Quantitative Easing and the Stock Market Surge

Everyone is talking about growing income inequality in the United States, and they are correct. However, the reality is never as simple as what newscasters and politicians report. Currently, the QE (whatever) program provides that the Federal Reserve Board will inject $85 billion of new money into the economy each month in order to keep interest rates low so that companies will invest and grow, and just maybe, provide more jobs. It sounds great, but it is not and most likely cannot work.

Companies grow and hire people when the demand for products outstrips their capability to provide them, period. With an ongoing tepid economy at best, and a dragging half-recession at worse, there is no demand for companies to add sales people or build new factories. So, they do not hire anyone and they do not borrow money and all that cash just sits in the Fed and major banks. If a company is smart (and many are), and they have a heavy debt load, they will borrow new money (at virtually 0% interest) to pay off their debts, instantly increasing their profitability. Still, no new jobs. But what makes QE the disaster you think it is, Karl?

Let’s look at the average shmuck (namely me). He keeps some savings in the bank where the principle is nice and safe, along with a small IRA or 401k. Turns out the money in the bank is not so safe after all. If I earn 0% on my balance, and inflation is even only 2%, then in effect, I’m losing 2% of my principle each year. So, what can I do to stop losing money? I move my cash into the equity markets (stocks)! Let’s say I find an index fund or individual stock with an average return of 5%. That’s fantastic, going from 0% to 5%. Unfortunately, I am not the only shmuck who thought of this. We all take our cash and pump it into the market, causing stock prices to go up, which is exactly what we are seeing now. Where is this leading?

Let us say so many people follow suit that the price of my stock doubles. Well, the company is not suddenly going to grow or become more profitable because the stock price is up. The company does not get any money from stock sales in the market (assuming no new issues or company-held stock), so the return goes to 2.5%. Of course I am disappointed, but it is still better than 0% from my bank. Unfortunately, all good things come to an end.

The Federal Reserve is already ratcheting back on the QE program. Even they realize that if the money supply gets too big, the value of the dollar will drop like a safe (envision Germany post WWI). As they cut back on printing money, interest rates go up. If the prime rate reaches 2.5%, suddenly my stock value will plummet. Anyone can now put their money in the bank and get the same return as I get in the more risky market. Why risk your principle to get 2.5% when you can get the same in a bank? If my company was foolishly leveraged, they may even go bankrupt, as their debt payments exceed their ability to earn profits.

And that leads to income inequality. Most people cannot invest significant capital in the market. We just do no have the resources. So now, the rich get all the winnings from the soaring markets, which leads to big bonuses and stock incentives for their leaders. They may pay a heavy price when the market swings downward, but believe me, the rich will be just fine. Since there are no new jobs and inflation rises, the poor get poorer.

And none of this points to the disaster that will occur in government spending when interest rates rise! Think of the impact on spending when the interest rate moves from 0% to 2.5% on $17,000,000,000,000 in government debt. The payment on the debt goes up $425 Billion a year. That is money that can no longer be used to pay our service men and women, or pay benefits to the poor, fund Social Security and Medicare, or whatever else the government does.

Maybe I am exactly wrong. Perhaps sunshine and lollipops will abound and kittens and puppy dogs will save the planet. What do you think?

One thought on “Quantitative Easing and the Stock Market Surge

  1. karljmorgancom Post author

    I hate to say I told you so, but the recent market tumble is directly tied to the Fed’s decision to cut back on its money printing operation. This will ultimately raise interest rates, cutting into the advantage of equity investments. Make sure the companies you are invested in have a strong balance sheet and positive outlook.

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