Sensex

Matthew Effect of Covid Pandemic: Rich Got Richer and Poor Got Poorer

In 1968, sociologists Robert K Merton and Harriet Zuckerman, came up with the concept of the Matthew Effect of accumulated advantage. The term takes its name from the Gospel of Matthew, which points out: “For to everyone who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away.”

In simpler terms, the Matthew Effect of accumulated advantage is stated as the rich become richer and the poor get poorer. This is precisely how things have played out over the last one year, as the covid pandemic has spread through India and large parts of the world.

Let’s take a look at the different ways in which this has happened.

1) Central banks in the rich world have printed a massive amount of money post covid. Just the Federal Reserve of the United States has printed more than $3.5 trillion between end February 2020 and now. Other big central banks like the Bank of England, the Bank of Japan and European Central Bank have also done the same.

This has been done in order to drive down interest rates. The hope is that at lower interest rates people will borrow and spend money, and businesses will borrow and expand. This will help the economy revive. Many rich countries have put money directly in the bank accounts of people, encouraging them to spend.

Some of this money has found its way into stock markets all around the world, including India, driving stock prices way beyond what the earnings of companies justify. The foreign institutional investors invested a whopping $37.03 billion in Indian stocks in 2020-21, the highest they have ever invested. The next best being $25.83 billion in 2012-13.

This sent stock prices soaring with the Sensex, India’s most famous stock market index, gaining 68% in 2020-21. In fact, the market capitalisation of all BSE listed stocks (not just the 30 Sensex stocks) went up by Rs 90.82 lakh crore in 2020-21.

The poor don’t buy stocks, the rich do. The rally in the stock market has benefitted them tremendously, making them richer. In 2019-20, investment in shares and debentures (which includes mutual funds), despite all the hype, formed a minuscule 3.39% of the overall Indian household financial savings. In 2020-21, this would have definitely gone up, but given its low base it would have still formed a very small part of the overall financial savings of Indian households.

As per the 10th Edition of Hurun Global Rich List 2021, India added 55 new dollar billionaires in 2020, with the total number of billionaires in the country going up to 177, a 45% jump in the number of billionaires in comparison to 2019. If one looks at the list of the richest Indian billionaires, most of their wealth is in the stock market. And with stock markets rallying big time in 2020-21, their wealth has gone up.

2) Like the central banks of the rich world, the Reserve Bank of India (RBI) also joined the money printing party and printed Rs 3.6 lakh crore between the beginning of March 2020 and the end of March 2021. This has primarily been done in order to drive down interest rates and help the government borrow at lower interest rates. The central government borrowed Rs 12.8 lakh crore last year and is expected to borrow Rs 12.06 lakh crore in 2021-22.

While money printing helps the central government borrow at lower rates, it hurts the middle class and the poor, who invest in fixed deposits and other forms of fixed income investments to save money. It needs to be remembered that most Indians save by investing in fixed deposits, small savings schemes, provident and pension funds and life insurance. In 2019-20, 84.24% of the household financial savings were made in these financial instruments. Low interest rates largely mean lower returns from these investments. 

In the last two years, the average interest rate on bank term deposits (fixed deposits, recurring deposits, etc.) of more than one year has come down dramatically. It was at 7.5% in March-April 2019. In March 2021, it stands at 5.5%. A bulk of this fall has happened from the beginning of 2020. Recently, the government had majorly cut the interest rates on small savings schemes for the period April to June. Nevertheless, it reversed the decision overnight, probably because of the assembly elections that were still on. It is now expected that the government will cut the interest rate on small savings schemes for the period July to September. 

Lower interest rates, hurt the middle class and the poor especially when the rate of inflation is as high as the interest rates on offer.

The money printing by the RBI to drive down interest rates is likely to continue in the months to come. The Indian central bank is expected to print Rs 1 lakh crore during April to June . This means that bank interest rates will continue to remain low, continuing to hurt the poor and the middle class.

