Wednesday, September 9, 2009
Another update in an important series of posts. The dollar has hit a new low for the current calendar year, and equities are making a new high. Coincidence? Craziness? No. The only plausible explanation for this is that the two phenomena are directly related. They both reflect an increase in confidence and a decline in the demand for safe assets.
The economic crash that happened last year was primarily driven by a widespread fear that the banking system was collapsing. No one was willing to trust anyone. People were desperate to increase their holdings of safe assets, and high on that list was dollar currency. The demand for money soared. Since then, the Fed has been going to remarkable lengths to increase the supply of money. If they hadn't, then we would have faced the real risk of deflation.
The story this chart tells is that we are now well into the process of recovery from last year's crash. People no longer want to stockpile dollar currency; the demand for dollars is returning to where it was before the crash. As the stockpiled dollars get spent, they are boosting the economy, helping it to recover to where it was before the crash. The stock market is the beneficiary not only of an increase in the velocity of money, but also an increased willingness to move from the safety of cash to risky investments once again.
As I've said before, a restoration of confidence is an essential ingredient to a recovery from this unique recession. Plus, it kickstarts a positive reinforcement cycle, since confidence sparks spending, and spending brings forth new confidence. We still have a ways to go to get back to where we were before everything collapsed last summer.
Posted by Scott Grannis at 9:04 AM