Asset markets – stocks, bonds, property – are performing well. The popular press points their finger at the easy money policies of the Central Banks as the source of asset market strength. Does this argument have merit?
‘Quantitative Easing’ (QE) is the trendy expression for expanding the Monetary Base (currency and bank reserves) in the financial system. This does not, of itself, expand the money supply. Monetary expansion takes place only if the banks use their reserves to increase lending. The ‘Velocity of Money’ measures how willing and effective banks are at lending out the fruits from QE. The following diagram shows that velocity has fallen significantly since 2007.
The decline in velocity is staggering and questions whether QE in the US has been expansionary at all. How can asset price increases be blamed on QE when banks do not seem to have been passing on the Fed’s actions in the form of loans?
If QE is not the culprit for the run in asset prices, then what is? Investor preference for risk would seem to be the best candidate. I have made this argument many times, but it would seem that investors have ratcheted down the compensation for risk that they are prepared to receive in the marketplace. This is plainly evident in the European bond markets where yields on everything from Greek Bonds through to German Bunds have almost halved in recent months, and no-one can argue that the debt crisis is over nor can they argue that policies are in place to reduce debt – on the contrary, the discussion in Europe is all about raising debt levels!
If not QE, what is driving asset prices? Falling risk aversion is driving asset prices