Where does the money come from?

Gary North really knows how to bring a brother down.

"The 401(k) programs are also Ponzi schemes. They depend, not on economic growth to provide wealth, but rather new investors in the stock market. Earnings are insufficient to provide the income required to provide a comfortable retirement. After deducting fund expenses, until 2008, earnings were zero or close to it. The dream of easy retirement always rested on the sale of shares to newcomers. This is Ponzi scheme financing."

Talking heads and radio ads like to tell you how well the stock market has performed in the last x decades, and assure us that this performance will continue indefinitely. We are not supposed to think about where the money comes from. But where does it come from?

Imagine a closed economy with a hard currency and 100% reserve banking. The only money that is available to stock-brokers is the money that they are given by investers. There is only so much money in the economy, and of that money, only so much of it is saved or invested. It should be generally true then that there is only so much money in the stock market, and in order for one share to increase there must be some sort of equal and opposite reaction to allow for it. The most likely answers would be: a) that some share was sold, thus lowering the value so that some other share could be purchased, thus raising the value, or b) consumption decreased in order to allow for the increased savings/investment. Of course, we don't live in a closed economy, we don't have a hard currency, and our banks only hold 10% reserves. In that case, we have a few more options: a) the money needed to purchase the additional share could be the result of printing new money (ie inflation), thus lowering the value of the dollar, or b) the money could have been lended to the investor by a bank, which is generally the same thing as inflation, or c) the money could have come from overseas, thus increasing the wealth of the U.S. at the expense of some other nation.

Now, there's also the question of the velocity of money through the economy, but I would wager that this applies more to consumption than to savings/investment. The dollar you have in your pocket may change hands hundreds of times in a year. The more the dollar changes hands, the higher our consumption, and the higher prices could hypothetically go. But monetary velocity applies more to consumption than to savings/investment. And like all things in the economy, it has a natural tendency to find an equilibrium. Monetary velocity can't increase multiplicatively indefinitely in order to generate returns.

So what does all this mean? The diversified buy-and-hold strategy that depends on increasing share values doesn't really make sense. It shouldn't be anything more than protection against inflation, which can only be caused by increased fractional lending or money printing. Theoretically, the only way to make money in the stock market would be to pick stocks that are growing at the expense of mature or shrinking stocks, or to put money into companies that pay dividends, which is a way of getting your hands on the monetary velocity of the consumption sector of the economy.

If Gary North is right, then those of us that have 401K's or investments in general need to be much more aware of the business cycle. It will be generally true that the stock market will expand due to money-printing and credit expansion, only to contract such that share values return to their original values + inflation. Money can still be made in the stock market. But it's important not to be fooled into believing that share values will increase at the same rate indefinitely. You have to know when to get in and when to get out.