The Big Plunge-What's Really Driving the Crashing Markets?

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Weekend Edition June 21-23, 2013

What's Really Driving the Crashing Markets?

The Big Plunge

by MIKE WHITNEY

Normally, stocks don’t fall off a cliff unless the economic data suddenly turns south or there are signs of an emerging crisis, like a run on the shadow banking system or threat to Middle East oil supplies. But neither of these played a part in this week’s equities massacre where the Dow Jones Industrial Average (DJIA) plunged 560-plus points in just two sessions and indices around the globe dipped deep into the red. What triggered this week’s selloff was an announcement from the Federal Reserve that it was planning to scale down it’s asset purchases (QE) in the latter part of 2013, and probably end the program sometime in the middle of 2014.   Here’s the offending paragraph in the FOMC’s statement that lit the fuse:

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains, a substantial improvement from the 8.1% unemployment rate that prevailed when the committee announced this program.” (FOMC)

Now–unless you think that Fed chairman Ben Bernanke is a complete idiot–then you can assume that he knew what the reaction on Wall Street would be. After all,  stock prices have more than doubled in the last 4 years mainly due to the Fed’s lavish liquidity spree. So any announcement that the program is “going away” was sure to  send traders racing for the exits. Which it did.  Traders were not having a “hissy fit” as many in the financial media have said. They were acting rationally. Absent the Fed’s turbo-charged monetary stimulus, stocks will go down, there’s no question about it. Current prices do not reflect fundamentals nor do they reflect the true health of the economy. They reflect a couple trillion dollars worth of UST and MBS purchases that have goosed stock prices dramatically. Traders know this, which is why they cashed in and walked away when Bernanke announced the prospective end of the program. They acted rationally.

But why would Bernanke want to throw a bucket of cold water on the markets now? Is it because he really believes that the economy is gaining momentum and the labor market is steadily improving?

Hell no, that’s pure baloney. Again, Bernanke is not a moron. He sees what everyone else sees, that the headline unemployment number (7.6%) is rubbish that doesn’t  reveal the rot beneath the surface; the abysmal participation rate, the sharp uptick in part-time workers, and the lousy starvation-wage positions that have replaced the good paying jobs. Trust me on this; Bernanke knows how to read a freaking jobs report. He knows the economy is crap and that people still can’t find work. Just look at this clip from the SF Fed’s own report on the condition of the economy. It will help you see that Bernanke really doesn’t believe the green shoots hype at all:

“Federal fiscal policy during the recession was abnormally expansionary by historical standards. However, over the past 2½ years it has become unusually contractionary as a result of several deficit reduction measures passed by Congress. During the next three years, we estimate that federal budgetary policy could restrain economic growth by as much as 1 percentage point annually beyond the normal fiscal drag that occurs during recoveries….

CBO projections and our estimate based on the countercyclical history of fiscal policy suggest that federal budget trends will weigh on growth much more severely over the next three years. The federal deficit is projected to decline faster than normal over the next three years, largely because tax revenue is projected to rise faster than usual. …The rapid decline in the federal deficit implies a drag on real GDP growth about 1 percentage point per year larger than the normal drag from fiscal policy during recoveries.” (“Fiscal Headwinds: Is the Other Shoe About to Drop?”, FRBSF)

See? So things are bad and they’re going to get worse. This isn’t a secret. Fiscal policy is DESIGNED to make things worse. It’s deliberate! It’s all there in black and white, read it again.

So what’s really going on here? Why is Bernanke pretending that the future is looking so rosy, when the exact opposite is closer to the truth?   Why is he announcing the end of a program that may never end? Just look at the rate of inflation, fer chrissakes! We are in a deflationary cycle. Inflation has been dropping for 3 straight months and–according to Bloomberg–” is at 53-year low, the lowest inflation since JFK was in office.” That means that the Fed will not hit its 2.5% inflation target and the bond buying will continue indefinitely. Guaranteed. Now, no matter how stupid or incompetent you may feel Bernanke is, I assure you, the Fed watches inflation like a hawk, and when the arrow starts to point down, they do everything in their power to get things going in the right direction again.  They are always looking for the sweet spot because that’s the rate at which their constituents can rake in the biggest profits. In other words, they take inflation (or deflation) seriously.

