Tuesday, 17 January 2017

A Plausible Reason For The Longevity Of The Bull Market In U.S. Stocks

The U.S. stock market, as represented by the Russell 3000 Total Market Index, has now increased for eight consecutive years on a year-end basis. This is unprecedented based on data starting in 1980. But, since broad stock market gains over time are primarily a result of monetary inflation and as the quantity of money has more than doubled since the end of 2008, it is no surprise that the stock market today is higher than eight years ago. 

The U.S. Money Supply and the Stock Market, y/y % change
The U.S. Money Supply and the Stock Market, y/y % change

FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/, FTSE Russell

It is surprising however that there has been no major stock market correction to speak of during this eight-year bull market. After all, economic theory does tell us that economic booms must be followed by busts. This boom-bust cycle is not however due to some inherent feature of a capitalistic system, but is instead caused by the elastic money supply implemented by government fiat (i.e. law, hence fiat money). In its essence, an elastic currency - money which can change in quantity to satisfy changes in demand - is capable of putting out of action the limits savings impose on the level of investments. When this link between savings and investments is broken the business cycle is unleashed.

Investment booms driven by an increase in the quantity of money rather than an increase in savings are therefore unsustainable. The boom must one day come to an end, frequently in the form of a crash in economic activity and stock market prices. The credit-driven investment booms that came to abrupt ends in the early 2000s and in 2007/08 are recent examples.

But something is different this time around in the U.S. compared to the previous two business cycles: there has been no wide-spread investment boom since the 2008 banking crisis even though monetary inflation has been significant ever since. This can clearly be seen in the relatively low ratios of the levels of investment compared to GDP...

Gross Private Domestic Investment / Nominal GDP
Gross Private Domestic Investment / Nominal GDP
FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/


...and especially when compared with the money supply. 


Gross Private Domestic Investment / Money Supply
Gross Private Domestic Investment / True Money Supply (short version)
FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/


Notice the uncharacteristically stable, but slightly declining ratio since 2009 in the chart above and how this contrasts the prior peaks and troughs in the ratio.

Since the saving rate remains relatively low in the U.S., the monetary inflation has supported consumption spending more than it has stimulated investments. ** This is shown in the chart below; since 2009, consumption spending has outpaced investments on a scale never before seen based on data since 1947.


Consumption Expenditures (private + government) / Gross Private Domestic Investment
FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/


The last eight years can hence be characterised as more of a money supply-driven consumption binge than a credit-driven investment boom. The relatively low levels of investments indicate the degree of malinvestments might be smaller during this cycle than was the case during the last two credit booms. If that is indeed the case, this would have had a dampening effect on the business cycle.

The relatively low level of investments may therefore have acted to soften the business cycle and hence prolong uninterrupted monetary expansion. Low levels of investments have arguably also reduced the pressure on market interest rates to rise significantly which is supportive of still further monetary inflation. Stocks of course have benefited greatly from the combined effect of money supply growth and low interest rates.

U.S. Money Supply / Bond Yield and the Stock Market
FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/, FTSE Russell, BofA Merrill Lynch


The developments described above may help explain the longevity of the U.S. bull market in stocks which started in March 2009. But, since increased consumption financed by debt (instead of increased production) also is unsustainable, it remains to be seen if the bull market survives another year. Watch that money supply!


*  The average personal saving rate since 2009 is 6.0% compared to an average rate of 7.7% for 1973-2008. 



Thursday, 12 January 2017

My Book Published Today: "Money Cycles - The Curse of an Elastic Money Supply"


As a long-time student of value investing and stock market cycles, I was in part blown away and in part disappointed when I first discovered Austrian economics back in early 2012. I was blown away as it dawned on me that this branch of economics answered the questions I had been carrying around for years. The disappointment was rooted in not having discovered it many years earlier.... Time is, as you know, scarce. But much better late than never. 

Anyway, a few years back I started writing down my findings and interpretations in an effort to understand the material in depth and to connect the theories to the stock market. I realised soon that I might as well structure these writings in the form of a book. This book was published this morning on Amazon (print and online) with the title Money Cycles - The Curse of an Elastic Money Supply

The first part of the book addresses the properties of money and how they are created before explaining in detail how monetary aggregates can be compiled. The mid-section of the book describes the economic consequences of employing an elastic currency and contrasts this with what would be the case if an inelastic currency was employed instead. The final part of the book then attempts to connect the theories discussed and analysed with the business cycle  and the stock market.

The book, some 580 pages in total, is at times quite heavy on theory and I hope readers will find that it is written in a straight-forward and comprehensible manner. 

I've listed the preface and contents below for those of you that would like to find out more about the book.

Preface

In today’s mixed economies, large-scale financial crises originate mostly in the banking sector, but are fundamentally caused by unsound monetary systems. It is the existing monetary system that brought about the previous banking crisis. It is also this system that will bring about the next one. I was not aware of this fact the day Lehman Brothers failed. This book is a result of research completed in recent years in an effort to understand the true nature of the business cycle, stock market cycles, and financial crises and why they will continue to be regular features of economic developments around the world.

