From The Wall Street Journal, The Fed Has Hurt Business Investment by Michael Spence and Kevin Warsh;
During the past five years earnings of the S&P 500 have grown about 6.9% annually. As the table nearby shows the current profit picture pales in comparison to prior economic expansions, in which earnings grew significantly faster. Moreover, only about half of the profit improvement in the current period is from business operations; the balance of earnings-per-share gains arose from record levels of share buybacks. So the quality of earnings is as deficient as its quantity. The current economic expansion is also unusual because the stock market and other financial assets have boomed in spite of relatively muted profit gains.
We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose “shareholder friendly” share buybacks over investment in a new factory. But public policy shouldn’t bias investments to paper assets over investments in the real economy.
How has monetary policy created such a divergence between real and financial assets?
First, corporate decision-makers can’t be certain about the consequences of QE’s unwinding on the real economy. The resulting risk-aversion translates into a corporate preference for shorter-term commitments—that is, for financial assets.
Second, financial assets are considerably more liquid than real assets. Trade among financial assets like stocks is far easier than buying and selling real assets like capital equipment. The financial crisis taught an important lesson to investors of all sorts: Illiquidity can be fatal. Financial assets have large liquidity benefits over real assets. In other words, it’s far easier to turn stocks into cash than to liquidate a new factory.
Third, QE reduces volatility in the financial markets, not the real economy. By purchasing long-term securities, the Fed removes significant market volatility from stocks and bonds. Any resulting reduction in macroeconomic volatility—affecting real asset prices—is far more speculative. In fact, much like 2007, actual macroeconomic risk may be highest when market measures of volatility are lowest. Central banks have been quite successful in stoking risk-taking by investors in financial markets, but have found far less success in encouraging risk-taking in the real economy.
This brief excellent article does more to explain why the financial markets are booming and the economy and middle class wages are still stagnant. Cheap, plentiful money combined with high friction costs (fiscal policy) has caused the allocation of the capital that was supposed to stimulate the economy to go instead into stock buybacks. QE has made the rich richer and exacerbated inequality.