from 1980-94 the financial return associated with the S&P index was greater than the percentage change in the price of gold. See Table 11.2S.
Sprinkel, B. (1964). Money and Stock Prices(Homewood, Illinois: Richard Irwin).
Budget Federal 1st Diff Dec-Dec 1st Diff Financial
Surplus Purchases Fed Pur Growth Growth Return
Year % GDP % GDP % GDP Real M-1 Real M-1 S&P Index
(1) (2) (3) (4) (5) (6)
1942 -20.8* 32.8 19.1 21.4** 13.7 19.2@
1943 -24.3* 42.5 9.7 23.7** 2.3 25.7#@
1944 -25.8* 42.4 - .1 12.0** -11.7 19.3@
1945T -19.7 35.4 - 7.0 10.0** - 2.0 35.7
1946 1.6 9.2 -26.2 -14.9 -24.9 - 7.8
1947 5.7 5.9 - 3.3 - 5.2 9.7 5.5
1948 3.5* 6.3 .4 - 4.0 1.2 5.4#
1949T - 1.0* 8.1 1.8 1.6** 5.6 17.8
1950 2.9 7.0 - 1.1 - 1.3 - 2.9 30.5#@
1951 1.8* 11.8 4.8 - .3 1.0 23.4
1952 - 1.0* 15.0 3.2 2.9** 3.2 17.7@
1953 - 1.6 15.4 .4 .5 - 2.4 - 1.2@
1954T - 1.6 13.2 - 2.2 3.2** 2.7 51.2
1955 1.0 11.4 - 1.8 1.8** - 1.4 31.0
1956 1.5 11.1 - .3 - 1.6 - 3.4 6.4
1957 .5 11.5 .4 - 3.6 - 2.0 -10.4
1958T - 1.9* 11.9 .4 2.0** 5.6 42.4
1959 - .5 11.6 - .3 .1 - 1.9 11.8#
1960 .7 10.8 - .8 - .8 - .9 .3
1961T - .5* 11.0 .2 2.7** 3.5 26.6
1962 - .6 11.4 .4 .6 - 2.1 - 8.8
1963 .2 11.0 - .4 2.0** 1.4 22.5
1964 - .4 10.4 - .6 3.3** 1.3 16.3
1965 .2 9.9 - .5 2.8** - .5 12.3
1966 - .2 10.6 .7 - .8 - 3.6 -10.0
1967 - 1.6* 11.4 .8 3.3** 4.1 23.7@
1968 - .5 11.2 - .2 2.9** - .4 10.8#@
1969 - .9 10.5 - .7 - 2.6 - 5.5 - 8.3
1970T - 1.3 9.9 - .6 - .3 2.3 3.5
1971 - 2.0 9.1 - .8 3.0** 3.3 14.1
1972 - 1.4 8.9 - .2 5.6** 2.6 18.7
1973 - .5 8.0 - .9 - 3.0 - 8.6 -14.5
1974 - .8 8.1 .1 - 7.0 - 4.0 -26.0
1975T - 4.4* 8.2 .1 - 2.1 4.9 36.9
Budget Federal 1st Diff Dec-Dec 1st Diff Financial
Surplus Purchases Fed Pur Growth Growth Return
Year % GDP % GDP % GDP Real M-1 Real M-1 S&P Index
(1) (2) (3) (4) (5) (6)
1976 - 3.0 7.7 - .5 1.6** 3.7 23.6#
1977 - 2.1 7.5 - .2 1.3 - .3 - 7.2
1978 - 1.3 7.3 - .2 - .8 - 2.1 6.4
1979 - .6 7.2 - .1 - 5.5 - 4.7 18.4
1980T - 2.2* 7.7 .5 - 5.3 - .2 31.5
1981 - 1.9 7.9 .2 - 2.3 3.0 - 4.8
1982T - 4.3* 8.5 .6 4.5** 6.8 20.4
1983 - 5.3* 8.6 .1 5.0** .5 22.3#@
1984 - 4.4 8.2 - .4 1.5 - 3.5 6.0
1985 - 4.5 8.5 .3 7.8** 6.3 31.1
1986 - 4.7 8.6 .1 15.3** 7.5 18.5#
1987 - 3.3 8.5 - .1 - 1.3 -16.6 5.7#
1988 - 2.8 7.9 - .6 .5 1.8 16.3
1989 - 2.3 7.6 - .3 - 3.5 - 4.0 31.2
1990 - 2.9 7.7 .1 - 2.2 1.3 - 3.1
1991T - 3.5 7.8 .1 5.5** 7.7 30.0
1992 - 4.7* 7.5 - .3 10.8** 5.3 7.4#
1993 - 3.8 7.0 - .5 7.2** - 3.6 9.9#
1994 - 2.4 6.5 - .5 - .9 - 8.1 1.3
T equals a year containing a recessionary trough in economic activity.
*Years when the federal budget surplus or Deficit (-) in the National Income and Product Accounts expressed as a percent of nominal GDP deteriorated by at least one full percentage point. In these years the financial returns in column (6) have always been positive.
**Years when the growth of the real money supply was equal to 1.6 percent or more. In these years the financial returns in column (6) have always been positive.
#Financial returns following years when the first differences in the December-to-December growth rates for the real money supply in column (5) are equal to four percentage points or more.
@Financial returns following years when the first differences in the share of federal purchases of goods and services in column (3) are equal to .6 percentage points or more.
Source of Basic Data: Economic Report of the President, BCI series 105, and Standard and Poor's Security Price Index Record. Since 1982 the December- December growth rates for real M1 are based on preliminary data published in the following January issue of Business Conditions Digest and the Survey of Current Business.
Year Closing price Percentage Change Financial Return
for Gold Price of Gold S&P Index
(1) (2) (3)
1970 $37.80 6.4 3.5
1971 44.00 16.4 14.1
1972 65.40 48.6 18.7
1973 112.75 72.4 -14.5
1974 186.75 65.6 -26.0
1975 140.75 -24.6 36.9*
1976 135.25 - 3.9 23.6*
1977 165.45 22.3 - 7.2
1978 226.30 36.8 6.4
1979 512.40 126.4 18.4
1980 589.75 15.1 31.5*
1981 397.50 -32.6 - 4.8*
1982 460.50 15.8 20.4*
1983 382.25 -17.0 22.3*
1984 308.25 -19.4 6.0*
1985 330.00 7.1 31.1*
1986 396.50 20.2 18.5
1987 486.37 22.7 5.7
1988 412.00 -15.3 16.3*
1989 403.50 - 2.1 31.2*
1990 384.60 - 4.7 - 3.1*
1991 354.50 - 7.8 30.0*
1992 333.00 - 6.1 7.4*
1993 393.07 18.0 9.4
1994 383.80 - 2.4 1.3*
*Years when the financial return for the S&P index exceeded the annual percentage change in the price per troy ounce for Engelhard industrial bullion.
Source of basic data: The Wall Street Journal and Standard and Poor's Security Price Index Record.
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