Money Printing, Debt Funding, Massive Distortions

The massive monetary injections in the form of Government debt and excessively loose Central Bank policy have been inflating a wide range of assets over the last year. When the Government authorities choose to stimulate the economy they are able to do so at some entry point, but after the money enter the economy it has very little control (outside of outright force) where the money will end up. What the Government understands is that it does not want the money to simply stay in banks; they want people to spend it. This is their interventionist thinking: should money stay in the bank it means that it is not circulating and therefore economic stimulation is not having the effects desired. But at the same time, they do not want the economy to be overly stimulated because it will lead to inflationary pressures, which will thereby derail any economic success. So, it is a fine balancing act; an art more than a science.

That being said, over the last year (March 2020 to March 2021) the Government has injected into the economy somewhere in the neighborhood of $10 Trillion dollars! Yes, Trillions! This comes in the form of roughly $4.5 Trillion of new debt issued by the US Department of Treasury (and if we add the recently passed COVID bill by Congress costing about $1.9 Trillion, then the total would be $6.4), and the $3 Trillion of extra money printed by the Central Bank. Never in the history of the US, perhaps with the exceptions of the early days of the Republic, has so much debt and money printing happened. 

This massive amount of money is what is fueling the skyrocketing equity valuation. Simply take a look at the box below. The Year-over-Year changes in valuations are eye-popping. The Price-to-Earnings ratio in the major US equity markets tells you how much value the market has place for each dollar of earning. Taking the Dow Jones, for example, people now are willing to pay now about $33 for each $1 of earnings. Last year at this time people were only willing to pay about $18 for the same $1 of earnings. That translates to an 85% increase in valuation. The same dynamic is seen in the other major Indices. The outlier here is the Russell 2000 where Earnings are Zero, which anyone having a basic understanding of arithmetic can attest that any number divided by zero is inoperable – that is, it cannot be done. When you also look at the Dividend yields, you see a significant decline. That is not indicative of a healthy outlook. 

When will this irrationality end, no one knows. In fact, it can continue for a lot longer; but when the day you begin to hear a general chorus coming from the mainstream media that we have overcome and that all is well, that will be your warning sign that the bubble soon will pop. We are not there yet, but as each day pass the day of reckoning approaches. Given the gigantic mountain of money being created, which is causing significant distortions, the downside will be in equal proportion.