There are two distinct trends that we have to divide and conquer to fully understand what we are dealing with (1) Parking capital and (2) Investing Capital
The motives behind each are totally different and this goes in part to also the question of the “reserve” status of the dollar. There is the dollar as a instrument of trade, and then there is the dollar that is PARKED by governments as reserves. If China demands other countries accept its currency and not dollars for trade deals, that has no impact on the “reserve” status that is determined by holding government debt. Such countries can accept their currency and the park it after conversion in US debt. Europe failed to create a national debt and thus the euro will never be a real single currency until that happens. The risks vary far too much with each nation to provide a single risk management. Thus, the vast size of the US National Debt makes it the only game in town for parking huge money. That is different from using dollars, euros, yen, or yuan in settling trades.
There is unquestionably the inevitable revulsion toward sovereign debt on a global scale because governments have been borrowing with no intention of paying anything off. The failure of Europe to create a single debt has barred that currency from ever becoming a reserve currency globally. Politicians live under the delusion that it is less inflationary to borrow than to print. That was true in the 1960s when you could not borrow against government bonds. But after the Bretton Woods System collapsed in 1971, the “reserves” became just dollars and thus money became pure debt that now simply paid interest. You could trade in the markets with TBills as collateral. Suddenly, money and bonds were indistinguishable. What emerged was currency now that paid interest. Hence, the national debts have exploded as the USA debt is nearly 70% composed of previous interest payments. It would have been a hell of a lot cheaper just to print that did not cost interest. The national debt would be 30% of what it is and taxes would not be rising.
During the 1960s, you deposited money in a Swiss bank and you PAID them a fee to have the account. This was a throw back to how private banking really began. You paid someone to STORE your money because you had no safe at home. That was the historical role of PARKING your money – not INVESTING. This is still present today for during the financial crisis cash poured into TBills as they went to virtually a zero rate of interest during the crisis post-2007. We call such periods the Flight to Quality. It has nothing to do with investing – just capital preservation.
Under INVESTING the decision process is determined based upon the rate of return. This will benefit stocks whenever the dividends rise above the rate of bond yields and/or when the capital appreciation potential emerges (as in bubbles).
The fate of the stock markets do not thus depend upon corporate cash flow or even dividends. When the confidence in government debt declines, capital then seeks the flight to quality rather than investing and will select key stocks for capital preservation. This is why private assets rise during such periods of government (PUBLIC) economic distress or even during the craziness of hyperinflation that emerges in isolated fringe economies as was the case in Germany and Eastern Europe during the 1920s. Germany ended the hyperinflation by backing a new currency with real estate assets not even gold!
There has been no massive beneficiary of extreme deficit spending other than exporting capital to bond holders – not the poor. About 40% of the US National Debt has been held by foreign hands and thus the interest spent does not necessarily stimulate the domestic economy anymore. The kicker here is the shift between PUBLIC to PRIVATE as a flight to quality. I believe that as rates rise, the deficits will not be as “costless” as they have been and will rise exponentially. This will cause further spending reduction and the raising of taxes. This is the suicide factor because a core economy, unlike a fringe economy, has bondholders who are demanding to be paid with UNINFLATED money. As the City of Mainz discovered, when they could not sell their bonds to pay off the last issue, they defaulted. They had already raised taxes and chased the rich out of the city. All that was left was the creditors sacked the city and burned it to the grown.
As these trends unfold, do not expect corporate cash flow and earnings to rise and provide a rate of return from an INVESTMENT perspective. The Bell Curve will kick in by 2016 and that will turn downward leaving capital seeking preservation and dumbfounded where to go. This historically has been a flight to tangible assets including shares, real estate, and commodities. Effectively, everything that is opposite of PUBLIC. Hence Germany’s use of real estate to back its new currency.
We are starting to witness the suicide factor already. The rising cost of government even during economic declines. Perhaps since politicians are dominated by lawyers, we need to include common sense economics as a mandate in law school. Perhaps these people will remember and a light will go off before falling off the fiscal cliff.
Consequently, an equity price rise is by no means purely earnings based. It will rise also on a flight to quality when capital has no place to park. Likewise, forget the nonsense about HYPERINFLATION that seems to be more of a sales pitch than any authoritative study. Gold will rise as a parking vehicle for the same reasons. Our risk is the implosion and death by suicide, not that they will print forever. We do not have that much time. When interest rates start to rise, the pressure will be on the Sovereign Debt Crisis. Why these governments REFUSE to investigate what they are doing is simply because politicians are only concerned about winning the next election. Not actually fixing anything.
Watch the end of 2013. After August 7th, things look like they will go nuts and we have the German elections in September. France has abandoned sound economics and they were the #2 anchor of the Euro. If Merkel goes, what is left but a fragmented socialistic government hell bent on grabbing other people’s money to buy the next election.