I've come across a blog post where the author maintained that QE has nothing to deal with rising stock indices and assets prices as P/E ratio of, for instance, S&P 500 is at its average level (http://www.multpl.com/), while if money created by QE had been spent on buying shares, then P/E would have been much higher. I don't hesitate a second that it's all because of QE but how to prove it?
1. The acid test of whether money printing [=QE] or something else has caused Product A to go up in price is this: Has everything else gone up, too?
2. What he seems to be saying is that if the new money was desperately seeking a place to go, it would buy stocks at a high price even though they don't really deserve such a high price. The fact that the price, as measured in one way specially chosen to be convenient for his argument, is about average, proves they are being sought for their intrinsic value, he thinks.
But we see here that he is making all kinds of assumptions.
First that P/E is a valid indicator, always, whether the price is right.
Second, granting his first assumption, he also assumes that the average P/E is a magic number that is what the price "should be" today. Which is of course pretty silly. Look at the wild swings in that chart.
Third, he had his facts wrong. If average P/E is 16, and now it's 24, meaning 50% higher, that's not exactly at its average level.
Hoist with his own petard.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
Liquidity (printed money) sloshes around and inflates both P and E, though not necessarily equally and at the same time. Both P and E are measured in the same manipulated unit ($).
Thank you, Dane.
He actually wrote 13,5 for the first quarter of 2011 so I decided to check it.
While pondering my possible reply I read this article from Mises daily http://mises.org/daily/4654/How-the-Stock-Market-and-Economy-Really-Work, where Kel Kelly explains why stock markets can not be considered an indicator of a real economic growth. I experienced some difficulty in understanding this peace:
The Fundamentals are Not the Fundamentals If it is, then, primarily newly printed money flowing into and pushing up the prices of stocks and other assets, what real importance do the so-called fundamentals — revenues, earnings, cash flow, etc. — have? In the case of the fundamentals, too, it is newly printed money from the central bank, for the most part, that impacts these variables in the aggregate: the financial fundamentals are determined to a large degree by economic changes. For example, revenues and, particularly, profits, rise and fall with the ebb and flow of money and spending that arises from central-bank credit creation. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase. Specifically, how this comes about is that new money, created electronically by the government and loaned out through banks, is spent by borrowing companies.[7] Their expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lags behind in time because of technical accounting procedures, such as the spreading of asset costs across the useful life of the asset (depreciation) and the postponing of recognition of inventory costs until the product is sold (cost of goods sold). These practices delay the recognition of costs on the profit-and-loss statements (i.e., income statements). Since these costs are recognized on companies' income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognized. For example, if a company recognizes $1 million in costs for equipment purchased in 1999, that $1 million is worth less today than in 1999; but on the income statement the corresponding revenues recognized today are in today's purchasing power. Therefore, there is an equivalently greater amount of revenues spent today for the same items than there was ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency). "With more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing." Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed. In summary, credit expansion increases the spreads between revenue and costs, increasing profit margins. The tremendous amount of money created in 2008 and 2009 is what is responsible for the fantastic profits companies are currently reporting (even though the amount of money loaned out was small, relative to the increase in the monetary base). Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit.[8] During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs. It is also new money flowing into industry from the central bank that is the primary cause behind positive changes in leading economic indicators such as industrial production, consumer durables spending, and retail sales. As new money is created, these variables rise based on the new monetary demand, not because of resumed real economic growth. A final example of money affecting the fundamentals is interest rates. It is said that when interest rates fall, the common method of discounting future expected cash flows with market interest rates means that the stock market should rise, since future earnings should be valued more highly. This is true both logically and mathematically. But, in the aggregate, if there is no more money with which to bid up stock prices, it is difficult for prices to rise, unless the interest rate declined due to an increase in savings rates. In reality, the help needed to lift the market comes from the fact that when interest rates are lowered, it is by way of the central bank creating new money that hits the loanable-funds markets. This increases the supply of loanable funds and thus lowers rates. It is this new money being inserted into the market that then helps propel it higher.
If it is, then, primarily newly printed money flowing into and pushing up the prices of stocks and other assets, what real importance do the so-called fundamentals — revenues, earnings, cash flow, etc. — have? In the case of the fundamentals, too, it is newly printed money from the central bank, for the most part, that impacts these variables in the aggregate: the financial fundamentals are determined to a large degree by economic changes.
For example, revenues and, particularly, profits, rise and fall with the ebb and flow of money and spending that arises from central-bank credit creation. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase.
Specifically, how this comes about is that new money, created electronically by the government and loaned out through banks, is spent by borrowing companies.[7] Their expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lags behind in time because of technical accounting procedures, such as the spreading of asset costs across the useful life of the asset (depreciation) and the postponing of recognition of inventory costs until the product is sold (cost of goods sold). These practices delay the recognition of costs on the profit-and-loss statements (i.e., income statements).
