Real vs Theoretical Wealth
Question in Economics I couldn't answer after thinking about it for 2 years.
There’s a question in economics I’ve been obsessed with for 2 years and couldn’t answer.
We all just hear people say how GDP growth will continue, how the rate of growth might even go vertical, and all these things.
And I just wonder, how is that even possible?
I’ll use VERY rough numbers.
Say that:
- There are $2tn in circulation. (The Physical Anchor)
- M2 is $20tn. (The Ledger)
- US GDP is $30tn. (The Output). 1.5x M2.
- US debt markets worth $50tn. (The Promises). 1.6x GDP
- S&P’s market cap is $60tn. (The Expectations). 2x GDP and 3x M2.
- US real estate market is worth $80tn. (The Collateral).
$2tn in circulation is holding up all of that economic activity and theoretical wealth.
How can one envision a world where theoretical wealth’s growth continues to outpace the actual money that’s out there?
That’s why busts hurt so much, and they’ll hurt increasingly more as the gap between “reality” and “theoretical” broadens.
The reason why people say GDP will grow indefinitely is that “new, better products will come along. Productivity will be enhanced. Etc”
Sure, but what if future technology and businesses, by the nature of competition, have lower profit margins than nowadays? How does this translate into market returns?
And what if you create a better solution for a $100bn market but you end up destroying the previous $500bn inefficient one?
Will the $400bn just go somewhere else? I don’t think so. I would think $400bn in theoretical wealth vanishes. And how do you start filling all these gaps? If it happens at one level, it’s likely happening at many levels.
How do you keep economic growth when you have such destruction?
People will quote Schumpeter and say it’s what has happened all throughout history, but I don’t know if that’s so right.
There’s such a gap between theoretical wealth and real wealth that the only way you continue to patch things is by either maintaining the gap or increasing it.
And how do you even increase it when you are this stretched?
Of Market Returns
Market returns have systematically outpaced economic growth for 2 reasons:
Multiple expansion: Expectations / a more favorable view of the future.
Margin expansion: SP&500 profit growth has outpaced GDP growth.
To think about this pragmatically, what happens if a company comes along and displaces the iPhone?
Apple is worth $4tn and generates $110bn in profit at a 27% margin. What if the contender’s technology is so efficient that the end-product can be sold at $100-$200? And what’s more, what if the competitive ground goes actually crazy and profit margins are not as high as Apple’s?
In this scenario, what if the TAM not only gets compressed, but also much less profit gets derived therefrom. At what multiple of earnings could that trade? The company might end up being worth $500bn or $1tn.
In history, new technology made complicated, expensive things more accessible and cheaper to everyone. And let’s imagine that accessibility will continue to expand, as there’s still room for penetration in total population. But what happens in the meantime? What happens while new-company profits catch up with Apple’s? I suspect current theoretical wealth either temporarily or permanently vanish.
And regarding the second bullet point, how far can profit margins even go? How can EPS continue growing at 8-12% (?) while actual output grows at 2%?
Personal Commentary
I don’t really know how to tackle this. I know I’m missing a lot, however. If you’ve some idea that could help think about it, I’d be more than happy to hear it.
Feel free to reach out: giulianomana@0to1stockmarket.com