3) While the Indian economy is expected to contract during 2020-21, data from Centre for Monitoring Indian Economy (CMIE) shows that the listed corporates (both financial and non-financial) have made their highest profits ever during the period July to September 2020 and October to December 2020.

As Mahesh Vyas of the Centre for Monitoring of Indian Economy pointed out in a recent piece: “In the December 2020 quarter, the net profit of listed companies exceeded…the record profits of September 2020.” The net profit during the quarters stood at Rs 1.51 lakh crore and Rs 1.53 lakh crore, respectively. These were the highest quarterly profits ever made by listed Indian corporates. 

This means that owners of these businesses have grown richer and so has the top management of these companies given that they own employee stock option plans and benefit from the dividends paid by the companies every year.  

But how did listed Indian corporates make their highest profits ever, while the economy was contracting? The net sales of the non-financial companies, which are a bulk of the listed corporates, fell by 10.4% in the quarter ending September and by 0.9% in the quarter ending December, in comparison to a year earlier, but the companies still made record profits. This happened primarily because the companies were able to drive down their operating expenses.

In the quarter ending March 2020, the operating expenses or the cost of running a business, made up 91.1% of their sales. In the quarters ending September 2020 and December 2020, the operating expenses amounted to 81.4% and 82.8% of the sales, respectively.

In simple English, the companies slashed employee expenses and they renegotiated their contracts with their suppliers and contractors, to drive down their costs. The larger businesses benefitted in the process  at the cost of the smaller ones.

Of course, if a small company gets paid a lower amount of money from a large company, it also has to renegotiate the money it is paying to its employees and suppliers. This also leads to job losses as smaller companies then need to fire employees in order to cut costs and continue to stay viable.

This has played out for the last one year and continues to play out now as well, with the second wave of covid spreading. It is not easy to put a number to this phenomenon, but that does not mean that this is not happening or is not important.

4) Data from the Centre of Monitoring Indian Economy shows that the size of the labour force between January 2020 and March 2021, has shrunk by 1.66 crore. This when the size of the working age population or the population greater than 15 years of age has increased by 2.88 crore during the same period.

What this means is that many individuals who can’t find jobs, have stopped looking and simply dropped out of the workforce. To be counted as a part of a labour force, an individual needs to be either employed or unemployed and be looking for a job.

The sheer size of numbers here tells us that it is the poor who are dropping out of the workforce, giving up on job search. Also as I have discussed in the past, women have faced the brunt of India’s unemployment problem.

5) The rise of the internet and the availability of cheap broadband has ensured that the need to have all hands on the deck is no longer there.

Of course, this does not mean that everyone can work from home. The working class has faced the brunt of the crisis. As Scott Galloway writes in Post Corona – From Crisis to Opportunity: “Most working-class people… can’t do their jobs at home, since they are tied to the store, warehouse, factory, or other place of work.”

People working in factories, hotels, bank branches, hospitals, real estate projects, mom and pop shops, emergency services, delivery services, etc., or driving cabs for that matter, need to turn up at their places of work and job sites every day.

Also, extended working from home, will end up having other major economic consequences. Other than permanent employees, every office has office maintenance jobs which are not on the rolls of the company. Most large offices have canteens run by a contractor. Some companies offer pick up and drop facilities to their employees.

This is how services companies create low-skilled and semi-skilled jobs. Around many large office complexes there are tapris (very small shops) selling tea, coffee and food. Further, the app cab drivers and normal taxi drivers, have already seen their business go down.

Working from home has already hit people in these professions hard. Again, while it is not easy to put a number to this phenomenon, that does not mean that this is not happening or is not important.

6) Given these factors, it is hardly surprising that many people have dropped out of the middle class. A Pew Research centre analysis found that “the middle class in India is estimated to have shrunk by 32 million in 2020 as a consequence of the downturn, compared with the number it may have reached absent the pandemic.”