Since these costs are recognized on companies' income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognized. For example, if a company recognizes $1 million in costs for equipment purchased in 1999, that $1 million is worth less today than in 1999; but on the income statement the corresponding revenues recognized today are in today's purchasing power. Therefore, there is an equivalently greater amount of revenues spent today for the same items than there was ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency).
Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed.
In summary, credit expansion increases the spreads between revenue and costs, increasing profit margins. The tremendous amount of money created in 2008 and 2009 is what is responsible for the fantastic profits companies are currently reporting (even though the amount of money loaned out was small, relative to the increase in the monetary base).
Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit.[8] During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.
It is also new money flowing into industry from the central bank that is the primary cause behind positive changes in leading economic indicators such as industrial production, consumer durables spending, and retail sales. As new money is created, these variables rise based on the new monetary demand, not because of resumed real economic growth.
A final example of money affecting the fundamentals is interest rates. It is said that when interest rates fall, the common method of discounting future expected cash flows with market interest rates means that the stock market should rise, since future earnings should be valued more highly. This is true both logically and mathematically. But, in the aggregate, if there is no more money with which to bid up stock prices, it is difficult for prices to rise, unless the interest rate declined due to an increase in savings rates.
In reality, the help needed to lift the market comes from the fact that when interest rates are lowered, it is by way of the central bank creating new money that hits the loanable-funds markets. This increases the supply of loanable funds and thus lowers rates. It is this new money being inserted into the market that then helps propel it higher.
I can't understand it. Can inflation, which always seemed to be quite low in the USA, be responsible for spreads between revenues and costs? And are the lags in recognition of costs in companies so large?
Random thoughts:
1. Inflation is close to 10% in the USA right now [source: Peter Schiff].
2. The CPI lies about what actual inflation is, and was invented for that very purpose by Nixon.
3. A bit about the flaws in CPI here: http://mises.org/Community/forums/p/18168/346988.aspx
4. I've seen Hazlitt write the same thing about the lag, with evidence. Hazlitt wrote two short, easy to read, free books on inflation. I reccomend both, the shorter one first, then the longer one.
5. That Kel Kelly article is a masterpiece. The big eye opener for me was his insight and proof that GDP really measures only one thing, how much money was printed.
Smiling Dave: 5. That Kel Kelly article is a masterpiece.
5. That Kel Kelly article is a masterpiece.
+1
Here's the link again for convenience.
Smiling Dave: 5. That Kel Kelly article is a masterpiece. The big eye opener for me was his insight and proof that GDP really measures only one thing, how much money was printed.
I read that article after this one http://mises.org/daily/5170/The-Myth-of-Japans-Lost-Decades, which is really awesome.
Smiling Dave: 4. I've seen Hazlitt write the same thing about the lag, with evidence. Hazlitt wrote two short, easy to read, free books on inflation. I reccomend both, the shorter one first, then the longer one.
Could you name these books? And could you remember where he wrote about the lag, because it is still not obvious for me.
Smiling Dane, z1235, thank you for replies.
This is the longer book: http://mises.org/books/inflationcrisis.pdf Chapter 16 is about the lag.
The shorter book: http://mises.org/books/inflation.pdf
YW. And it's Dave.
EDIT: And yes, that piece on Japan is another masterpiece. Wow. So Japan never had a lost decade, just had growth without inflation. I ask you, where else you find this out from but the Mises Institute?
Smiling Dave:YW. And it's Dave.
Smiling Dave:EDIT: And yes, that piece on Japan is another masterpiece. Wow. So Japan never had a lost decade, just had growth without inflation. I ask you, where else you find this out from but the Mises Institute?
EDIT. I have just read Chapter 16 in that book. Wow.... Never thought understatement of costs could be that large. By the way, have there been any changes in technics of inventory accounting since 1970s? Do companies allow for inflation now while calculating their profits?
By the way, have there been any changes in technics of inventory accounting since 1970s? Do companies allow for inflation now while calculating their profits?
Dunno, that's one for an accountant. The Kel Kelly article seems to say no.
And the last question :)
In the article Kel Kelly wrote that nowadays money created by banking system are flowing into financial markets and thus bid up assets prices rather than consumer ones. He also stated 2 reasons for that.
There are two main reasons for this channeling of money into financial assets. The first is changes in the financial system in the mid and late 1980s, when an explosive growth of domestic credit channels outside of traditional bank lending opened up in the financial markets. The second is changes in the US trade deficit in the late 1980s, wherein it became larger, and export receipts received by foreigners were increasingly recycled by foreign central banks into US asset markets.[10]
I understand the 2nd one but didn't get the 1st. What are these credit channels?
What are these credit channels?
credit cards
But one will use a credit card to buy food or another staff rather than financial assets... Am I wrong?
Let's take QE. The Fed bought T-bonds thus leaving commercial banks with more cash. How will this cash get to financial markets? Banks will buy assets or shares with it?
I think he means that people saw big money to be made investing in credit card companies [="channeling of money in financial assets"], because of the explosion in their use.
Oh, now I got it. Thank you, Dave, for spending time on my silly questions.)