Fraud of Money

 A year or two ago, I read a book, which I thought was entitled “The Fraud of Money”. However, I am unable to find any such book. Anyways, this book (if it did really exist) had some interesting ideas about finance, particularly about how new money from the Federal Reserve impacts asset prices. I introduce quite a bit of finance jargon in this piece, so I will have a glossary with links to investopedia below.

Now one idea of monetary policy is this:

1. increasing the supply of money decreases interest rates (after all, borrowers and lenders use supply and demand, increase the supply of money and if demand is held the same, the price [which in this case could be described as an interest rate] at which those two lines will be lower.)

2. decreased interest rates, result in decreased returns on investment (detail to follow, see below)

3. decreases in required returns on investment stimulates new investments that otherwise would not have been profitable 

Let's look at some of these ideas in detail. Using the CAPM we can see a decrease in risk free interest rates affects debt and equity returns. If the FED lowers rates, well, asset prices could increase in response, rate and price have an inverse relationship. This is a relationship we have seen play out recently in the stock market. With the recent rate drop, markets have moved upward.

This change in interest rate also changes the WACC business should use to calculate NPV.  Decreases in rates should cause some otherwise negative NPV projects to become positive or zero NPV. Ultimately businesses try to generate returns in excess or equal to the cost of funding required to get those returns.

This book I'm reading claims this is not the case. Instead it argues that increasing the money supply does not increase investment in new useful assets. Rather, this triggers investment in the same existing assets, which causes asset prices to increase artificially 

But is this the case?

At the time I wrote this piece, that could have been the case! I wrote:

Well, perhaps that is what we are seeing right now. With interest rates nearing all-time lows, and large amounts of money in the economy, people need a place to put their money. With stocks at all-time highs, it seems reasonable to think that people are putting their money into stocks, which is driving up the price.

https://fred.stlouisfed.org/series/M1

However, also consider this, R&D spending by companies across the world has still increased in 2020 ( Source). So while some of the funds provided by the Fed probably are increasing asset prices, like stocks, or real estate. It is also prompting the development of new real estate and R&D in private companies.

While the exact mix of the use of these funds would be hard to determine (sounds like a great thesis idea). I think it is clear the mix is not 100% to new assets and development or 100% to existing assets and inflation.

What do you think? Do you think most of the recent increase in money supply has gone to inflating asset prices? Or do you think most of the money has gone to productive uses, like new projects at companies and new developments? Or perhaps you think something else entirely. Let me know in the comments below.

Glossary:

CAPM: The Capital Asset Pricing Model. 

NPV: Net Present Value

WACC: Weighted Average Cost of Capital