Most people think that the biggest problem with money printing by the Federal Reserve (either in the form of Quantitative Easing or in Zero-Interest (ZIRP) money-lending) is inflation. Inflation is a problem (if you doubt me, go to the grocery store), but it is not the worst.
The worst problem with money printing is the massive misallocation of resources that it causes. Money is supposed to be a measuring device. Provided I don’t do anything fraudulent, profit is essentially the added utility that a business adds to the economy. More profit = more economic benefit.
However, ZIRP heavily distorts the economic picture. As a case in point, look at Amazon.com. Its stock price is currently at $1,000, which is a P/E of 187. That means that it is essentially giving a return of 0.5%, which is less than treasury bonds at this point. So why all the investment here? There are a few reasons, but the biggest one is that when money is printed, it has to go somewhere. The easiest way to make a winning trade is to stick the printed money in the stock market.
Think of it this way – if I can get money for nothing, I don’t need a large return to be profitable. If I am getting money for 0%, then a 1% return is great – I just need to borrow a lot of it. Things don’t work quite that simply (the Fed rate is not actually zero, only a few people get to borrow at that rate, you don’t have unlimited borrowing, etc.), but the general effect is the same. What works right now is to massively leverage small gains. This generally turns into a pile-on in the stock market, where everybody buys stocks even though they are overvalued, and that in turn drives them still higher.
Now, let’s go back to Amazon. They have a market cap of HALF A TRILLION dollars. Under normal circumstances (i.e., a P/E of 15 instead of 180), Amazon would be worth about 50 billion. That means that almost all of that HALF A TRILLION is misinvested. Let that sink in – there is a half a trillion dollars that are misinvested in a single company! It isn’t quite that bad because not all of that is actual investment (not everyone paid $1,000 per share), but nonetheless, it is pretty bad.
Now, imagine this – let’s say that you couldn’t make money for free. Let’s say that companies actually had to show returns to get investment. What happens then? Well, the biggest returns are not in the stock market. The biggest returns are in building companies from scratch, or taking a small company and building it into a giant. Therefore, if I needed actual returns, I would build a company rather than just invest in an existing one. However, right now we have half a trillion dollars NOT DOING THAT. It is easier to simply leverage and buy rather than actually work for money. If I can just borrow extra and get the same result, that’s what I’ll do.
If you wondered what is sucking America dry, it is ZIRP! There is no reason to invest in building America. We just prop the existing companies in the stock market up and up and up, and America’s actual economy just languishes in the dust. The resources are all committed to the stock market. There’s hardly anything left for anyone else. Real businesses giving real jobs to real people isn’t where the big money is, because we can simply leverage ourselves to a financial benefit without any actual benefit.
Again, I should point out, this half a trillion dollars is the misinvestment in a single company. The focus on the stock market and the ZIRP policy that brings money to it are part of what is keeping main street America from succeeding.
Think of it this way. You are a millionaire. You have $1 million sitting around. What are you going to do with it? The stock bubble is heating up. You can invest it in the stock market, or you can risk it all and go invest in two guys in a garage starting a business. With the stock market, you have people printing money who will buy the stocks that you buy later on. With a business, you have to actually produce something in order to sell it. Which one will you do? And so the bubble grows bigger.
The other side of the coin is that this belief that the stock market can save us has made us all lazy. We want other people to make money for us. We have outsourced even the basics of making a living to other people. I hope we can find a way out of all of this. This is why in Microsecession I suggested we try to get away from the money economy. If we can, then the eventual disaster that is waiting to happen in the money economy will not affect us as strongly.