This accounted for three-fifths of the global retreat in the number of people in the global middle class (defined as people with incomes of $10.01-$20 a day).

While the number of people dropping out of the middle class is high, the increase in the number of poor is shocking beyond belief. Their number is “estimated to have increased by 75 million because of the COVID-19 recession.” This also accounts for around three-fifths of the global increase in poverty.  

In fact, this is something that Nobel Prize winning economist Angus Deaton confirms in a recent research paper, where he points out:

“China did better than almost all other countries, while India did worse. China’s 1.4 billion people experienced few deaths and growth in per capita income, which took them closer to the richer countries of the world and decreased (weighted) global inequality. India’s 1.4 billion people experienced many more deaths, as well as a large drop in income, which increased (weighted) global inequality.”

Of course, with the second wave of covid starting, all this is likely to continue. One point that we need to consider here is the ability of individuals to make a living in the years to come. School and college students are being taught digitally since the last one year. It needs to be considered here that not every student has access to a computer. Further, even if there is access to a computer, it might have to be shared among multiple siblings. Then there is the question of internet speed, electricity and so on.

The quality of education being delivered digitally will impact the earning capacity of many middle class and poor students, in the years to come.

In short, like the disease itself, the negative economic effects of covid, especially among the poor and the middle class, will continue to be felt in the years to come. 

Sensex@50,000 points and Some Basic 5th Standard Maths That Some Journalists Still Need to Learn

Early morning today, the BSE Sensex, India’s most popular stock market index crossed 50,000 points during intra day trading.

Not surprisingly, this led to the bubbly being opened on the social media and business TV. These are celebrations which will be carried into the newspapers appearing tomorrow morning. This is hardly surprising given that every time the Sensex has crossed one of these major landmarks, the media has gone crazy celebrating it.

And I don’t have a problem with it, given that the media is in the business of cashing in on good sentiment or to put it more precisely, creating good sentiment and then cashing in on it. The days of what bleeds that leads, are long gone.

One of the ways of celebrating is through graphics and data. One such graphic was shared by the Twitter handle of Business Today. It basically plots the number of days the Sensex has taken over the years to move 10,000 points in the upward direction.

Hence, it plots the number of days, the Sensex took to cross the first 10,000 points, then move from 10,000 points to cross 20,000 points and so on, and finally, to move from 40,000 points to cross 50,000 points.

This is how it looks like.


Looking at the above chart, Business Today concludes that the Sensex moving from 40,000 points to crossing 50,000 points has been the fastest, as it has happened in just 415 days. This, as we can see, is the least number of days. The next fastest was between 10,000 points and crossing 20,000 points, which took 432 days, which is seventeen days more.

Yay, and that is a cause for huge celebration. Okay, Business Today, didn’t say that, I added it.

During the course of my nearly 18 years of writing for the business media, I have seen a lot of stupid charts and data being used to make a point, but this takes the cake.

Why? Simply because it doesn’t take fifth standard percentages into account.

The BSE Sensex is an index. Every index has a base value. The base value of the BSE Sensex is 100. So, when the BSE Sensex first rose from 100 points to 10,000 points in 5,942 days, it meant a rise of 9,900 points or 99 times the original value of 100 or 9900%.

In comparison, the rise between 40,000 points and 50,000 points is just 25%. So, what are we really comparing? Who are the editors clearing such graphics? Why are people being misled on such simple data points?

The question is how do we analyse this properly. The right way to do this is look at the average jump in percentage terms per trading session, in each bracket. So how do we calculate this? The Sensex moved up 9,900% in 5,942 sessions, when it crossed the first 10,000 points. Hence, it moved around 1.67% per trading session on an average (9,900% divided by 5,942 trading sessions), during the period .

Further, the Sensex moved 25% in 415 sessions, when it moved from 40,000 points to cross 50,000 points. Hence, it moved 0.06% on average per trading day (25% divided by 415 trading sessions), during the period. So, the movement of the Sensex between 40,000 points to crossing 50,000 points has been much slower than crossing the first 10,000 points.