But if that’s so, then why did Bernanke hardly mention inflation in the FOMC’s announcement?

He didn’t mention it because he’s trying to buffalo investors into thinking that QE is going to end sometime in the near future.   But how can he end it, after all, unemployment is still high (and likely to go higher when the budget cuts kick in), GDP and output are weak, wages are flatlining, capital investment is non existent, corporations and financial institutions have money piled up around their eyeballs with nothing to invest in,  middle class households have seen nearly half their wealth wiped out in the last five years, and the banks have a couple trillion more in deposits than loans because no one in their right mind is borrowing money in the middle of an effing Depression. If any of this sounds like an economic rebound, then maybe Bernanke is actually telling the truth and really plans to terminate QE next year. But I think that’s pretty bad bet, all things considered.

So let’s cut to the chase: The reason Pavlov Bernanke took away the punch bowl on Thursday and put markets into a tailspin, was because stocks are overheating and because his goofy printing operations have generated all kinds of risky behavior. Keep in mind, that it was Bernanke who said that he thought that goosing stock prices would create the “wealth effect” that would lead to a broader recovery in the real economy. Just as it was Bernanke who signaled that he would keep stocks from breaking lower. (The “Bernanke Put”). In other words, investors have just been following their Master’s lead, which is why they  loaded up on stocks to begin with. And that’s why junk bond yields dropped to record lows. And that’s why margin debt climbed to record highs. And that’s why all the big corporations have been buying back their own shares hand over fist. And that’s why the financial markets are riddled with bubbles. It’s because Bernanke tacitly implied that he would  support rising stock prices with lavish infusions of funny money NO MATTER WHAT.

Well, guess what? Now Bernanke is worried. He’s worried that the real economy is still in the doldrums while  bubbles are popping up everywhere in the financial markets; in stocks and bonds, CLOs, CDOs, MBS and every other dodgy debt instrument, derivative or swap. It’s all getting very frothy thanks to the Bernanke.

So, how does the Fed chair intend to “contain” the emergent asset bubble until he retires at the end of the year and returns to blissful academia?

He’s going to keep doing what he’s doing right now; cherry-picking the data so he can rattle Wall Street’s cage every so often and  keep stocks from zooming  too far into the stratosphere. That’s the plan. Of course, he could just tell the truth–that QE has been great for Wall Street but done jack for anyone else. But I wouldn’t count on that.

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. Whitney’s story on declining wages for working class Americans appears in the June issue of CounterPunch magazine. He can be reached at fergiewhitney@msn.com.

http://www.counterpunch.org/2013/06/21/the-big-plunge-2/

Weekend Edition June 21-23, 2013

Armageddon Without Nukes

The Myth of the Rational Market

by PAUL CRAIG ROBERTS

One of the myths of economics is that markets are rational. Theories are based on this assumption, and the belief that markets are rational fuels the argument against regulation.  The market response to the Federal Reserve’s June 19 statement that it will taper off its bond purchases if its forecast comes true is unequivocal proof that markets are irrational.

The Federal Reserve’s statement that it “currently anticipates that it would be appropriate to moderate the monthly pace of purchases [of bonds] later this year” depends on a very big “if.”  The ”if” is the correctness of the Fed’s forecast of moderate economic growth and employment gains.

The Fed has not stopped purchasing $85 billion of bonds each month. So nothing real has changed. Indeed, there was no new information in the Fed’s statement. It has been known for some time that, according to the Fed, its bond purchases will gradually cease.

In response to this old information, the stock and bond markets sold off in a major way on June 19-20. This market response to the Fed’s statement indicates that the Fed’s forecast is unlikely to come true. Low interest rates and a high stock market are totally dependent on the liquidity that the Fed is injecting by printing $1,000 billion per year. If this liquidity is not injected, what will sustain the markets? If the markets crash and interest rates rise, how can the Fed expect recovery?

