Could too much money in the system lead to deflation? There is a risk.

Low interest rates and quantitative easing could deter new capital investment projects. QE is no doubt helping asset prices rise, but it is also forcing down the cost of capital at a time when the return on capital should, arguably, be higher, given the risks. Returns on the different components of the cost of capital equation should justify the risk, and cash and bonds are both important components.

Currently, the returns on cash do not justify the risks (in my opinion), the returns on fixed interest investments are at historic lows and cyclically adjusted valuations of equities are at historically high levels.   When you need more investment, should you raise the investment cost to providers of capital?

We continue to experience a significant increase in cash holdings:

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The larger the monetary base/narrow money supply and the lower the potential supply of return on capital investment opportunities, the lower the return on debt and loans and the higher the risk of such investment.  

Where there is an aversion to loan capital for new investment and where there is significant narrow money supply growth, there is a risk that money supply may become more asset focussed. 

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The question is, could this dynamic also be reinforcing deflationary forces in the economy? Less investment = less productive capital; the greater the net depreciation of capital, ergo the lower the future output and all its nom de plumes.

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