Here is how the proper chart looks like.


What does this tell us? It tells us that the first 10,000 points were achieved the fastest. This was followed by the movement between 10,000 points and 20,000 points, where the average gain was 0.23% per trading session. The movement between 40,000 points and 50,000 points at 0.06% per trading session comes third.

Sorry for belabouring on this rather basic point but I get really irritated when people use mathematics and data to mislead, sometimes not even knowing that they are misleading.

Sensex @28,500 : Stock Market as a beauty contest

bullfightingVivek Kaul

We never know what we are talking about – Karl Popper

The Sensex closed at 28,499.54 points yesterday (i.e. November 24, 2014). The fund managers are confident that this bull run will last for a while. Or so they said in a round table organised by The Economic Times.
Prashant Jain of HDFC Mutual Fund explained that during the last three bull markets that India had seen, the market had never peaked before reaching a price to earnings ratio of 25 times. The price to earnings ratio currently is 16 times, and hence, we are still at a “reasonable distance” from the peak.
This seems like a fair point. But how many people invest in the stock market on the basis of where the price to earnings ratio is at any point of time? If that were the case most people would have invested in 2008-2009, when the price to earnings ratio of the Sensex through the year stood at 12.68.
By buying stocks at a lower price to earnings ratio, they would have made more money once the stock market started to recover. But stock markets and rationality don’t always go together. Every investor is does not look at fundamentals before investing. “In investing, fundamentals are the underlying realities of business, in terms of sales, costs and profits,” explains John Lanchester in How to Speak Money.
A big bunch of stock market investors like to move with the herd. Let’s call such investors non fundamentals investors.
So when do these investors actually invest in the stock market? In order to understand this we will have to go back to John Maynard Keynes. Keynes equated the stock market to a “beauty contest” which was fairly common during his day.
As Lanchester writes “Keynes gave a famous description of what this kind of non-fundamentals investor does: he is looking at a photo of six girls and trying to pick, not which girl he thinks is the prettiest, and not which he thinks most people will think is the prettiest, but which most people will think most people will think is the prettiest…In other words the non-fundamentals investor isn’t trying to work out what companies he should invest in, or what company most investors will think they should invest in, but which company most investors will think most investors will want to invest in.”
Or as Keynes put it in his magnum opus The General Theory of Employment, Interest and Money“It is not a case of choosing those [faces] that, to the best of one’s judgement, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”
Hence, a large bunch of investors invest on the basis of whether others round them have been investing. That is the beauty contest of today.
Nilesh Shah, MD and CEO of Axis Capital pointed out in The Economic Times round table that nearly Rs 25,000-Rs 30,000 crore of money will come into the stock market through systematic investment plans (SIPs).
Anyone who understands the basics of how SIPs work knows that they are designed to exploit the volatility of the stock market—buy more mutual fund units when the stock market is falling and buy fewer units while it is going up. This helps in averaging the cost of purchase over a period of time, and ensures reasonable returns.
Investors who are getting into SIPs now are not best placed to exploit the SIP design. Nevertheless, they are still investing simply because others around them have been investing. This also explains why the net inflow into equity mutual funds for the first seven months of the this financial year (between April and October 2014) has been at Rs 39,217 crore. This is when the stock market is regularly touching new highs.
And if things go on as they currently are, the year might see the highest inflow into equity mutual funds ever. The year 2007-2008 had seen Rs 40,782 crore being invested into equity mutual funds. This was the year when the stock market was on fire. In early January 2008, the Sensex almost touched 21,000 points. It had started the financial year at around 12,500 points.
So, now its all about the flow or what Keynes said “what average opinion expects the average opinion to be.” And till people see others around them investing in the stock market they will continue to do so. This will happen till the stock market continues to rise. And stock market will continue to rise till foreign investors keep bringing money into India.
No self respecting fund manager can admit to the fact that these are the reasons behind the stock market rallying continuously all through this year. This is simply because all fund managers charge a certain percentage of the money they manage as a management fee.
And how will they justify that management fee, if the stock market is going up simply because it is going up. Nobel prize winning economist Robert Shiller calls such a situation a naturally occurring Ponzi scheme.
As he writes in the first edition of Irrational Exuberance: “Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere. When prices go up a number of times, investors are rewarded sequentially by price movements in these markets just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the markets will go up further. There is no reason for these stories to be fraudulent; they need to only emphasize the positive news and give less emphasis to the negative.”
And that is precisely what fund managers will do in the time to come. In fact, they have already started to do that.
They will tell us stories. One favourite story that they like to offer is that India’s economy is much better placed than a lot of other emerging markets. This is true, but then what does that really tell us? (For a real picture of the Indian economy check out this piece by Swaminathan Aiyar).
Another favourite line you will hear over and over again is that “markets are never wrong”. This phrase can justify anything.
The trick here is to say things with confidence. And that is something some of these fund managers excel at. Nevertheless it is worth remembering what Nassim Nicholas Taleb writes in The Black Swan: “Humans will believe anything you say provided you do not exhibit the smallest shadow of diffidence; like animals, they can detect the smallest crack in your confidence before you express it. The trick is to be smooth as possible in personal manners…It is not what you are telling people, it how you are saying it.”
And this is something worth thinking about.

