The Funk Soul Brother

The other day I got to see this graph. I’m sorry I cannot say where it comes from but I got it in a e-mail that somebody sent to somebody who, in turn sent to somebody else. Over and over, so I’m afraid I cannot give due credit to the author.

S&P vs Balance sheet

Anyway, I believe the reality it describes is pretty much clear to everybody: ultimately the increase in Fed’s balance sheet is not only sustaining but also driving up equity prices. This is the helicopter theory at its best, the fundamentals behind the rally ever since March 2009.

In reality it is not such a clear cut deal. The Fed began its balance sheet expansion before equity markets did pick up. At first, most investors run for cover and prefered hard currency to uncertain ventures. It is only when they began to trust business as usual would find support that they gradually came back. But, what about now? (The funk soul brotha, right about now…)  Back they are, so how come the FED is not reversing their policy?

The answer is, of course, it can’t. I know there are talks of taper but talking is cheap. What the balance sheet expansion aims at is to make interest rates low enough to make any financial asset an attractive investment, irrespective of how low its productivity is in satisfying human needs. If leveraged the better. There is no turning back. Massive savings are now supporting expensive and hardly profitable capital structures. The largest and less productive of these is called “the government”.

I do not know if this is an intended or non-intended consequence of central bank policy (I suspect the later), but I do know that the only way for governments to keep their promises to creditors, voters and supporters alike is by exacting more resources, a.k.a. wealth, from their subjects in the future. Those wealth producers, in turn, will have less to go around with. Believing the possibility of creating virtually infinite amounts of money (more accurately money substitutes) equates to being able to almost infinitely increase capital is an illusion. It ignores the decreased quality of that specific capital good that is being “produced” in exponential amounts. The rally will continue for as much as the illusion that wealth is being produced is maintained. New ventures backed by promises of future wealth will be issued, while in reality capital is being destroyed/malinvested  throughout the whole process.

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