Dividend Discount Values & Market Prices

By Tony Hayes CFA
Thursday, August 14, 2014 5:51 PM EDT

How to make a small fortune?

Wait for economic conditions to be perfect and invest a large fortune!

Since March 2009 the U.S. economy has struggled to be anemic as economists, pundits and the media have worried themselves silly about every groan, blip and burp emanating from the entrails of every government economic pronouncement. Meanwhile the DJII has risen 150% paying absolutely no heed whatsoever to the economic woes of the world. 

The End of Quantitative Easing

The Fed is in the process of ending quantitative easing leaving the monetary base at $4 trillion at the end July. Of this $2.63 trillion are excess reserves held at the Fed by commercial banks and other institutions. The difference, $1.37 trillion, is the amount of the monetary base that is actually working in the economy at large.

For the full impact of Fed’s quantitative easing to felt, the excess reserves have to be put to work.  Douglas Flint, the chairman of HSBC Holdings, says excessive regulation is making bankers too risk-averse for their own, and their clients', good. As the commercial banks are either unwilling or unable to lend at a rate close to matching the creation of new money by the Fed, it is hard to see that the end of QE in October will have any impact whatsoever on long term interest rates.

In effect the Fed has filled up the header tank with money to an unprecedented level. However, it is taking much longer for the money to flow through into the economic bathtub because either the commercial banks have not opened the spigot, or the plumbing is unable to handle the deluge stored above.

The chart below shows the monthly average London p.m. gold fix and the Actual Working Monetary Base AWMB. Following Lehman the consensus was for the gold price to rise in line with the total monetary base.

However, the build-up of excess reserves at the Fed slowed down the economic recovery, inflation, rising interest rates and the emergence of a much lower AWMD to which the gold price gravitated after 2011.

Point to point, since 2008 the price of gold has moved 57% while the AWMD has risen 63%. Had the total monetary base flowed through to the economy, then the chances are high that the gold price would be at $4,000 per oz.

Data Sources: US Federal Reserve, Dow Jones and the London Bullion Market

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Tony Hayes CFA

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Moon Kil Woong • 9 years ago • Contributor's comment
I think tracking gold to see the effect of oversupply in the monetary base is not a good measure, primarily because it is so easily manipulated by the same agents responsible for monetary expansion. In general, its better to look at the whole inflation picture including volatile aspects the governments like to discount. Even then, an argument these reports are still undervaluing inflation is certainly credible and worth consideration. The simple fact is those connected to the central bank and government sweet have gotten much richer while the average American has gotten poorer. This is not a coincidence, it is a direct result of socialism and crony capitalism destroying the free market and despoiling America's growth engine.
Tony Hayes CFA • 9 years ago • Contributor's comment
According to the late Milton Friedman - "Inflation is always and everywhere a monetary phenomenon." This time around it is just taking a great deal longer for the expansion of the monetary base to make its way into the economy at large and to show up in the what is generally thought of as inflation WPI, PPI, CPI etc. It is coming but it may take a good few years for the AWMB to grow to match the reported monetary base.
Moon Kil Woong • 9 years ago • Contributor's comment
Thanks for your reply. Indeed, I agree this is predominantly the case with fiat money. Prior to it, there have been marked times when there was a lack of inflationary pressure or deflation ruled the roost. Indeed monetary expansion inevitably pushes the cart forwards and the lack of adequate goods and services to meet it generates inflation. How many people fall off it as it tilts depends on the excess of the people pushing the cart too hard.