The article originally appeared on www.equitymaster.com on Nov 25, 2014

Sensex hits record high: Now Japan takes over the easy money party from the US

japanVivek Kaul

Two days after the Federal Reserve of the United States brought to an end its money printing programme, the Bank of Japan decided to do exactly the opposite. In a surprise move the Japanese central bank on Friday (October 30, 2014) decided to increase the amount of money it has been printing to get the Japanese economy up and running again.
The Bank of Japan will now print 80 trillion yen (or around $727 billion) per year. The central bank has been printing money since April 2013 and was earlier targeting around 60-70 trillion per year. It pumped this money into the financial market by buying Japanese bonds.
In fact, the Bank of Japan entered the money printing party rather late. The money printing efforts of the Japanese central bank in the aftermath of the financial crisis were rather subdued and it had expanded its balance sheet (by printing yen and buying bonds) by only 30% up to December 2012. And then things changed.
This was after Shinzo Abe took over as the Prime Minister of the country on December 26, 2012. He promised to end Japan’s more than two decades old recession through some old-fashioned economics, which has since been termed as Abenomics.
Abenomics is nothing but money printing in the hope of creating some inflation. Abe’s plan was to get the Bank of Japan to go in for money printing and use the newly created “yen” to buy Japanese bonds.
By buying bonds, the central bank ended up pumping the printed money into the Japanese financial system. The hope was that all this extra money in the financial system would lead to lower interest rates. At lower interest rates people would borrow and spend more, and in the process the government would manage to create some inflation, as more money would chase the same amount of goods and services.
The Bank of Japan, the Japanese central bank, went with the government on this and is targeting an inflation of 2 percent. It wants to reach the goal at the earliest possible date, by printing as much money as maybe required.
And how will that help? In December 2012, Japan had an inflation rate of –0.1 percent. For 2012, on the whole, inflation was at 0 percent, which meant that prices did not rise at all. In fact, for each of the years in the period 2009–2011, prices had fallen in Japan.
When prices are flat, or are falling, or are expected to fall, consumers generally tend to postpone consumption (i.e., buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses, as their earnings either remain flat or fall. This slows down economic growth.
On the other hand, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So, by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decades old recession.
In fact, when it started to print money, the Bank of Japan had planned to inject $1.4 trillion into the Japanese financial system by April 2015. This was pretty big, given that the size of the Japanese economy is around $5 trillion. Now it will end up printing even more yen. The size of the balance sheet of the Bank of Japan has gone up rapidly since March 2013, a month before it actually started to print money.
Back then the size of the balance sheet of the Bank of Japan had stood at 164.8 trillion yen. Since then it has jumped to 276.2 trillion yen as of September 2014. This has happened because the Bank of Japan has printed money and pumped it into the financial system by buying bonds.
The question is why has the Bank of Japan decided to increase the quantum of money printing now. The answer lies in the fact that even with all the money printing it hasn’t managed to create the desired 2% inflation even though the inflation in Japan is at 3.4%. But how is that possible? As investment letter writer John Mauldin explains in a recent column “What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voilà, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1%.”
Given this, the real inflation is at 1%. The Bank of Japan wants to increase it to 2% and hence, has decided to print more money than it did before.
The irony is that Bank of Japan like other central banks in the developed-world before it have, is trying more of a policy which hasn’t worked for it. James Rickards explains this dilemma beautifully in The Death of Money: “the great dilemma for the Federal Reserve and all central banks that seek to direct their economies out of the new depression [is that] … the more these institutions intervene in markets, the less they know about real economic conditions, and the greater the need to intervene.”
This move by the Bank of Japan also means that the era of “easy money” will continue. More money will now be borrowed in yen and make its way into financial markets all over the world. In fact, the Indian stock market has already started partying with the Sensex rallying by 519.5 points or 1.9% and closing at 27,865.83 points on Friday.
And this is the irony of our times. The stock markets treat bad economic news as good news because the investors know that this will lead to central banks printing more money as they try and get economic growth going again.
As Gary Dorsch, Editor, Global Money Trends newsletter, wrote in a recent column “Bad economic news is treated as Bullish news for the stock market, because it lead to expectation of more “quantitative easing.” Quantitative easing is the term economists use for central banks printing money and pumping it into the financial system by buying bonds. This is precisely what is happening in Japan.
As Dorsch further points out “And the easy money flows that are injected by central banks go right past goods and services (ie; the real economy) and are whisked into the financial markets, where it pushes up the prices of stocks and bonds. In simple terms, what matters most to the stock markets are the easy money injections from the central banks, and to a lesser extent, the profits of the companies whose stocks they are buying and selling.”
To conclude, this is not the last that we have seen of a developed-world central bank deciding to print more money to create some inflation. There is more to come.
Stay tuned.

