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It’s the end of Unhedged’s first week. How are you? Email me: Robert.Armstrong@ft.com.
QE and Stock Quotes (Part Two)
Here are two lines that mostly go up and to the right:
The two lines are the M2 money supply (cash, deposits, money market accounts) and the S&P 500. M2 increases rapidly due to the quantitative easing: the Fed buys securities for cash and thus provides new money. Why the S&P is rising fast is less clear. The fact that the two lines have merged lately suggests a popular causal story: “The Fed prints money and it has to go somewhere and it goes public.” A few days ago I did written down that these causal stories are wrong because cash is not converted into stocks. When I buy stocks, the seller gets the money. It’s not “on the stock market”.
What really happens is that all of the extra money sloshing around is making people want it less compared to stocks, and the increased relative demand for stocks is forcing stock prices up. This is how QE affects stock prices (or in some way; other people, central bankers especially, prefer stories of QE lowering the discount rate, which will come soon.)
Eric Barthalon, global head of capital markets research at Allianz Research, notes that this process is self-limiting. As stock prices rise, the weight of cash relative to stocks in investors’ portfolios decreases to a level at which investors are satisfied. So often investors stop trading and prices stabilize. In this story, it is not the Fed that is simply stuffing the markets with cash. There is an intermediate factor: the relative preference of investors for cash.
Barthalon’s argument – I find it quite persuasive – is that (a) investors’ preference for cash is not stable and (b) the Fed has no control over it at the crucial moments when markets are falling. You can track investors’ unstable preference for cash by looking at the speed of money or the change of money. Barthalon told me:
“It is not the supply of money, but its circulation that causes asset prices to rise or fall. . . Historical experience shows that the central banks do not control the speed of money, especially in the capital markets. “
Now we see why central bankers might prefer the idea that they are using QE to control the discount rate that determines the value of stocks by keeping government bond yields low. Because in theory, this lever works even if investors suddenly decide they like cash very much – which they do when the markets fall.
Here is Barthalon’s long-term graph of the speed of money in the exchange (the value of daily market transactions divided by M2) versus the value of the exchange. Check out how much the speed slows down when the market declines:
These two lines vary with each other and are linked by a neat causal story. The takeaway is that the sheer volume of money floating around cannot keep the stock market high.
Armstrong’s division is wrong: Bitcoin
Yesterday I argued that Bitcoin can best be viewed as equity in a company whose only advantage is unproven technology. This technology will be proven when Bitcoin becomes money. But Bitcoin is not money now, because while people are trading it, it is not widely accepted as a form of payment, there are few transactions, the transaction costs are high, and so on.
The most common response I received was that Bitcoin is not trying to be money. Money has two key properties. It is a store of value and a medium of exchange. Most people who think I’m wrong think Bitcoin is all about storing value. That is why its limited supply is so important. If it’s a little expensive to trade, a little illiquid and so on – who cares? It is like gold and diamonds, goods whose standout feature is their rarity and how highly valued they are, not their ease of use.
I’m not sure. Gold and diamonds are used in industry and jewelry. They have millennia of conventions supporting their preciousness. The only thing that Bitcoin supports as a store of value, as a precious commodity, is that it can be both a store of value and a particularly good medium of exchange – one that can carry out far, smoothly, at low cost and (here) transactions is the actual one Key) without supervision by third parties or government control. And I don’t think we know yet that this is the case. Bitcoin is rare, but so are the watercolors I painted in high school. That doesn’t make them a store of value.
Bitcoin heads should also register for #fintechFT, our newsletter about the interface between technology and finance. click Here.
I was impressed with these Bloomberg story of how strong the demand for homes is in the US, with home builders moving away from fixed prices and running blind auctions to get the highest bids possible:
“A collision of forces caused by a pandemic [is] Only hold back new inventory when it is needed most. Buyers stamp for new homes as remote working boosts employment, while rising timber costs and labor shortages slow construction. “
This description suggests that the mixture does not contain any 2007 style toxic speculation. That makes me paranoid. Isn’t speculation everywhere these days? Why not live I don’t know if there is any evidence of this, but I’ll search. If you have any, email me.
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