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PrintMarch 26, 2011
Economic danger signs mounting
While much of the world's attention is focused on Libya and the ongoing Washington follies staring Barack Obama, the global markets are the midst of their own struggle with reality.
It has long been a truism that the stock markets are a bellwether as to the future of the domestic or international economy and are thus highly sensitive to factors that have financial implications either negative or positive. However that adage has been stood on its head thanks to unprecedented and highly dangerous monetary policy pursued primarily by the Federal Reserve but also by various central bankers throughout the world.
The list of reasons for markets to sell off: the sight of US and European airplanes bombing an oil exporting country (Libya); the entire Middle East in turmoil; major damage to 10% of the global gross domestic product (Japan); the resignation of the Portuguese prime minister and an imminent fiscal crisis in Portugal and Spain; weakness in various emerging markets and corporate profit margins; the looming end of QE2 (quantitative easing) by the Fed; inflation particularly food prices running rampant and the prospect of much higher interest rates by various central banks.
Yet with all the above the stock markets are showing remarkable resiliency. The markets are not only still standing but many are up over a year ago.
What lies behind this strength and what will cause it to end? This resilience has been largely underpinned by the efforts of the central banks, led by the Federal Reserve, to pump unprecedented and massive amounts of money into the financial system. These same institutions are arbitrarily keeping interest at near zero thus making returns on cash very unattractive as inflation adjusted interest rates are either negative or extremely low.
There is an enormous amount of cash on the sidelines, and with negative interest rates in many countries money is thus pushed into risk assets helping to create a bubble effect in the markets. In essence there is no place to put cash but into stocks or commodities, both of which are extremely volatile.
Many investors are beginning to get nervous as a number of factors are looming on the horizon that will impact the markets. The Fed has announced that its latest round of essentially printing money (QE2) will end in June which will lead to excess cash in the system drying up. The central banks, including the Fed, will finally have to confront inflation by raising interest rates. Many companies will be unable to pass on their rising raw material costs drastically affecting earnings. European politicians still cannot come to grips with needed reforms to handle the debt crisis in the Eurozone, with Portugal in imminent danger of default and Spain not far behind. Lastly with the US still running trillion dollar plus deficits and the Fed no longer planning to buy the debt as of June, higher interests rates will have to be offered to make the bonds more attractive.
Right now the investment community is rolling the dice trying to anticipate when the markets will take a tumble, will it be in the next few days, weeks or even months.
Unless the Federal Reserve does the unthinkable and embarks on another round of quantitative easing thus guaranteeing long term stagflation, liquidity from the markets will be withdrawn and the upward cycle of the markets will turn negative. That change will happen sooner than most people think and another bubble, like the real estate bubble (aided and abetted by the Fed) will burst. The Federal Reserve will thus add another boom and bust cycle to its list of accomplishments.
