Worse Off

We’ve been meaning to write about what hasn’t happened yet. Not that we claim any knowledge of tomorrow or the day after. But we can look at the present. And here’s a guess about where it might lead.

The middle classes – aka “the voters” – expressed themselves last week. They have been sorely used and they know it. The biggest money-fabricating program of all time – the Fed’s QE – has done nothing for them. Instead, it has made their lot worse.

Investment in new business output has gone down. Their meager savings produce no revenue. And “bread-winning jobs” are scarce.

For all the talk of an “improving labor market,” there is no sign of it in wages. The typical household has $5,000 less income than it had when the 21st century began.

 

1112-DRE-blog

The Bank of Japan

(Photo via Wikimedia Commons / Author: Fg2)

 

Cold, Dark and Desperate

Meanwhile, Europe and Japan grow cold, dark and desperate. Last week, ECB chief Mario Draghi announced the central bank would buy another €1 trillion of bonds to try to light a fire under the euro-zone economy.

And Bank of Japan governor Haruhiko Kuroda got out his matches the week before, claiming potentially unlimited tinder. Can the US resist the worldwide slump?

Our view is it’s just a matter of time before either the US economy or US stock market begins to wobble. We could see the Dow fall 1,000 points or more… or we could hear GDP growth has gone negative… or both. Then what?

It’s a good bet that the Yellen Fed would intervene again – hoping to keep a small problem from becoming a bigger one. Ever since the 1930s, central bankers have learned that they will scarcely ever be criticized for overreacting. But if they sit on their hands, they will be damned to hell.

And ever since Alan Greenspan’s 1987 “put,” the Fed has backed up the stock market with whatever policy it deemed appropriate. Lower rates? QE? It’ll do “whatever it takes.” Janet Yellen is aware that the two previous Fed chairmen were hailed for having saved the economy from destruction. She won’t want to be the first to let it fail.

While we are guessing, we’ll suppose each rescue effort will be more costly and less effective than the one that preceded it. That’s the way “stimulus” works. Like looking at naughty pictures, the first are exciting and titillating. Later, they are just boring and sordid. Still, a vigorous new response from the Fed would probably produce another rise in financial asset prices. But then what?

 

1105_yellen_970-630x420One thing we like about Ms. Yellen is that she often seems to be in a sunny mood. We still disagree with her economic views though.

(Photo credit: Ian Waldie/Bloomberg)

 

Coaxing Stocks Higher

Central bank activism – stimulating credit creation with artificially low interest rates – only works when people see little risk of default or rising rates. But that risk cannot be ignored forever.

It’s called a “credit cycle” for a reason. Rising rates come around sooner or later – often ferociously – after a long period of apparent stability, over-optimism, overpriced equities and artificially suppressed yields. When that happens, the central banks lose their ability to coax stocks higher with lower rates.

The Fed has been interfering with the credit cycle for the last 20 years. But when it believes it can overturn the cycle for good… that is when it becomes a big loser.

At that point, and it could be months – or years – ahead, we are likely to see central banks become more creative.

What else can they do?

They will still be fully committed to “saving” the economy. When their policy tools fail, they will have to come up with something different. What? We see three things:

 

1) Central banks will buy stocks. Japan, as usual, is ahead of the curve.

2) Governments will bring out large fiscal stimulus packages aimed at infrastructure “investments” that are supposed to pay for themselves.

3) Some form of Direct Monetary Funding from central banks will finance these stimulus packages. Central banks will simply “print” the needed funds.

 

All of these measures are either already in service or much discussed in the leading financial journals. What will they mean to stocks? Bonds? The dollar? Stay tuned…

 

dude with matchesThe dude with the matches. He’s buying stocks already for a while now and recently upped the allocation. This may actually finally produce more rapid yen money supply growth, assuming the sellers are mainly non-banks. The belief that all of these activism will have no negative consequences is going to be challenged eventually. Tic-toc.

(Photo by Takashi Nakamichi / WSJ)

 

 

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

 

 

 

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