Thursday, June 20, 2013
The Stock Market Doesn't Understand Monetary Policy
Stocks have fallen sharply in reaction to the latest news from the Fed about the end of QE. It would appear that the so-called “lead steers” have concluded that an end to QE would hurt growth and make stocks less valuable. I am sorry to have to say it, but the lead steers don’t understand monetary policy.
The lead steers are laboring under the misconception that growth and stock prices have been artificially stimulated by “massive monetary stimulus” since 2008. Where did they get such an idea? Do they own a computer? Can they google FRED? The last time that we had sustained double-digit money growth was exactly thirty years ago, in 1983, following the “Reagan Recession”.
I’m going to repeat this until it finally sinks in: money growth since the crash has been quite low. M2 has grown at about 5%, while the broader aggregates have grown by much less. There has been no monetary stimulus; Fed policy has not been “extraordinarily accommodative” no matter how many times Bernanke uses those words. The linkage between the Fed’s balance sheet and the money supply is simply nonexistent. QE has been pushing on a string, resulting in a massive buildup of sterile excess reserves that have no impact on the money supply.
It remains true that M x V = P xT, but QE has no influence on M. It is incorrect to say that “Monetary policy has lost its power”. The correct formulation is “The Fed’s policy of buying bonds from banks has lost its power”. If Bernanke had dropped $3 trillion from helicopters, or bought houses instead of mortgages, we would have had good money growth. People say that the Fed has engaged in “unconventional” policies. Well, buying bonds from banks is pretty conventional, if you ask me. When you take your balance sheet from $800B to $3.5T and money growth goes nowhere, you might consider doing something else. As far as we know from the FOMC minutes, there has never even been a discussion about doing something else.
Here’s the bottom line for stocks: since QE has had no impact on money growth, ending it won’t affect money growth, it will simply end the buildup of useless excess reserves. Money growth depends mainly on credit growth. As I have said before, the household sector has only now stopped deleveraging. When household credit begins to grow, we should see stronger money growth. That will happen this year, and therefore the outlook is bullish, not bearish.
If you use DCF to value financial assets, you will find that there is no alternative to stocks. They are the only asset left that will pay you any money. Once it sinks in that there is nowhere else to go, equity valuations will return to their historic levels, which means much higher PEs. You will not see these bargain prices again in your lifetime.