Hero or Villain?
Another week dominated by Federal Reserve Chairman Bernanke’s remarks has passed in the financial markets. Any market participants worried about economic conditions were reminded that there will be “liquidity” provided to the markets as long as necessary. http://finance.yahoo.com/news/fed-affirms-easy-money-tilt-234900025.html
As a result, practically all assets went up in price against the currency($) they are valued in. After all, the prospect of endless future supply of money lowers the desirability of holding it. As for stocks, Dr. Bernanke has created the Goldilocks scenario as he promises to inject “liquidity” into the market should economic indicators decline. In the case of decent earnings stocks should rally with or without the Fed’s support. Therefore, stocks have nowhere to go but up. That is the theory currently prevalent in the market and it will continue until something breaks. For now, there are no troubles in sight but when they are apparent, I hope I will be able to identify and forewarn.
Interestingly, the stock market chart for 1987 and 2013 look eerily similar.
Now, I do not predict a crash as in 1987 but I do think that with every uptick, the probability of a crash increases as the divergence between economic reality and asset valuation is large and growing.
As for the global economic indicator of choice, I want to point out the price trend in (Dr.) copper.
Market lingo for the base metal that is reputed to have a Ph.D. in economics because of its ability to predict turning points in the global economy. Because of copper’s widespread applications in most sectors of the economy – from homes and factories, to electronics and power generation and transmission – demand for copper is often viewed as a reliable leading indicator of economic health. This demand is reflected in the market price of copper. Generally, rising copper prices suggest strong copper demand and hence a growing global economy, while declining copper prices may indicate sluggish demand and an imminent economic slowdown. http://www.investopedia.com/terms/d/doctor-copper.asp
As you can see, copper prices are currently not constructive in pointing to a rebound in global economic activity. Central banks can add infinite liquidity to address structural problems yet the likely outcome of such policy is stagflation as the economy does not improve while the currency loses purchasing power due to dilution.
The Fed and other central banks
As most of you know, I am very critical of the Fed’s monumental QE programs. Furthermore, I do not believe that any central bank should be in the business of creating money to buy Treasuries and mortgages. One negative effect of such policy is the distortion of price discovery in financial markets. The whole point of capital markets is to determine efficient capital allocation that should lead to productive investment and growth. Currently, this function has been taken away from the markets as central bank policy distorts all markets simultaneously. Having no short term interest rates while suppressing long term rates and providing funding to some instruments rather than others is a very problematic road to be on. I think this will end in tears as we are swapping short term gain for long term pain. I hope I am wrong but in my experience everything goes in cycles. Night follows day, spring follows winter, age follows youth… The longer the central banks push all markets one way the bigger the counter reaction in the future.
Just for the record, I am NOT in the camp that proposes getting rid of central banks. The Fed has an incredibly important role in arresting financial crisis and restoring monetary health in a scenario where panic breaks out. Akin to the fire department in emergencies, the Fed should be there as lender of last resort and use all current policies when necessary. Considering the last crisis was five years ago I doubt that the same policies are still necessary today. Perhaps, we should listen more to former Fed Chairman Volcker who successfully steered the US central bank from the inflation ridden 1970’s into the booming 1980’s. Trying to solve an issue of solvency with liquidity has not- and will not work.
Finally, I highly encourage you to listen to this interview on Bloomberg Radio. It involves, Jim Rickards, author of best selling book “Currency Wars”.
Mr. Rickards is a rather strong critic of current central bank policy himself and his views practically mirror mine. What makes this interview interesting is the fact that the interviewer takes the opposite point of view and does so very eloquently and intelligently. Enjoy and be patient. It takes a few seconds to upload the interview.