The senior central banks choose not to do more damage
immediately
As expected, the Fed took no action last week. At the
moment it is offering only words. For example, the statement issued last
Wednesday after the FOMC Meeting included the words "The Committee will
closely monitor incoming information on economic and financial developments
and will provide additional accommodation as needed". This is just a
statement of the obvious, because "the committee" is always closely
monitoring incoming economic information and will always provide additional
accommodation as needed. After all, there is no limit to the amount of
so-called accommodation that can be provided by the Fed.
In this case, "accommodation" is such a poor
choice of word it is almost Orwellian. When the Fed plays around with
interest rates and the money supply in its efforts to "accommodate"
the economy, it damages the economy. The more it tries to accommodate, the
more inaccurate the interest rate and other price signals become. This leads
to a greater number of wrongheaded decisions being made by businessmen and
investors. If the accommodation happens during normal times it will lead to
an obvious "price inflation" problem within a few years, but if it
happens during a major de-leveraging (a period when the private sector is
attempting to clean-up its collective balance sheet) it will get in the way
of the corrective process and delay the start of a sustainable recovery.
The day after the US central bank promised to do more
if necessary but nothing immediately, the euro-zone (EZ) central bank did the
same. The ECB's decision not to immediately boost its
"accommodation" was more surprising than the Fed's, because a week
earlier Mario Draghi had excited the markets by
saying that the ECB was ready to do whatever it takes to reduce the borrowing
costs of financially-stressed EZ governments and support the euro. At this
stage, doing whatever it takes apparently means taking no immediate action.
Things are more complicated for the ECB than for the
Fed. The Fed can essentially do whatever it likes as long as what it likes
isn't in conflict with the short-term goals of the US federal government, but
the ECB can't support the bonds of one EZ government without blatantly
imposing additional costs on the taxpayers of other EZ governments. It
therefore often finds itself torn between the conflicting goals/desires of
different governments.
Right now the best indicator of financial stress within
the EZ is the yield on the 10-year Spanish Government Bond (see chart below).
When no immediate action was announced at the conclusion of last Thursday's
ECB meeting, the yield on the 10-year Spanish government bond moved above 7%.
This prompted declines in the euro and most stock markets. For some unknown
(to us) reason, however, the yield on this bond dropped back below 7% on
Friday, prompting strong up-moves in the euro and most stock market indices.
Perhaps the ECB took some action after all.
The stock market and the central bank
The slowing growth or accelerating contraction in
Europe, the US, China and many other parts of the world is due to real
problems. It isn't due to depressed confidence and therefore it can't be
permanently reversed by boosting confidence. In fact, boosting confidence to
the point where the problems are ignored could only lead to imprudent
decisions, thus destroying more wealth and further weakening the economy. In
other words, the problems that are weighing on economic growth wouldn't
magically disappear if everyone were injected with 'happy juice' or visited
by the 'confidence fairy'.
In addition, the problems couldn't possibly disappear
as a consequence of central bank money creation. Money is just the general
medium of exchange, so manipulating the supply of money can only act to
distort the price signals upon which the economy relies. Causing distortions
to price signals prompts bad decisions and the destruction of real wealth. In
fact, rather than being a potential solution, monetary inflation is the most
important CAUSE of the current problems.
That's economic reality. Economic reality dictates what
SHOULD happen on the policy-making front, but due to a combination of
ignorance and Machiavellian politics there's often a big difference between
what should happen and what will happen. The sad truth is that there WILL be
a lot more monetary inflation in the future. The only question is: when? The
best answer that we can come up with is: within the next two months for
ECB-sponsored inflation and after the stock market tanks or the
backward-looking economic data gets much weaker for Fed-sponsored inflation.
In the mean time, expectations
regarding central bank machinations are by far the most important drivers of
stock market performance. The performances of individual shares can still be
affected by company-specific developments, but the overall market is rising
and falling in reaction to changes in expectations regarding what the central
banks will do and when they will do it. To put it another way, the stock
market no longer serves as a vehicle for the efficient allocation of capital
to businesses. It is now almost solely an instrument for speculating on the
decisions of a small group of official price manipulators. That's one reason
why the bull market in gold is not remotely close to being over.
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