The article originally appeared on www.FirstBiz.com on Nov 1, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

A 400 year old economic theory explains who really runs the Indian stock market

 helicash

Vivek Kaul

On September 12, 2008, the Bank of England, had total assets worth £83.8 billion on its books. In the six years since then, the total assets of the British central bank have gone up by a whopping 385.6% to £ 404.3 billion, as on September 17, 2014.
Things haven’t been much different in the United States. The Federal Reserve of United States had assets worth $905.3 billion as on September 3, 2008. Since then it has jumped to $4.45 trillion, as on September 17,2014. An increase of close to 392%.
The total assets of the Bank of Japan have more than doubled since the start of 2011. In January 2012, the total assets of the Japanese central bank had stood at 128 trillion yen. Since then, it has more than doubled to 275.9 trillion yen at the end of August 2014.
Since the start of the financial crisis in the middle of September 2008, Western central banks have printed money big time. This money has been pumped into the financial system by buying bonds. These bonds have ended up as assets on the balance sheet of central banks.
The idea behind this, as I have often mentioned in the past, was to drive down long term interest rates, leading to people borrowing and spending more at lower interest rates. This would, in turn, lead to economic growth, the hope was.
When central banks started printing money, the Cassandras (which included yours truly as well) started to point out that the era of high inflation was on its way. The logic offered was fairly straight forward. With so much money being pumped into the financial system, it would lead to a lot of money chasing the same amount of goods and services in the economy, and that would drive prices up at a rapid rate, and lead to high inflation.
But that did not turn out to be the case. The Western world had already taken on huge loans before the financial crisis broke out and was in no mood to borrow and spend all over again.
This lack of inflation has been used by central banks to print and pump more money into the financial system. The hope now is that with all the money that has been pumped into the financial system some inflation will be created. This inflation will lead to people spending more. The logic here is that no one wants to pay a higher price for a product, and if prices are going up or likely to go up, people would rather buy the product now than wait. And this will lead to economic growth. That in short is the gist of what the policy of the Western central banks has been all about over the last few years.
The economist Milton Friedman had suggested that a recessionary situation could be fought even by printing and dropping money out of a helicopter, if the need be, to create inflation.
And this is what Western central banks have done since September 2008, in the hope of reviving economic growth. While they may not have been able to create “some” conventional inflation as they wanted to, there is a lot else that has happened. And that needs to be understood.
When central banks print money, they do so with the belief that money is neutral. So, in that sense, it does not really matter who is standing under the helicopter when the money is printed and dropped into the economy. But the Irish-French economist Richard Cantillon who lived during the early eighteenth century, showed that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, i.e., the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines.
