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Will We See an Asset Bubble or Dollar Devaluation?

With trillions of dollars ready to be injected into the U.S. economy, we could once again see a massive asset bubble, as well as a fundamental re-evaluation of risk/reward ratios for all investments. The historical average of the Price to earnings ratio (P/E ratio) for S&P 500 companies is about 16, meaning investors accept making investments back in 16 years in static market conditions. 

Since it’s clear now that the Fed will bail companies out, corporations are more incentivized to take on as much debt as possible in hopes of inflating their stock prices. In good times, executives enjoy bonuses. In bad times, bailouts. Over the next decade, we might see growth in the stock market. 

If debt-holders worldwide lose faith in the dollar, however, and begin dumping Treasuries, enduring hyperinflation might be in our future. In recent weeks, the dollar has strengthened. Central banks all over the world are printing money, potentially contributing to confidence in the dollar, which might be seen as the best house in a bad neighborhood.

At a certain point, debt-holders might change their feeling on Fed’s printing operations. That would precipitate the need for more money printing, devaluing the dollar. Currently, the Bank of Japan balance sheet is more than 100% of GDP, while the Fed balance sheet is 30% of GDP. 

If the Federal Reserve expands its balance sheets via stock purchases could allow the Fed to abate the global dollar short squeeze, while avoiding a stock price reset. 

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