Wall Street, hedge fund managers and other investment professionals, financial pundits and economists have few reservations about presenting their views on changes in asset prices, employment, interest rates, and trade. Very few of them however seem to incorporate changes in the quantity of money in their analyses. This to me remains a bit of a conundrum as the great majority of prices are quoted in monetary terms. This is also a primary reason this book deals extensively with monetary developments. The book’s focus on this subject must not however be misconstrued as it being the only relevant economic variable for economic progress or lack thereof. Nothing could be further from the truth. Having said that, it seems to me that the powerful effects changes in the money supply have on asset prices and economic progress is at best underestimated and at worst ignored. To my experience, this must be due to a lack of education and a general deprivation of exposure to this more than a century-old science. A goal of this book is therefore to reintroduce this old knowledge in a concentrated manner as the nonmonetary aspects of economics are written about extensively elsewhere by all schools of economic thought.

In many ways, this is a book about what transpires when increased consumption and investment are driven by inflationary credit growth rather than increased production and savings. It is the elastic currencies employed around the world today that make such moves away from economic equilibrium effortless. As it turns out, consumption and investment not fully backed by production and savings have important repercussions for not only the stock market, other asset prices, and prices in general, but more importantly for economic growth and people’s standards of living.

At the time of writing, financial markets appear to indicate all is swell. Major U.S. stock market indices are hitting new all-time highs. Underneath however, things are not quite so rosy. Many large European banks are struggling and Monte dei Paschi, the oldest surviving bank in the world today, is currently being bailed out with taxpayers’ money. Across the pond, U.S. banks are as poorly capitalised as ever though their cash balances, in total and compared to net assets, are substantially higher today than in 2008. The debt problems in the U.S. and many countries in the Eurozone have for years been attempted solved with more of what created them in the first place: more debt and lower interest rates. Consequently, the excesses accumulated during the previous decade have not been dealt with, but have instead been magnified. There is no painless way out of this economic mess. But for it to be dealt with conclusively causes, rather than symptoms, need to be addressed. Government spending and interventions must be reduced drastically over time. A determined move toward the implementation of hard currencies needs to be initiated. Central banks as lenders of last resort must be ended. If not, economic growth will increasingly become a relic of the past and increased poverty, not prosperity, will become firmly established as the norm. I attempt to answer why in this book. Economic regression has already been on its way for at least a decade and arguably much longer in many so-called developed nations. No matter what path is chosen, with the proviso that central banks will contain what they may deem “excessive” price inflation, cash will soon again be king and stock markets will again tumble. This year, 2017, might very well be the year when it all unravel once again.

            The great majority of the sources used in this book were found on the Mises Institute website. This is not by design, but solely due the tremendous collection of writings, especially old books, from the classical- and Austrian economics schools of thought the institute have made freely available to all. For that I thank the Mises Institute for opening up a whole new world of knowledge to me and many others. As Thomas Sowell once so wisely explained, "It takes considerable knowledge just to realize the extent of your own ignorance.”

Finally, facts have been presented as accurately as possible and established theories have been stated as fully as deemed necessary for the messages I try to get across. The interpretation of those facts and theories are in many cases subjective however and my analysis and conclusions may therefore at times differ even from others having a similar philosophy to mine. All errors and omissions are my own.

Atle Willems

Norway, January 11th 2017

PART I. MONEY  
CHAPTER 1. THE ROLES AND FUNCTIONS OF MONEY                        
CHAPTER 2. THE VALUE OF MONEY & LUDWIG VON MISES’ REGRESSION THEOREM  
   
PART II. THE MONETARY SYSTEM & THE MONEY SUPPLY            
CHAPTER 3. FRACTIONAL RESERVE BANKING   
CHAPTER 4. CENTRAL BANKING: THE FEDERAL RESERVE               
CHAPTER 5. THE MONEY SUPPLY          
CHAPTER 6. MONEY SUPPLY AGGREGATES PUBLISHED BY THE FEDERAL RESERVE      
CHAPTER 7. THE “AUSTRIAN” TRUE MONEY SUPPLY    
CHAPTER 8. THE MONETARY BASE        
CHAPTER 9. HISTORICAL DEVELOPMENTS OF THE U.S. MONEY SUPPLY AND MONETARY BASE 

PART III. THE MONEY CREATION PROCESS          
CHAPTER 10. HOW BANKS CREATE BANK CREDIT: MAKING LOANS AND BUYING SECURITIES    
     APPENDIX: THE DEPOSIT CREATION PROCESS: BANKS MAKING LOANS                
     APPENDIX: THE DEPOSIT CREATION PROCESS: BANKS PURCHASING SECURITIES     CHAPTER 11. HOW THE FEDERAL RESERVE CONTROLS THE BANKING SYSTEM’S EXCESS RESERVES AND THE MONEY SUPPLY               
CHAPTER 12. ALTERNATIVE MONETARY SYSTEMS: ELASTIC VS. INELASTIC MONEY      
     FULL RESERVE BANKING             
     THE GOLD STANDARD   
     FREE BANKING 

