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Do Extra Dollars Distort the Distribution of Wealth?


The data suggests yes.


The government does not directly create wealth. No, wealth creation would be the output of productive private labor applied to economic resources.


What the government can do, via the Treasury and its partner, the Federal Reserve, is redistribute wealth via the expansion of the money supply, deciding who directly receives checks, and who indirectly receives low interest loans, from banks with recently expanded lines of credit. Wealth flows to these two receiving entities from all others who happen to hold dollars and dollar denominated debt, both of which lose some value due to this expansion of the money supply.


When such redistribution of wealth by the government goes beyond the normal redistribution (i.e., taxation & spending), it is cleverly referred to as an “economic stimulus”, but is nothing more than a market distortion, the sub-optimal allocation of wealth, often with a political purpose. Just taking wealth from Peter and giving it to Paul.


That is not to say that such market distortions are never required, often they are, correcting for prior market distortions, preventing social unrest, etc.


All agree that our economy requires some minimum amount of money/credit to facilitate trade. But as each “stimulus” of the economy injects even more dollars into the system, the result is an excessive supply of money/credit, much more than what is required.


Contrary to what many believe, money/credit beyond that which the economy requires does not create more wealth. But it does lead to market distortions, one of them being abnormally low interest rates. Some will benefit from this distortion; others will be penalized.


Are their other observable market distortions taking place today?


The answer is surprisingly clear.


Before we look at the charts, recall that the price of financial assets is determined at a market, established by the small percentage of such assets that are being actively traded, with that price being projected to all such assets, even though the vast majority are passive.


For example, all homes are perceived to have some value, to store some amount of wealth, even though most will not be sold this decade.


So as the price for a particular asset is pushed higher at the market, this implies that the economy collectively believes that more wealth is being stored in that particular asset, with the total stored wealth being the “market cap” for that asset, the number of unit’s times the average price.


The first graph is the M2 Money Supply, from 1988 to the present. The thick orange line is my sad attempt to draw the average curve. About a 6X increase over this 32-year span. Even accounting for population and economic growth, more dollars than our economy can possibly require.



The next graph is the S&P/Case-Schiller U.S. National Home Price index. Same period. Note that the shape of the orange graph is about the same, with about a 3.5X increase.


The net value of all U.S. real estate today, commercial, and residential, is about $50 trillion.



Followed by the Wilshire 5000 Total Market Index, a market-capitalization weighted index representing all U.S. stocks. Same shape, with perhaps a 20X increase. Wow. We collectively believe that the combined wealth stored in all U.S. public stock is about $50 trillion dollars (weird coincidence).



And finally, there is gold., same rough shape, about a 4X increase. With about 200,000 metric gold in the world today, this represents a net value of about $7.7 trillion.


Note that this exponential increase is not true for all financial assets. If it were, with all about the same gain, it would simply indicate that the dollar was losing value at an accelerating pace, that wealth was not accumulating in any particular asset.


For example, the next graph is the price of oil over the same period.


Note the impact of the shale revolution, which starting around 2009, which dramatically increased the supply of oil. Demonstrating that there are other factors at play other than the strength of the dollar, specifically the unique demand and supply each commodity, good and service.



Implying that some financial assets are accruing wealth at the expense of others.


This redistribution of wealth is not random, that it has something to do with the exponential increase of the M2 Money Supply. Which raises the question, why do those with excess cash find some assets more desirable than others, especially stocks?


One reason would be inherent limited supply. There are only so many companies, so many houses, and so much gold. Supply growth is possible, but slow.


The other reason would be ease of purchase. While the purchase of some financial assets, such as bonds, continues to be a mystery to many, Robin Hood has opened Pandora’s box as far as the democratization of the ownership of stock is concerned.


Hmmm. What other financial asset is inherently limited in supply, and has recently become extremely easy for many to buy and sell?


That would be Bitcoin, with just under a $1 trillion market cap. Are you still a denier?


A third reason would be the perception that a positive ROI can be achieved, that there is a fair amount of speculation involved. For now, greed is overwhelming fear.


The fourth reason is given their inherent limited supply, all these assets are perceived to be a hedge against inflation & higher interest rates. A good place to park all this excess cash, because if the rate of inflation increases, cash, and especially bonds, will not be the best place to store wealth.


So if inflation remains low, and our government continues to “stimulate” the economy, this trend will continue? Or is this nothing more than a speculative bubble, dollars having to go somewhere? But is the price of stocks and/or real estate come down, where do the dollars go next? Bonds? You make joke!


It should be noted that this market distortion, this run-up in the price of stocks and to a lesser degree real estate, has benefited a few, with the majority being left out. It is the prior wealthy that already had a significant amount of their wealth invested in stocks and real estate, and they are now ever wealthier.


I question the fairness of continued government over-spending disguised as “economic stimulus”. Perhaps it is time to revert to a market driven economy with less distortion.


If the CPI remains low, many argue that such stimulus can continue, pain-free.


Why has this historical, year-long run-up in home prices and stocks not reflected in the CPI? Good question and has everything to do with how the CPI is computed. The quick answer being that the CPI does not include the price of homes and stocks in its calculations, being focused instead on the day-to-day purchases of the average consumer. The calculation kind of sort of accounts for rent, but in a contorted sort of way that very, very few understand. That tends to introduce a time lag in the number.


So, if the price of clothing and eggs remains stable, all is good! Inflation will be officially “low”, the government will borrow more, and the stock market will apparently reach the moon.


Until the price of energy increases….


Keep an eye on the 10-year Treasury rate, it remains the inflation bell weather.


I will go out on a limb an make the call that the CPI is inaccurate or delayed, that inflation is already upon us, and will become very apparent once aggregate demand and the velocity of money recover to normal levels.


And that once again, a prior market distortion will lead to an even greater market distortion.

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