Here’s a little thought experiment for you. But first a brief bit of background. We know a few things:
- QE is an asset swap of privately held bonds for some form of money (reserves if banks sell or deposits if a non-bank sells the bond). So there’s no change in the private sector’s net financial assets. In other words, the private sector doesn’t experience some form of excess financial assets from QE. If you want to call it “money printing” then fine, but it’s a lot like changing a saving account (t-bonds) to a checking account (reserves/deposits). So the moneyness of the private sector’s assets change, but the net financial assets do not change. Confused? See this primer.
- We also know that all government taxing, spending and deficit spending (spending in excess of tax receipts) is some form of redistribution. When Paul pays his taxes the govt redistributes Paul’s inside money (his bank deposits which were created INSIDE the private sector when a bank made a loan) to Peter. When the govt deficit spends Paul buys a bond and the govt issues Paul a bond and then redistributes Paul’s inside money to Peter. Confused? See this primer.
- Corporate profits have been disproportionately driven by the government’s deficit in the most recent cycle because private investment collapsed. Confused? See this primer.
So, knowing all that – what would happen in the current environment if the govt announced that it was going to run a sustained 5% budget SURPLUS position with a current account deficit and QE in the form they’re currently running? What do you think would happen to the economy and the stock market in the ensuing quarters and why?
I’ll let you all chew on that for the day and provide my own thoughts in a follow-up post with pretty pictures and projections. Obviously, there are a lot of moving parts here and I am oversimplifying many things, but let’s just keep it overly simple for now….