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Why All That Cash Floating Around Won't Boost The Stock Market

In June, CNBC.com discussed the implications of all of the money that fled into cash as a result of the pandemic-induced sell-off of stocks. They pointed out that some strategists believed that this flight to cash could soon rotate back into stocks, thereby causing the market to rise. This belief in the power of "cash on the sidelines" has an intuitive appeal. And why would you argue with "strategists?" But, their reasoning turns out to be false.

 Cash does not lie ready to ignite the market to new highs because there is no such thing as "cash on the sidelines." As recently explained on the website Pragmatic Capitalism:

"When you decide to buys stocks you are also deciding to sell your cash. In a brokerage account this actually means that your short duration instrument (called cash) is being sold and exchanged for the stock. So, you are buying stock, but someone else is buying your cash. This results in a clean swap of financial assets. There isn't more or less cash on the sidelines after this transaction. There is the exact same amount of cash on the sidelines before and after this transaction."

Another way of looking at it is that every time a stock is bought it is, concurrently, being sold. One side of the transaction is investing and the other is cashing out. The amount of cash in the system remains the same.

So what's driving the rise in the stock market? Among other reasons, extremely low interest rates earned on cash act as an incentive for investors to take on additional risk (buying stocks) in an attempt to achieve higher returns.

Beyond the implications for the stock market, the potential impact caused by an increase in the money supply (via the Federal Reserve) may not be purely benign. The goal has been to prop up the economy to avoid a recession. But, we should keep an eye on the potential for inflation, especially as the post-pandemic economy opens up and all that money gets put to work.

Thus concludes our economics lesson for today. Let me know if you wish to take a deeper dive into any of these topics.

Words of Wisdom

Out of college/money spent
See no future/pay no rent
All the money's gone, nowhere to go
-- The Beatles (You Never Give Me Your Money)