---------- Forwarded message ---------- From: John A Imani <johnaima...@gmail.com> Date: Mon, Mar 18, 2013 at 12:19 PM Subject: Commentary on Two Articles in The Economist on Asset Bubbles Blown by The Federal Reserve To: rac...@lists.riseup.net, rac-lasupport...@lists.riseup.net, copwatc...@lists.riseup.net
(JAI: ...the history of the past 30 years has been marked by a series of asset-price bubbles, often fueled by cheap money. With this startling admission, in the article just below, The Economist seemingly accepts the asset-price bubblesfueled by central banks (esp the Federal Reserve)as a 'given' and from thence goes on to explain the falling cost of capital as reflected in corporate bond yields, i.e. the interest rate they promise. In a second article also below, the same magazine operating with the same given assumption of the existence of these asset-price bubblesthis time in equities, i.e. corporate share pricesand concludes: It is tempting to attribute the strength of the Dow to optimism about the American economy. Tempting, but wrong. Studies have shown almost no correlation between GDP growth and equity returns...this *rally * *in the Dow has been accompanied by the weakest GDP growth of all the bull markets since the second * *world war*. There is an old adage: When stocks go up, bonds go down.<http://answers.yahoo.com/question/index?qid=20080123064331AALopBG>That is, when the risks which are taken with an investment in company ownership are rewarded with a rising share price, more conservative investments in the forms of corporate or Treasury bonds find the market-price of the bonds fall. I say more conservative as in the event of bankruptcy, bond-holders are paid off before equity-owners of shares. Part of this seems to be a 'herd instinct' endemic in capitalism as investors pile in after the 'good thing' raising the prices of, in this case, equities; and, in order to do so, some of these investors must divulge themselves of their holdings in bonds so as to 'chase the rainbow'. And to sell their holdings in bonds they must lower their asking price below the existing market-price as an increase in supply (in this case the supply of corporates being proffered in the bond market)almost 'as a rule'results in a lowering of market-price. Thus stocks going up and bonds doing the same is somewhat of an anomaly. And one explanation, for at least a part of it, is the intervention by the Federal Reserve. What is unusual about the situation now is that both equities (as reflected in the prices of stock market shares) and corporate bonds (as reflected in the lowering of the interest rate they pay) are both rising. Something is afoot here and that something is, of course, a Federal Reserve charged by law and tradition with a 'dual mandate'<http://www.chicagofed.org/webpages/publications/speeches/our_dual_mandate.cfm>to maintain both full employment and price stability but seemingly unable to accomplish either. 'Quantitative easing' <http://en.wikipedia.org/wiki/Quantitative_easing> is what they call it, this intervention by the Fed into the corporate bond markets. Injection into the economy of newly created money is what it is. Akin to the electric shock given by physicians to restart a heart that has ceased to beat, or similar to 'jump-starting' a car with a dead battery, the introduction of this 'artificial purchasing power' into the stocks and bonds markets is powering their simultaneous rise. The hope (of the Fed) is that the rising prices of these assets will trigger what is called the 'wealth effect' <http://en.wikipedia.org/wiki/Wealth_effect> causing the owners of these financial instruments to be more apt to both invest in business opportunities as well as be more profligate in their personal consumption expenditures. All of this to be caused by a bubble, in such assets, blown by the Federal Reserve which before had blown the housing bubble<http://en.wikipedia.org/wiki/United_States_housing_bubble#Background> which burst in 2007in response to the devastating explosion of the internet bubble<http://en.wikipedia.org/wiki/United_States_housing_bubble#Background> which crashed in 2000. This is a prescription for an ailing capitalist economy in which production and, therefore, employment is less than it could be given the amount of potential productive capacity and the size (and skills) of the potential workforce existing. This is all but a riff on a prescription straight out of Keynes<http://en.wikipedia.org/wiki/The_General_Theory_of_Employment,_Interest_and_Money#Summary> : When involuntary unemployment exists...wasteful loan expenditure may...enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth...If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of *laissez-faire *to dig the notes up again...there need be no more