Forget everything you’ve ever learned about the economy and the supposed link with financial markets.
Just three months into what the Bank of England describes as the deepest and sharpest downturn in centuries and stock markets are on a tear, galloping back towards record levels at breakneck speed.
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Investors, many of them new converts to the cargo cult, are overlooking the hit to corporate earnings that has yet to play out, the potential housing market slump and spending blow from a lengthy period of elevated unemployment or the many geo-political risks building, particularly between China and the West.
Instead, they are pricing in a swift and almost perfect recovery based upon the presumption that maybe, just maybe, there’ll be a vaccine that will suddenly rid the world of the pandemic that has created so much pain and hardship in such a brief space of time.
Or maybe, the whole thing is just an illusion.
For when it comes to finance, free markets have become captive to central banks, which now are pouring trillions of dollars into the global economy each month to fabricate a recovery.
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It’s cash that’s being created out of thin air.
And a huge portion of it is being poured straight into stock markets regardless of what is happening out there in the real world.
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On Thursday night, Jerome Powell, the head of America’s central bank, made no bones about where he saw the American economy heading.
The dire picture he painted, a future where millions of Americans would never get their jobs back, included predictions that unemployment would be sitting at around 9.3 per cent at the end of this year and 6.5 per cent by the end of next year.
The economy would take years to recover, he told them.
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For anyone who has been following global events, it wasn’t exactly a revelation. But it sent shivers through the investment world.
His message served as a reality check from the past two months of frenzied share trading that has seen American tech stocks regain their record levels and pushed global stocks into the strongest bull run in history.
Wall Street, having erased all its losses for the year, plunged almost 7 per cent.
On Thursday night, Wall Street plunged almost 7 per cent. By Friday night, it was back to business.(REUTERS/Andrew Kelly/File Photo)
But the pessimism was short-lived. By Friday night, it was back to business as punters regained much of the previous night’s lost ground.
So intense was the economic downturn, which has seen US unemployment go from its best in 50 years to its worst in 90 years in the space of two months, Mr Powell warned that the Fed wasn’t thinking about raising rates.
“We’re not even thinking about thinking about raising rates,” he added for good measure.
And then he included the magic words. “What we’re thinking about is providing support for this economy. It could take some time.”
That was the not-so-subtle message that the money was going to keep on flowing at record pace.
The graph above tells the story. In the past few months, America’s central bank has bought more than $US3 trillion ($4.37 trillion) worth of “assets”.
These include US government debt, mortgage debt and other debt securities, using cash it has generated out of thin air, simultaneously driving interest rates down and flooding the economy with cash.
It has spent more than double the amount outlaid at the height of the global financial crisis. And, it appears, we’ve only just begun.
Who controls whom?
Once upon a time, the Fed used to see itself as the great moderator. Its role, according to one-time boss William Chesney Martin Jr back in the 1950s, was to provide enough punch to get the party going and then remove it just when things were warming up.
These days, central banks around the world have found themselves trapped by their own creation.
Having gone too far warming up the party, no-one really wants the pain associated with the extended hangover.
Money printing is all central banks have left.(AAP: Darren England)
So it’s been a policy of hair of the dog for at least the past 20 years.
That’s because when stock markets turn south, people lose money and stop spending.
When they collapse, as they did in March, they now have the power to take the economy with them.
For most of the past half-century, central banks have been content to rely upon interest rates to speed up or slow down economic momentum.
But with rates now at zero, money printing — or quantitative easing as it is called in polite circles — is all they have left.
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Unless of course they head into negative interest rate territory, where few are reluctant to venture.
We’ve arrived fairly late at the party. But a few months back, our very own Reserve Bank was forced to do the same.
It waded into the financial markets and bought about $50 billion worth of Australian government debt in a bid to massage interest rates lower.
Again, it was because Australian interest rates now sit at just 0.25 per cent, as low as the RBA is prepared to go.
But it is a paltry amount compared to the trillions outlaid by the US, the UK, Europe and Japan.
Save the rich
Quantitative easing is supposed to lower borrowing costs, thereby boosting profits and investment, and encourage firms to start hiring workers. That’s the theory, anyway.
In reality, it has done little of any of the above.
Instead, it’s encouraged firms to borrow but then hand the cash straight back to investors, which has encouraged ordinary savers to abandon relatively safe interest-bearing accounts and invest in stocks that yield a better return but which are far riskier.
It’s also encouraged speculation in housing, in a boom that commenced with financial market deregulation in the early 1980s and which barely encountered a hiccup through the global financial crisis, as this Reserve Bank of Australia graph shows.
What this huge injection of cash has done is prevent what central banks fear most; the contagion that could spread from what’s known as the negative wealth effect.
If housing and stocks get slammed, it could cascade into a deep and severe recession. The problem is that central banks created that boom in the first place.
Now, they are too scared of the repercussions to let those bubbles pop.
The biggest side effect, however, is that wealth becomes more concentrated among the already wealthy.
If you own a house or stocks or bonds, you’ve become rich without even trying.
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“The Fed’s response has deepened wealth inequality,” says Mohamed A El-Erian, chief economic advisor at Allianz.
“They’ve produced an incredible recovery in asset prices, and most of these assets are owned by the rich and white segment of the population.
“All they can say is the alternative would have been worse.”
Stock markets globally have been on the swiftest rebound in history. If the world’s central banks have anything to do with it, that’s going to continue.
Well, at least until some other crisis rattles investor confidence to the core.
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