Thursday, October 23, 2014

A Debate with Myself

Have the long-term, equilibrium valuation multiples of the stock market increased?

THESIS: in a fiat money world, inflation insurance is worth paying a premium for. This raises valuation multiples like the price/earnings ratio and q (price / replacement value). Deflation, which would hurt equities, is no longer much of a risk, now that it is so easy to create money.

ANTITHESIS: An arbitrage exists. If companies trade for more than it would cost to create them, which appears to be the case now, business people will start them, sell shares in public offerings, and pocket the difference. This is more apparent with the q ratio than price/earnings. And there is no limit to number of companies that can be created and sold off. Prices will get competed back down to replacement value (or in other words, the q ratio will tend back toward a value of 1.0).

SYNTHESIS: Fiat money creates the venture capital industry! or at least supports it.