How Liquidity Flows From Asset Markets Into The Real Economy - Part 14 of 17

Going back to houses, the same principle applies, A and B could stick a £200,000 price label on their houses, as they exchange, but builder C comes along who can build the same house for £100,000. Seeing that they can, however, sell such a house to A and B for £200,000 that is the price they put on it, and so make £100,000 surplus profit. The landowner, however, now charges a rent/price for this land, equal to this £100,000 surplus profit, so that, unlike with the production of cars, where surplus profits induces capital in from other firms in search of it, there is no incentive for other builders to also enter production to drive the price down, and remove the surplus profit.

If the price of existing houses falls, then the price that builders can obtain for new houses will also fall, meaning that their surplus profits would fall, and so rent/the price of development land would also fall. But, instead of this liquidity simply remaining trapped in a paper chase of never ending circulation from one asset to another (as with A and B above), one asset class to another (as with sellers of bonds buying land or equities and vice versa), the fall in asset prises, here land prices, surges out in liquidity to the real economy, as the money previously required to buy the land becomes available to buy the elements of productive capital to, actually, build additional houses, rather than merely inflate the prices of existing ones. Moreover, the production of these additional houses, and lower house prices, meaning that buyers also have revenue released, which also surges out into the real economy, because, contrary to the negative wealth effect, and trickle down theory, homebuyers and renters, now enjoying lower rents and prices to buy, now have much increased disposable income/discretionary income to spend on other commodities, giving a spur to the rest of the real economy.

The inflated price of houses is a result of excess liquidity injected into the economy over a long period of time, and particularly since the 1980's, but with that process intensified after 2008, and with the liquidity directed into the purchase of assets, and away from the real economy. If the excess liquidity is removed, via QT, and by a limitation of the quantity of new notes and coins thrown into circulation, then the value of money tokens (the amount of social labour-time each represents) will rise, so that the general level of prices is reduced.

But, in conditions, such as we have now, where economies are growing, under the dynamic of the long wave uptrend, employment is expanding, and labour supplies are dwindling, resulting in higher wages, firms will be led to continue accumulating capital, to meet this rising demand, or face losing market share to competitors. To do so, they will need to use a greater proportion of realised profit to accumulate capital, so that the demand for capital rises relative to its supply, causing interest rates to rise. In a reversal of the conditions of the last 40 years, that means that asset prices fall more precipitously, and as that means that capital and revenue is released, instead of being tied up in the purchase of those inflated assets, the corresponding liquidity provides additional demand for real goods and services.

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