Much of the speculation in the financial media today centers on the reasons for today’s minor tumble in the stock market; as I write this, both the Dow and the S&P are down about 1%. It seems that memories are short and, after the breathtaking, some of us think frightening, run-up in the stock market of late, even such minor stumbles becomes news. Just a few years ago, a 1% down day would be cause for rejoicing on a relative basis. But I digress.
The disappointing employment report is most often cited for today’s troubles in stocks. Some are arguing that these mediocre numbers are the result of the dreaded sequester’s having finally reared its ugly head. Those of us who have long questioned whether a 2.5% cut in federal spending can have any noticeable, let alone dire, impact on the economy are doubtful of this political statement disguised as market prognostication by people whose familiarity with the markets is akin to their familiarity with life outside the public payroll. While trying to determine why the market does what it does on a day to day basis is nearly as perilous and pointless as trying to guess where it is going to go, it is fun and, for many, apparently profitable, to engage in such games. If yours truly had to play this game, I would guess that the market is down today largely because it has been up so much the last several months and people are looking for an excuse to take profits. The only item that somewhat rattles my confidence in that guess is that gold is up just short of 1% today, and I have long said that I won’t believe a market correction that is not accompanied by a run-up in the price of gold. Of course, gold might be up simply because it has been taking a hammering for about the last six months. See how dangerous, and silly, this stock prognostication game is? Better to buy index funds and kindred products and rebalance religiously (See my 2/26/13 post CZAR BERNANKE’S DIKTAT: BONDS MUST BE RICH, STOCKS MUST BE CHEAP), but, again, I digress.
Suppose, though, for a moment that the employment report was as tepid as it was because of the sequester. This raises a frightening question: What if the economy is indeed so fragile that a mere 2.5% cut in spending can derail it? But this leads the fertile mind to an even more terrifying question: If the economy, and presumably the markets, react like this to the damage done by the paltry sequester, what will happen when the massive monetary stimulus that has been the crack cocaine of this economy and this market is withdrawn? Given the support the housing sector is getting from the fantasy land interest rates the fed has created, the break federal and state governments are getting on their interest payments, and the massive long positions our entire financial system holds in treasuries and mortgage backed securities, what will happen when rates start to approach reality if the markets and the economy can be thrown into a tizzy by the laughable attempt at fiscal restraint called the sequester?
This leads to a further question, one that I cited in my aforementioned 2/26/13 post. We have put most of our eggs into the monetary basket, depending, as I just wrote, on the Fed for the low interest rate crack that keeps the economy going. Is it healthy to put such power in the hands of Obsequious Ben and His Merry Men and his colleagues across the oceans? I heard a St. Louis Fed official on Bloomberg radio the other day saying that there is no danger of a bout of inflation, or even asset bubbles, from massive injections of money into the system as long as the Fed has a credible (emphasis mine) plan for withdrawing that liquidity.
There are two problems with this statement. First, we are already seeing asset bubbles, certainly in treasuries (Again, the 2/26 post) and almost as certainly all along the risk spectrum in the bond market. Too late for the Fed’s credibility to save the day in those markets.
Second, how can the Fed have a credible plan for withdrawing its liquidity when, by all historical measures, the Fed should have no credibility whatsoever? I heard Jim Grant make the point of CNBC a few weeks ago (I’d like to think he got the idea from reading my 2/26/13 post, but Jim, one of the most brilliant thinkers in finance today, or ever, probably doesn’t need even this insightful piece to come up with his ideas.) that we seem to put far too much credence in an institution that has a history of repeated failures. Think G. William Miller’s inflation, Alan Greenspan’s mortgage and real estate bubbles, the Hoover
Mr. Grant, and yours truly, are absolutely right; we have clearly ascribed awe approaching credibility to an institution or, on a worldwide basis, institutions, that have not merited that credibility and respect. Given the performance of the bond markets (though one wonders how they would be doing if the Fed weren’t buying about ¾ of net treasury issuance) and the stock markets (at least until today), the markets seem to think that the fed and its central bank colleagues are worthy of the enormous trust we have placed in them by placing not only monetary policy, but the very functioning of our financial system and our economy, in their hands.
This is indeed frightening. But what might be more frightening is that some day the markets are going to sober up and realize that they have put their confidence in an institution that is in way over its head. This is not necessarily a knock on Mr. Bernanke and his colleagues; it is simply an observation that the management of the functioning of the worldwide financial system is beyond the capability of any single institution or group of institutions; it is the business of the market, not monetary mavens and economic shamans ensconced in modern day temples of monetary munificence, to guide the world’s finances. What will happen when the markets relearn this lesson?
For all I know, or anyone knows, by the end of the day the stock market indices could all have turned positive. Speculation on this is pointless. But the type of speculation that a day like today germinates is always fruitful.
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