Abstract

This paper proposes a solution to an important financial market puzzle. Why have U.S. corporate profits and equity valuations reached historic highs despite a concurrent secular decline in net domestic investment? We argue that financialization of the economy created and sustains this divergence. First, fiscal deficits flow into profits by stimulating consumption. Second, distributions from those profits are recycled back into financial assets rather than into productive investment, thereby inflating valuation multiples. We conclude that financialization has likely produced a fragile market valuation that is fundamentally dependent on deficit spending and vulnerable to a severe correction when that fiscal support is inevitably withdrawn.