In other words, the participants in the stock and bond markets know that the markets are bubbles created by the printing press. There is no real basis for the high stock and bond prices. The prices are an artificial reality created by the printing press.  Rational markets would take into account the printing press element and would price stocks and bonds at a much lower level.

Zero real interest rates mean that there are no risks.  But how can there be no risk in Treasury bonds when the debt is growing faster than the economy?

Normally, high stock values mean strong profits from strong consumer income growth and retail sales.  But we know that there is no growth in real median family income and real retail sales.

I suspect that the reason the Fed made the announcement, which seems to be derailing the Fed’s forecast of recovery on which the announcement depends, is to relieve pressure on the US dollar.  For several years the Fed has been printing 1,000 billion new dollars each year. There is no demand for these dollars. So far these dollars have inflated stock and bond prices instead of consumer prices. But the implication for the dollar’s price or exchange value in currency markets is clear. The supply is increasing faster than the demand. If the dollar falters, the Fed would lose control. Rising import prices would soon drive domestic inflation and interest rates far higher than the Fed’s targets.

Washington has succeeded in getting Japan and the EU to print yen and euros in order to eliminate the likelihood of flight to other large currency alternatives to the dollar. Smaller countries have also had to print in order to protect their export markets. With so many countries printing money, the Fed’s statement implying that the US might stop printing makes the dollar look good, and, indeed, the dollar rose on the currency exchange markets.

Having neutralized the alternative currency threat to the dollar, the Fed and its agents, the bullion banks, the banks too big to fail, are still at work against the gold and silver threats to the dollar. Massive short selling of gold began at the beginning of April. Again on June 20 massive shorts of gold were sold at a time of day chosen to maximize the price decline.  Only those who intend to drive down the price would sell in this way.

Since QE began, the Fed has deprived retirees of interest income and has forced retirees to spend down their capital in order to pay living expenses.  Judging from the initial market response, the Fed’s latest policy announcement is adversely impacting bond, stock and real estate investors, and the manipulation of the bullion markets

continues to wreak destruction on wealth stored in the only known safe haven.

How can a recovery happen when the Fed is destroying wealth?

The Fed’s irrational behavior could be seen as rational if the assumption is that the Fed’s intent is not to save the economy but to save the banks.  As the Fed is committed to saving the banks “too big to fail,” it is likely that the banks know of the Fed’s announcements in advance. With inside information, the banks know precisely when to short the stock, bond, and bullion markets. The banks make billions from the inside information. The billions made help to restore the banks’ balance sheets.

Guy Lawson’s book, Octopus (2012), shows that front-running on the basis of inside information has always been the source of financial fortunes.  In order to save the banks, the Fed now supplies the inside information.

How is this going to play out?  I suspect that the recovery, although officially a weak one, does not really exist. However, thanks to statistical artifacts that understate inflation and unemployment and overstate GDP growth, the Fed and the markets think that a

recovery of sorts is in process and that the unprecedented money printing by the Fed will succeed in shifting the economy into high gear.

No such thing is likely to happen. Instead, as 2013 progresses, a further downturn will become visible through the orchestrated statistics. This time the Fed will have to get the printed money past the banks and into the economy, and inflation will explode. The dollar will collapse, and import prices–as globalism has turned the US into an import-dependent economy–will turn high inflation into hyperinflation.  Disruptions in food and energy deliveries will become widespread, and a depreciated currency will cease to be used as a means of exchange.

I wouldn’t bet my life on this prediction, but I think it is as likely as the Fed’s prediction of a full recovery that allows the Fed to terminate its bond purchases and money printing by June 2014.

Americans, who have been on top of the world since the late 1940s, are not prepared for the adjustments that they are likely to have to make.  And neither is their government.

Paul Craig Roberts is a former Assistant Secretary of the US Treasury and Associate Editor of the Wall Street Journal. His latest book is  The Failure of Laissez-Faire Capitalism. Roberts’ How the Economy Was Lost is now available from CounterPunch in electronic format. 

http://www.counterpunch.org/2013/06/21/the-myth-of-the-rational-market-2/