As a financial markets trader, it’s hard for me lately not to feel that we’re living in a Lewis Carroll-inspired stock market. Stock prices often move counter-intuitively, and with large price swings that have the distinct smell of “momentum traders” rather than results of true fundamental changes in the U.S. or worldwide economy.
Stock prices frequently go down on decent news and up on weak economic news. It is not without reason, however: traders hope that bad news will force the Federal Reserve into yet another feckless but asset price-inflating round of “quantitative easing.” It is indeed an Alice in Wonderland market (or perhaps an Orwellian one) when good news is bad, and bad is good. A bad employment report pushes stocks up, and a strong GDP report (not that we’ve had one lately) brings out the trading Queen of Hearts screaming “Off with their heads!”
Markets also move wildly on vague rumors or news about central bank activity, as if the actions of a few self-styled economic geniuses will save Europe’s economic bacon, as if the wolves who smell the blood of decades of social welfare mentality and accompanying deficits and debt can be defanged by waving a magic wand and using words designed to impress and confuse the ordinary citizen.
Thursday was such a day, with the Dow Jones Industrial Average rising about 155 points on rumors that, as Reuters put it, “major central banks are preparing coordinated action if the results of Greek elections this weekend lead to turmoil in financial markets.” The rally was despite weak U.S. economic news in the morning, and a downgrade of Spanish debt to near-junk levels by a major ratings agency.
But is more central bank paper-pushing really something to get excited about? Will you go out to dinner or take out a loan to buy a new house because the European Central Bank is providing liquidity in the face of Greek idiocy? (For the record, I predict that the Greek election will result in a reasonably strong governing coalition in favor of staying in the Euro and continuing some degree of “austerity.”)
Britain led off the Thursday buying frenzy by announcing that it would loan money to English banks at below-market rates if the banks would lend to businesses. Just as with “QE” in the United States, this move may serve as a temporary boost to asset prices… but little more. But haven’t we seen this movie before?
The problem is not that banks don’t have capital to loan. It is that loan demand is weak because entrepreneurs have little interest in business startup or expansion. Who wants to take risk when the short-term future is so likely to be a chaotic mess of politicians playing politics while bankers wallow in the Keynesian muck, each enabling the other to add more inflation risk to the economy and more debt to our children and grandchildren?
A metaphor often used in finance to describe plans like what Britain announced yesterday is “pushing on a string,” something that was tried for more than two decades in Japan without success, and for a recent few years in the U.S. with equally limited results: great for investors in government bonds, a waste of time and money for the rest of us.
Sadly, central bankers are no less susceptible to Hayek’s “fatal conceit” than are senators or presidents, and perhaps more so. After all Federal Reserve Board Chairman Ben Bernanke is a “scholar,” a “historian” of the Great Depression; he teaches courses to wide-eyed college students who fawn in the presence of such greatness and wisdom, his actual job performance and refusal to be guided by results rather than theoretical models notwithstanding.
George Osborne, the British Chancellor of the Exchequer (roughly analogous to our Treasury Secretary except that Osborne has not been shown to be a tax cheat), understands that more government borrowing poses real risk to his country and is a committed budget-cutter and opponent of the burgeoning welfare state. But once in power, it is difficult even for him to avoid attempting to use aggressive monetary policy tools to avoid the unavoidable storm that decades of fiscal malfeasance are raining down across Europe, with the U.S. soon to follow.
Even Angela Merkel, the princess of European austerity, may be pushed into a “growth pact” by pressure from other European nations (particularly France’s new Socialist econo-moron president, François “lower the retirement age” Hollande) and from domestic politics. Merkel seems likely to go along with a German financial transaction tax that will do great harm to her nation’s financial markets and German companies’ ability to raise capital, while driving millions or billions of dollars of business into the waiting arms of the City of London. But what is she going to do when her party keeps losing regional elections and the head of the German Green Party proclaims confidently that “the Europe of austerity is ending”?
When most Europeans talk about “growth” they usually mean — as Barack Obama does — the growth of government. With their plans drifting that way, with even conservative bankers desperately pushing on a string, how can stock markets put on a big happy face? After all, whether it is a “growth pact” or coordinated bank action, the real message is not that there’s a new sheriff in town but rather that their economies are dangerously fragile — as are therefore their political careers.
But all is not lost, at least not here in the United States. And even though stock buyers today might be wrong tomorrow or next week (following Sunday’s elections in Greece and the results of Spanish banks‘ “stress tests”), they will probably be right soon — even if for the wrong reasons. American institutions have cut their exposure to European debt, so direct contagion from turmoil across the pond will be limited. This is not to say that there won’t be some panic here if a major European bank or government fails, but rather that the panic will probably represent a buying opportunity in U.S. stocks.
Furthermore, to the extent that people fear credit or liquidity risk in dealing with European companies, they’ll look to American suppliers; despite a modestly strengthened U.S. dollar, American exports will not fall as much as one might expect during a time of economic turmoil.
Our hope in the United States, the thing that can make Thursday’s semi-rational stock buyers look smart in the long run, is that we are not Europeans. Despite the wishes of President Obama and the views of his friends in Manhattan and Hollywood, Americans do not aspire to a massive, bloated social welfare state where success is defined by what percentage of the citizenry is in a public sector union.
A nation’s polity and its economy, especially those as large as ours, are like battleships, not speedboats. They can be turned around, but it takes some time. Still, our entrepreneurial class may at least see that we’ve begun to turn our massive, misguided ship of state when we get the Supreme Court’s decision on Obamacare, likely on Monday, June 25, but perhaps this coming Monday — the same day that markets will have the first chance to react to Greek election results. Another aspect of a giant ship is that once it is turning, it cannot be stopped on a dime (or on a halibut); the turn away from Obamacare may presage American voters’ distancing themselves from the man for whom the law is nicknamed.
If that happens, Thursday’s stock buyers may look like wise investors indeed.
But until then, we remain in Alice in Wonderland’s stock market.
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