Last week’s column on margin debt and the US stock market confirmed that leverage plays a key role in driving movements in share markets – and vice versa. But it left one technical question unanswered for me: is the causal link between change in debt and change in asset prices, or between acceleration in debt and change in asset prices?
My logical argument was the latter. In my monetary approach to macroeconomics, aggregate demand is income (effectively gross domestic product) plus the change in debt, and this money is expended on both goods and services (also effectively GDP) plus net asset sales. Net asset sales in turn reflect the price level of assets, the quantity in existence, and the fraction of that stock that is sold over a year.
