A really simple explanation of how Quantitative Easing is fueling the rise in the stock markets.

I am running another blog which can be found at www.tradedesk911.com. I have just published one of my "Realy Simple Explanations"  These have attracted interest despite my long absence from this blog. I have just written a new "Really Simple Explanation" This time about Quantitative Easing and how it feeds cash into stock markets making them rise at a time when economies are still in trouble.

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A really simple explanation of how Quantitative Easing is fueling the rise in the stock markets.

I have mentioned many times in my trading blog that I think the reason why stock markets are rising relentlessly while economies continue to languish is the result of Quantitative Easing. QE is the most up-to-date euphemism for printing money. 

The printing of money inevitably results in inflation: more cash chasing the same volume of goods leads to a rise in prices so there must be inflation somewhere. This is one of the first things a student of economics learns.

Consumer, commodity and property prices have remained relatively stable or falling until recently. And this while governments have been printing money continuously. Somehow the cash must be finding its way into the only arena where asset prices have been rising: stock markets. What I did not know was how the mechanism worked. That is until I came across an interview by Steve Keen.

Dr Keen showed the link between margin debt and the level of the US markets. This means that investors are buying shares on margin (another word for borrowed money) supplied by their brokers. 

The way QE works is this: governments buy bonds (which are long term assets) from banks and pay for it with newly-created money. The banks are now sitting on a pile of cash.

What the governments want, and their motive for printing money in the first place, is that it should be lent to companies to invest in their businesses and to consumers to buy goods from companies. In short, they hope it will be a shot in the arm for the real economy.

Partly because the banks are fearful of lending to customers who will subsequently default; and partly because people and businesses are uncertain that they will be unable to repay what they borrow, banks can't easily find borrowers. So they lend it to stock brokers who offer margin to their customers who buy stocks. They are willing to
pay interest on money which they invest to make capital gains as their stocks
appreciate. And the banks rub their hands as they earn good returns on the cheap
money provided by the governments' QE.

The parallel between margin debt and the DJI shown in Dr Keen's chart is scary. The video is here.

Dr Keen's margin trading versus stock market movement chart may not be all that it seems at first sight. It presents a chicken and egg problem. Does the margin trading drive the market or does the market encourage margin trading. I would guess it's a bit of both. Nevertheless the availability and take up of credit is linked to QE. And the relationship between stock brokers and banks provides a mechanism for all that money to find its way into the market.

I have noticed that there has been a flurry of adverts by lenders who specialize in lending to high risk borrowers. I wonder if QE money is finding its way into this market too: lending at extortionate interest rates to people who don't care whether they can pay their debts or not. It used to be called sub-prime; now it's called payday loans.