These individuals would end up with a greater amount of gold and silver , i.e., money. They would spend this money and thus drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would have impacted even people not associated with the mining industry, even though they wouldn’t have seen a rise in their incomes, like the people associated with the mining industry had.
This is referred to as the Cantillon Effect. As analyst Dylan Grice puts it : “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printing that has happened in recent years has been unable to meet its goal of trying to create consumer-price inflation. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
As the economist William Bonner put it in a column he wrote in early 2013: “The Fed creates new money (not more wealth… just new money). This new money goes into the banking system, pretending to have the same value as the money that people worked for. And people with good connections to the banks take advantage of the cheap credit this new money creates to aid financial speculation.”
This financial speculation has led to massive stock market rallies all over the world. As I wrote in a piece last week “The Dow Jones Industrial Average, America’s premier stock market index, has rallied more than 30 percent since October 2012. This when the American economy hasn’t been in the best of shape. The FTSE 100, the premier stock market index in the United Kindgom, has given a return of 15 per cent during the same period. The Nikkei 225, the premier stock market index of Japan has rallied by 53 per cent during the same period. Closer to home, the BSE Sensex has rallied by around 43 per cent during the same period.”
Let’s take a closer look at the Indian stock market over the last two years. The foreign institutional investors have invested Rs 1,82,789.43 crore during this period (up to September 19,2014). During the same period the domestic institutional investors sold stocks worth Rs 1,07,327.65 crore.
It is clear from this that foreign money borrowed at low interest rates has been driving the Indian stock market. The domestic investors have continued to stay away.
So, even though a lot of domestic investors may talk about the India growth story being strong, they really don’t believe in it. If they did, they would invest money and not simply talk about it.
Hence, even though the economic growth through large parts of the world continues to remain subdued, the stock markets can’t seem to stop rallying. The explanation lies in the access to the “easy money” that the big institutional investors have.
And this access to easy money will continue in the days to come. The Bank of Japan, the Japanese central bank is printing around ¥5-trillion per month and is expected to do so till March 2015. The European Central Bank is also preparing to print €500-billion to €1-trillion over the next few years. All this money will be available for big institutional investors to borrow at very low interest rates.
The Federal Reserve of United States has made it clear that even though it will go slow on printing money in the days to come, it is unlikely to start pumping out all the money that it has put into the financial system any time soon.
Hence, the stock market bubbles around the world are likely to continue in the days to come. As Claudio Borio and Philip Lowe wrote in the BIS working paper titled Asset prices, financial and monetary stability: exploring the nexus  “lowering rates or providing ample liquidity when problems materialise but not raising rates as imbalances build up, can be rather insidious in the longer run. They promote a form of moral hazard that can sow the seeds of instability and of costly fluctuations in the real economy.”
The worst, as they say, is yet to come.
The article originally appeared on www.FirstBiz.com on Sep 27, 2014

(Vivek Kaul is the author of Easy Money trilogy. He tweets @kaul_vivek)