Just when you think central bankers are as clueless as our Treasurer, they go and surprise you. The release of minutes from the latest US Federal Reserve Advisory Panel meeting was a bit of a revelation.
The Federal Reserve’s ‘mad scientists’ appear to realize they have created a financial monster. Call it Bernankenstein’s Monster if you like. Take this extract (bold emphasis is mine):
‘There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices.’
Concern about an ‘unsustainable bubble‘? Given the Federal Reserve’s previous track record of creating bubbles (housing rings a bell), all they can muster is ‘concern’. What about fear and alarm?
Here’s another bit of genius from the minutes:
‘Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Federal Reserve’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system.’
‘Reestablish normal valuations?’ Is this Fed code for the fact we now have abnormal valuations? The minutes insinuate the ‘mad scientists’ know they have stuffed it up.
And as for the idea that the withdrawal of stimulus ‘may be‘ painful, please spare us the ‘may be’. The market is a highly dependent ‘junkie’. When the Federal Reserve turns off the ‘juice’ (voluntarily or involuntarily), a world of hurt waits.
Haruhiko Kuroda (Bank of Japan Governor) can’t afford to be as contemplative as the Fed. He is a modern day kamikaze – if he thinks of the inevitable outcome, he would never have signed up in the first place. Kuroda is zeroing in on the battleship called ‘deflation’.
A lot of others have moved into Kuroda’s slipstream and had a free ride on the devaluing yen and rising Nikkei. But poor old Kuroda has run into severe turbulence. This is tossing the markets around like a single seater in a cyclone.
Uncertainty and volatility are the hallmarks of Japan’s experiment in printing their way to inflation. The Nikkei’s wild swings (of up to 500 points in a day) illustrate investor nervousness.
According to Wikipedia ‘about 14% of kamikaze attacks managed to hit a ship‘. I think Kuroda’s odds of achieving his mission are even lower.
Central banks believe (publicly at least) asset bubbles can rescue the global economy. History doesn’t just tell us, it shouts at us; asset bubbles don’t fix anything.
The pain of the bust far outweighs the euphoria of the bubble. Time and again this is the lesson central bankers never learn.
Andy Xie, from Caixin Online summed it up:
‘Japan and the United States are using asset bubbles to revive their economies. They are struggling to manage the speed of bubble expansion or contraction. This dancing on a pinhead brings big uncertainty to the global economy. When they fail, a global recession may follow.’
Central bankers tell you they are busy conducting an ‘experiment’. But the economy isn’t a scientific research project. They can’t control it. The global economy is a complex and unpredictable ecosystem. Its evolution is a function of the decisions the seven billion people who inhabit the earth make every day.
A handful of bureaucrats and academics with computer models can’t control this ecosystem, any more than marine scientists can control the ocean.
Acknowledging this fact is a step towards understanding the gravity of the situation. Otherwise, these crackpot scientists will blow the lab sky high.
We only have to look back a dozen years to see how their previous experiments (of lesser intensity) have failed.
US fund manager John Hussmann made this observation in his latest report:
‘… the last two 50% market declines – both the 2001-2002 plunge and the 2008-2009 plunge – occurred in environments of aggressive, persistent Federal Reserve easing.’
The significant share market losses suffered during the ‘tech wreck’ and ‘GFC’ occurred when the Fed was aggressively intervening (meddling) in the economy. The Fed’s tampering only makes a bad situation worse.
If we look further back in time, Hussmann discovered:
‘…the maximum drawdown (loss) of the S&P 500, confined to periods of favorable (meddling) monetary conditions since 1940, would have been a 55% loss. This compares with a 33% loss during unfavorable (non-meddling) monetary conditions.‘
According to Hussman the market collapses ‘were preceded by overvalued, overbought, overbullish euphoria‘. This is what asset bubbles do. The animal spirits run strong – the need for greed drives values well above rational levels.
Anyone with a passing interest in the financial world knows the current level of meddling is without precedent. So if all the previous periods of ‘Fed intervention’ resulted in 50+% losses, what pain is in store for this market?
The following charts show the current level of disconnect between the market and the economy.
The first chart tracks US economic activity. In 2008/09 (the grey shaded area represents a recession) all measures of economic activity fell into a crater.
The important take from this graph is 2010 onwards. After the economy ‘recovered’ from its initial GFC shock, it has steadily declined. This is in spite of the US Fed spending trillions (over the past four years) ‘stimulating’ the economy. The Great Credit Contraction is proving far more powerful than the printing press.
This next chart compares the performance of the S&P 500 index with the level of margin debt (borrowing to invest) in the US. Talk about a mirror reflection.
While the economy (Main Street) is tanking, Wall Street is gearing up and milking the experiment for all it’s worth.
The next wave down in this Secular Bearmarket will be gut wrenching. It’ll make the previous two corrections look like gentle slippery slides.
Interest rates are destined to go lower, but being in a cash bunker is still the best place to observe the inevitable detonation of this experiment.
Vern Gowdie
Contributing Editor, Money Morning
From the Archives…
Keep One Eye on Resource Stocks and the Other on the NASDAQ
31-05-2013 – Kris Sayce
Getting in on the ’99 Cent Craze’ with Crowdfunding
30-05-2013 – Sam Volkering
Buyer Beware: Japanese Government Bonds are Moving
29-05-2013 – Murray Dawes
The Best Contrarian Play on Gold I’ve Ever Seen…
28-05-2013 – Dr Alex Cowie
A Revolution in the Share Market is Coming…
27-05-2013 – Kris Sayce
