Wednesday, 1 November 2017

Historically Low Interest Rates Are Not Alone In Supplying The Stock Market With Rocket Fuel

In my experience, saving data is a widely under-reported and ignored economic statistic. The reason for this is fairly self explanatory since economic growth, as defined by modern-day economists (i.e. GDP growth), is consumption-driven. Their focus is hence on consumption since saving play a negligible role other than serving to reduce the former. 

But saving is tremendously important for many reasons, two eminent ones being as a source of financial stability and as a key ingredient for economic growth. Increased saving is therefore in general a good thing. The opposite applies to the money supply however as monetary expansion brings about financial instability and actually act as a drain on economic growth over time. As I wrote some months ago,
Monetary inflation causes headwinds to economic growth as a higher proportion of resources becomes more easily misdirected and as the risk of overconsumption, to the detriment of saving, increases. Given a choice between monetary inflation and deflation, the economic risks associated with the latter are noticeably smaller, precisely because it reduces the risk of overconsumption.
The rate of saving is a crucial determinant of economic growth as investments can only be undertaken on a sustainable basis when financed with prior saving. A sufficient amount of savings is also a safeguard for economic stability as it provides a cushion against adverse economic developments, including natural disasters. A higher saving rate over time thus can reduce the level of risk in an economy as it can help smooth out economic downturns.
Therefore, when money supply growth outpaces saving growth considerably over an extended period of time, probabilities favour increased financial instability and possibly an economic crisis at a later stage. In the medium term however, this acts as rocket fuel for the stock market since it brings about a decline in the purchasing power of money

Following years of aggressive monetary expansion and a declining personal saving rate, the U.S. economy now finds itself in a position with a high probability that financial instability soon will be on rise. 

As the chart below demonstrates, money supply growth has outpaced saving growth in recent years on a scale that even exceeds the run-up to the 2006-2009 financial crisis. The chart says little about how much longer the ratio between the two will remain elevated, but based on developments during the last 30 years it could soon head down. And when it does, a financial crisis will be upon us once again and the stock market will plunge as the purchasing power of money again increases. 

For more on this subject, see:

The Purchasing Power Of Money: 5 Factors Supporting The Case For Cash

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