What part of Austrian theory explains the contemporary economic phenomenon of price inflation in the commodities and equities markets? What is the mechanism that translates the monetary injections by the Fed into nominal prices increases in stocks and commodities?
It seems to me the answer is that the banks and their big money clientele obtain possession of the new money first, and equities and commodities is where they put a certain impactful percentage of the new money. Is this right?
Can someone please explain to me how this works, exactly? Is it mainly through new stock issuances by investment banks? Do commercial banks tend to park assets in these markets?
There are two main reasons for this phenomenon. First, as central banks facilitate monetary expansion beyond the demand for cash holdings, market interest rates are pushed below the natural rate, reducing the rate of return on savings. This is not coincidental. Keynesian monetary policy aims at reducing interest rates in order to stimulate additional consumption (as opposed to saving). As the return on savings falls, and as the general price level begins to rise, individuals begin to seek out higher rates of return in order to protect their savings. The savings shifts from the commercial banking system towards funds (Hedge funds, mutual funds, private equity funds, sovereign wealth funds). The funds, in turn, take the savings given to them and redirect them towards securities (stocks and bonds). This causes a rapid acceleration in the price of securities and perpetuates financial bubbles. In addition to this, individuals seek other forms of investment with relatively high rates of return, such as, for example, real-estate investments.
Next, and this is an explanation that you will find in most college texts: banks, when given additional liquidity (open market operations) see a spike in excess reserves, as opposes to the required reserves that are determined by legal considerations. They can do primarily two things with their excess reserves: (a) they can make loans, or (b) they can buy securities. But even when they buy securities, that money does not lie idle; it will enter the economic system and be redeposited back into the financial system only to be lent out once again (either to create loans or to invest in securities once again). Thus, theoretically speaking, if the central bank gives a commercial bank 1 dollar, than that commercial bank can buy the same security 10 times (if we assume a 10% reserve ratio). Additionally, during times of economic depression, when risks are extremely high, banks tend to allocate their funds towards securities by a greater extent. Not because it’s absolutely safe, but because it’s relatively safer (relative to making loans).
I never would have guessed this. “Banks offering loans to business” appears to me quite similar in risk to “banks purchasing the public shares of business”. If the risks are SIMILAR, maybe the difference is the costs incurred by banks when things go south for business—i.e. Maybe it’s less costly for banks to take hits to their equity and commodity investment portfolios than deal with loan defaults. If the risks are DIFFERENT, then maybe this explains the whole thing.