Perhaps one of the most interesting observations history will make in regard to the present bull market is just how much it’s governed by language and not numbers. While this may have always been true to some extent, there are few times in the history of the American stock market when this fact, by itself, so obviously outweighs fundamental and technical considerations.
So clear and present is the power that language, backstopped by no more than mere words, wields over today’s market that I’d even go so far as to describe the situation as a managed stock market.
You’ve heard of managed economies, of course. Well, let me introduce you to the idea of a managed stock market, a bright red cape waving at the charging bull, luring him on.
As the market indices approach and break all-time highs, the story that bears the most responsibility for these amazing feats is not so much the one that has to do with underlying economic strength. Or future productivity gains. Nor is it one driven by the prospect of magnificent technological breakthroughs to come.
It’s merely the one that has to do with the Federal Reserve, like Mr. Draghi’s sister institution in Europe, promising to do “whatever it takes” to ensure financial stability through unbelievably experimental monetary policy. In short, a seemingly resolute commitment to hold down interest rates until the unemployment rate comes down and the economy goes up. Come hell or high water.
But hell and high water comes in many forms. Inflation being one of them. The question that begs for admittance to the bullfight is the one about an economy that really does pick up steam. Enough say, to spur out-of-control inflation. What will Mr. Bernanke do then?
Absurdity notwithstanding, it’s perceived weakness in the economy that is underwriting the current market euphoria. Whether you’re a dove or hawk, I think we can all agree that this is the condition that really provides our over-zealous monetary policy with all the rope. But let’s put that on hold for the moment. For now, suffice it to say, we believe we have the luxury of balancing on the razor’s edge of low inflation over a vast roiling ocean of money supply.
As a market observer, I find it fascinating how the low interest rate promise pops up whenever the bull seems about to take a breather. Moreover, how effective it is. Yesterday, on April 10th, for example, as the S&P 500 snorted past all previous milestones, it was the collective belief that the Fed, despite their indications to the contrary a mere couple of weeks ago, will stick to it’s easy money mantra through the end of the year that almost single-handedly drove the market higher. The reason? Highly disappointing employment numbers last Friday. Traders and talking heads reason that since the employment reading came out after last week’s Fed meeting any talk of higher rates will be silenced–at least for now.
This means we’re in a very curious predicament: in spite of economic negativity, the surging stock market has come to rely on persistently low interest rates coming to the rescue. The idea that a story like this will trump economic signals and move the market higher is by definition perverse. In this upside-down financial reality, bad economic news turns out to be good for investing. Even more amazingly, there have been many instances over the past year or so when the market actually declined just because investors believed that higher rates might soon be riding in on the back of a strengthening economy.
It’s therefore interesting to ask what happens once the collective forces of Wall Street really start to believe that our economy is getting better. That is, when everyone believes that low interest will have to be banished. For how can a situation that’s become so dependent on low rates survive when conditions change?
The frightening answer is that it won’t. Many people will lose a lot of money. In a market of buyers and sellers (i.e., winners and losers), one side must always pay.
But there are already losers. Right now, extreme low interest rates are being purchased out of the accounts of retirees. Thanks to Mr. Bernanke and the Federal Reserve Board, it’s grandma and grandpa who are recapitalizing Wall Street. It’s also our pension funds. And everyone who pays insurance premiums. Or purchases gas or any other petro-chemical or commodity product denominated in weak dollars. Or signs a contract on a house the value of which has been summoned higher by the genie of low mortgage rates. Nowadays money may be produced by phantom printing presses, but we’re all paying whether we like it or not. Incredibly, virtually no public debate about all this has taken place in our ostensible democracy save for what may or may not occur behind the Kafka-like closed doors of the Fed. Unfortunately, none of this institution’s sages are elected.
It’s hardly necessary to state that low inflation expectations enable the band to play on. And how convenient it is for the Federal Reserve to discount certain types of inflation over others! After taking stock of all the exclusions they apply to the inflation numbers used to justify low rates, one begins to wonder how abstract and arcane the exclusion criteria must be to actually include something. But surely these are things that only a Harvard economist comprehends. The rest of us must accept it on faith that this rarefied view of reality is beneficial.
More frightening yet is that, when interest rates finally increase, our massively indebted government will need prodigious inflation in order to offset the effects that a higher debt service will entail.
More frightening still is the the question that if huge economic forces are prospering in today’s low interest rate environment, how will they react to a serious threat of significantly higher rates? The answer, I think, is that they will do everything in their power to ensure very modest and gradual changes. That doesn’t mean they’ll succeed, but it does point to the types of policies the mainstream power base will trumpet.
This is the other side of the low interest rate promise: if and when the economy improves enough to warrant weaning off of low rates, the Fed will be in a position to ensure that rates increase in a way that assures financial stability. But will they actually possess this power? Or will the power that they think they wield today vanish tomorrow?
The most frightening thing of all is that, while it’s easy to make grand promises, there’s no one on earth who can predict the kind of variables the global economy will face a year or two down the road when the necessity of finally raising rates may rear its monstrous head. How will China react to Japan’s own radical attempts to debase its currency (both countries, by the way, hold enormous quantities of U.S. government debt)? Combined with the looming specter of a weak dollar and a weakening euro, this may pressure the rising dragon to do things it might not otherwise have done. Already, intelligent prognosticators might wonder whether China may be using the crazies in North Korea as a proxy to intimidate the region and further assert itself. In other words, North Korea cast as China’s very own mad dog of the Far East. Do we think that we’re the only ones capable of using proxies? Or that the Monroe Doctrine can only be made in America?
More to the point, how do rising tensions among the great and growing powers of the East factor into our faith in our ability to manage low interest rates and the stock market? How much can we rely on economists to predict political outcomes?
When the world’s largest central banks collude in managing global financial markets through monetary experimentation, the magnitude of which the world has never witnessed, how can we possibly put any real faith into the kinds of promises that are currently being made? Let alone our future financial security? Yet that is just what these bastions of finance would have us do. You would think they’d at least have the decency to tell us that it’s precisely our future financial security that may be the price exacted for such a fanatical faith.
If something’s too good to be true, my grandma used to say, then it’s probably just a pile of bullshit.Tags: Ben Bernanke, bull market, China, doves, Far East, Federal Reserve, hawks, interest rates, investors, Japan, mad dog of the far east, managed stock market, Mario Draghi, Monroe Doctrine, North Korea, rising dragon, S&P 500 index, U.S. debt, Wall Street