Party like it’s 1999… On EV/Sales, the market is at 99th percentile in history

Although the repo market is little known to most people, it is a $1-trillion-a-day credit machine, in which not just banks but hedge funds and other “shadow banks” borrow to finance their trades. Under the Federal Reserve Act, the central bank’s lending window is open only to licensed depository banks; but the Fed is now pouring billions of dollars into the repo (repurchase agreements) market, in effect making risk-free loans to speculators at less than 2%.

This does not serve the real economy, in which products, services and jobs are created. However, the Fed is trapped into this speculative monetary expansion to avoid a cascade of defaults of the sort it was facing with the long-term capital management crisis in 1998 and the Lehman crisis in 2008. The repo market is a fragile house of cards waiting for a strong wind to blow it down, propped up by misguided monetary policies that have forced central banks to underwrite its highly risky ventures.

The Financial Economy Versus the Real Economy

The Fed’s dilemma was graphically illustrated in a Dec. 19 podcast by entrepreneur/investor George Gammon, who explained we actually have two economies – the “real” (productive) economy and the “financialized” economy. “Financialization” is defined at Wikipedia as “a pattern of accumulation in which profits accrue primarily through financial channels rather than through trade and commodity production.” Rather than producing things itself, financialization feeds on the profits of others who produce.

The financialized economy – including stocks, corporate bonds and real estate – is now booming. Meanwhile, the bulk of the population struggles to meet daily expenses. The world’s 500 richest people got $12 trillion richer in 2019, while 45% of Americans have no savings, and nearly 70% could not come up with $1,000 in an emergency without borrowing.

Gammon explains that central bank policies intended to boost the real economy have had the effect only of boosting the financial economy. The policies’ stated purpose is to increase spending by increasing lending by banks, which are supposed to be the vehicles for liquidity to flow from the financial to the real economy. But this transmission mechanism isn’t working, because consumers are tapped out. They can’t spend more unless their incomes go up, and the only way to increase incomes, says Gammon, is through increasing production (or with a good dose of “helicopter money,” but more on that later).

So why aren’t businesses putting money into more production? Because, says Gammon, the central banks have put a “put” on the financial market, meaning they won’t let it go down. Business owners say, “Why should I take the risk of more productivity, when I can just invest in the real estate, stock or corporate bond market and make risk-free money?” The result is less productivity and less spending in the real economy, while the “easy money” created by banks and central banks is used for short-term gain from unproductive financial investments.