PART IV. PRICES, VALUATION AND APPRAISAL

PART V. THE TIME MARKET     
CHAPTER 13. THE LOAN MARKET: SAVINGS, BORROWINGS AND THE INTEREST BRAKE 
CHAPTER 14. THE LOAN MARKET: THE SAVING-INVESTMENT RELATION              
CHAPTER 15. THE FACTORS OF PRODUCTION: LAND, LABOUR, AND CAPITAL    
CHAPTER 16. THE STRUCTURE OF PRODUCTION  
             
PART VI. THE PURCHASING POWER OF MONEY              
CHAPTER 17. THE MONEY RELATION      
CHAPTER 18. CONSUMER PRICE INFLATION: THE SEEN AND THE UNSEEN    
      
PART VII. ECONOMIC GROWTH               
CHAPTER 19. MALINVESTMENT, OVERCONSUMPTION AND SQUANDERING OF MEANS 
CHAPTER 20. WHAT “PRODUCTION” IS. AND WHAT IT IS NOT.  
CHAPTER 21. THE IMPORTANCE OF PRODUCTION, SAVING, AND INVESTMENT: A TALE OF TWO ISLANDS         
     SAY WHAT, PRODUCTION OPENS A DEMAND FOR PRODUCTS?              
CHAPTER 22. THE ECONOMIC MEANING OF PROFIT      
CHAPTER 23. THE ECONOMIC SIGNIFICANCE OF SAVING           
FORCED SAVING AND INVOLUNTARY SAVING  
CHAPTER 24. THE ECONOMIC CONSEQUENCES OF DEBT             
     LACK OF LENDING – THE CULPRIT FOR LACKLUSTRE ECONOMIC GROWTH?      
CHAPTER 25. ECONOMIC GROWTH: NATURAL AND INFLATIONARY – SOUND AND UNSOUND 
     NATURAL ECONOMIC GROWTH              
     INFLATIONARY GROWTH           
CHAPTER 26. A NOTE ON ECONOMIC ACTIVITY 
CHAPTER 27. A NOTE ON GDP   

PART VIII. MONEY CYCLES & THE ECONOMY     
CHAPTER 28. MONEY CYCLES DEFINED 
CHAPTER 29. THE BANK CREDIT CYCLE  
CHAPTER 30. THE BANKING CRISIS – A HOUSE OF CARDS           
CHAPTER 31. THE AUSTRIAN THEORY OF THE BUSINESS CYCLE  
CHAPTER 32. THE CONTRADICTORY MISSIONS OF CENTRAL BANKING: STABLE PRICE INFLATION & ECONOMIC STABILITY          
CHAPTER 33. THE “ECONOMIC STIMULUS” FABLE AND THE MONETARY CRANK   
      
PART VIIII. MONEY CYCLES & THE STOCK MARKET          
CHAPTER 34. THE FUNDAMENTALS OF A STOCK MARKET BOOM            
    INDIRECT AND DIRECT EFFECTS OF AN EXPANDING MONEY SUPPLY ON STOCK    
    MARKET PRICES   
CHAPTER 35. THE FUNDAMENTALS OF A STOCK MARKET CRASH           
CHAPTER 36. THE STOCK MARKET AS A LEADING RECESSION INDICATOR          
CHAPTER 37. STOCK MARKET SELL-OFFS AS RECESSION TRIGGERS         
CHAPTER 38. THE MONEY SUPPLY-TO-SAVING RATIO  
CHAPTER 39. MONEY CYCLES – A SHORT SYNTHESIS     

Friday, 2 December 2016

Wednesday, 30 November 2016

Chart of the Day II: Out-of-Control Money Supply to Saving Ratio


Chart of The Day: Why the Average U.S. Citizen Depends on More Debt

As of October 2016

There Are Two Types of Credit — One of Them Leads to Booms and Busts

By Frank Shostak

In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs.

Businessmen themselves are confused as to why. They cannot make sense of why certain business practices that were profitable yesterday are losing money today. Bad business conditions emerge when least expected — just when all businesses are holding the view that a new age of steady and rapid progress has emerged.

In his writings, Ludwig von Mises argued against the prevailing explanation of the business cycle of over-production and under-consumption theories, and he critically addressed various theories that depended on vague notions of mass psychology and irregular shocks.
In the psychological explanation, an increase in people’s confidence regarding future business conditions gives rise to an economic boom. Conversely, a sudden fall in confidence sets in motion business stagnation.

Continue reading the article here.

Sunday, 6 November 2016

The Contradictory Missions Of Central Banking

I have just published an article on Seeking Alpha addressing a fundamental problem with central bank policies: the incompatible objective of achieving both consistent price inflation and economic stability. 

The article can be accessed here.

Saturday, 5 November 2016

Chart of The Day: Why Do Many in the U.S. Struggle To Make Ends Meet?

And perhaps, a reason why reported price inflation is so low.

As of September 2016

Check out this article by Kevin Dowd, a free banking advocate and a former professor of mine:

Have Central Bankers "Lost the Plot?"