Stock market corrections are by definition deflationary events. The financial press seem to understand this. They’ve even started referring to “bubbles” once again with regard to recent shocks in US and Chinese stock markets. But they never explain what caused the rapid inflationary rise in equity prices to begin with. Somehow this is a mystery, since many economists insist that QE doesn't cause inflation.
The awful truth is that the monetary base has quadrupled since the Crash of 2008. But the simple and obvious inference that adding trillions in new bank reserves to the Fed's balance sheet might cause price bubbles is dismissed as old fashioned thinking.
Here's the question we should be asking in the wake of Monday's crash: did the “wealth” represented by rising equity prices since 2009 (among publicly traded companies in the US) reflect actual increases in productivity, capital expenditures, development of new products and markets, and earnings? Or did rising prices simply reflect the Fed’s relentless increase in base money since 2008, aided by a very unholy stock buyback spree?
A comparison of the Fed’s balance sheet with the performance of US equity markets from 2009-2015 strongly suggests the latter: equity prices have risen nearly as rapidly as the supply of base money. And this rise in equity prices is every bit as much an indication of inflation as a rise in the price of milk at the grocery.
Deflation follows inflation. Anyone asking “Where’s the inflation?” caused by QE need look no further than US equity markets. Many stocks cost three or four times what they did just 6 years ago. Price inflation-- a symptom of monetary inflation-- does not occur uniformly or simultaneously across all prices in an economy. CPI is not the whole story.
The question of whether monetary expansion is benevolent or harmful goes to the heart of whether our economy is real or phony, built on productivity or a house of cards. Enduring economic prosperity requires stable commodity money, profit and loss signals, real earnings and profits, capital accumulation, and investment. There is no shortcut or substitute.