Does the Stock Market follow the Money Supply?
This is the 3rd installment in my Monetary Economics series. The first two installments were:
From these two articles, we have learned that:
Home loans use money created out of thin air
When the principle is paid back, it is destroyed
There is no justification for charging interest
House prices can be halved by banning this practice
The ‘Interest Rate’ monetary tool is used by central banks to extract as much money as possible from the public without a collapse
Money supply is constantly increasing in most countries due to the credit creation system of banking that we have. When more money is injected into the economy, people have more to spend. And they do spend it.
Because people have more to spend, prices go up. That is inflation, and its inefficient, but not inherently bad as long as everybody’s money increases equally.
Just as the price of bread goes up, so too does the price of a stock. People spend more—> companies make more money—> companies are worth more money—> shares cost more.
There have been several papers on the link between stock markets and the money supply. They find that the money supply tends to be the primary driver behind stock market prices, although it is not the only factor.
Certainly in the short term the link is not clear, but over 6 months and more, the money supply tells the stock market which way to go.
This is why you are supposed to “diversify” when you invest in the stock market. Because money supply is almost always increasing, the whole stock market tends to also increase.
If you choose one or two stocks, it is possible they might not follow the general trend, and you could lose money. But the more stocks you select, the more likely your portfolio will follow the overall trend of the market - up.
In other news, my last article predicted that the Reserve Bank of Australia would increase the Interest Rate, despite 70% of economists believing they would not increase it.
I again predict that the RBA will increase rates, although traders give it a 50-50 chance this time around. Just ask, can they increase Interest Rates without crashing the economy? Yes they can, although the squeeze is getting real for many people, and it will have to stop soon.
References
Kehoe, J. (Jun 30, 2023). Three reasons why interest rates are still too low. Financial Review. https://www.afr.com/policy/economy/three-reasons-why-interest-rates-are-still-too-low-20230629-p5dkjk
Maskay, Biniv. (2007). Analyzing the Relationship between change in Money Supply and Stock Market Prices. Illinois Wesleyan University. Economics Department. Honors Projects. 35. https://digitalcommons.iwu.edu/econ_honproj/35
McClellan, T. (Feb 12, 2021). Understanding M2 and Stocks. StockCharts. https://stockcharts.com/articles/tac/2021/02/understanding-m2-and-stocks-597.html
ŠIRŮČEK, M.: Effect of money supply on the Dow Jones Industrial Average stock index. Acta univ. agric. et silvic. Mendel. Brun., 2012, LX, No. 2, pp. 399–408. https://mpra.ub.uni-muenchen.de/68167/1/MPRA_paper_68167.pdf