unemployment... http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch10.htm The obvious difference between what Keynes proposed above and what the Federal Reserve is doing today demonstrates, I believe, the gravity of this present capitalist crisis. While both seek to inject into 'artificial purchasing power' into a moribund capitalism, a key codicil of Keynes was that such an injection of 'artificial purchasing power' must not directly compete with existing commodity production suffering already from saturation of existing markets and hence the layoffs and recession: Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they *could not serve the needs of man by being consumed*,...The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. ibid. Today, it seems, the Federal Reserve is not trying to compete with existing commodity production so much as to 'jump-start' it. The transfer of this 'artificial purchasing power'in the form of rising asset prices fueled by purchases of such by the Federal Reserveit is hoped will trigger the 'wealth effect' leading to increased consumption and investment on the part of the owners of these assets, i.e. 'trickle down economics'<http://en.wikipedia.org/wiki/Trickle-down_economics>in but a new garb. The Fed is essentially giving newly printed money to the wealthy in exchange for their corporate bonds and from thence this 'profit' flows from their hands into the stock market triggering its rise while simultaneously these Fed purchases raises the price of corporate bonds lowering the interest rate that they pay and therefore decreasing the costs of the capital for which the bonds were issued. Lower costs of capital, it is assumed, make the issuers of these bonds more apt to resume and/or increase their production. This is 'sleight-of-hands economic legerdemain'. Instead of putting people to work via government sponsored and directed infrastructure and productive ventures, the Fed instead continues to give this 'artificial purchasing power' to the owners and issuers of corporate bonds via its 'Quantitative Easing): Buttonwood Desperately seeking yield The striking appeal of corporate bonds<http://www.economist.com/news/finance-and-economics/21573112-striking-appeal-corporate-bonds-desperately-seeking-yield/print> Mar 9th 2013 "Emerging markets, technology stocks, American (and Irish) houses and the mortgage-linked debt that was associated with them: *the history of the past 30 years has been marked by a series of asset-price bubbles, often fuelled by cheap money*. Investors have put their cash to work in search of the next sure thing. Several years of historically low interest rates<http://www.economist.com/news/finance-and-economics/21573112-striking-appeal-corporate-bonds-desperately-seeking-yield/print#>in the rich world have caused many to speculate on where the next bubble might occur. One possibility is the corporate-bond market, where yields have fallen remorselessly (see chart). The dangers are twofold. The first is that investors are not allowing for a sufficiently high margin, or spread, over government-bond yields to compensate for the higher risk that companies may default. The second is that bond yields could rise (and prices fall) if either the economy returns to robust growth or inflation rises sharply, prompting central banks to increase interest rates. One of the nastiest years for bond investors in history was 1994, when the Federal Reserve started to tighten monetary policy. PIMCOs Bill Gross, probably the best known bond manager in the world, said in his latest outlook that: Corporate credit and high-yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile. Spreads are not yet at the lows they reached in 2007 when the credit bubble was at its height. But in a speech last month Jeremy Stein, a Fed governor, pointed to a number of signs of frothy markets. In the fourth quarter of last year, for instance, two forms of risky debt issuancepayment-in-kind (PiK) bonds and covenant-lite loansreached volumes last seen in 2007. The former are bonds where interest payments are made in the form of more bonds, rather than cash; the latter are loans with fewer safeguards for creditors if the borrowers financial condition deteriorates. An increased appetite for such securities suggests that investors are willing to take more risk. Matt King, a strategist at Citigroup, points to further warning signs. Spreads normally rise when companies take on more debt. This time European corporate leverage has risen but spreads have fallen. In addition, broker-dealers have very low bond inventories, a result of reduced risk-taking and tougher regulation since the financial crisis. If bond investors were to turn from buyers to sellers, prices could fall sharply in an illiquid market. Given these worries, what explains the continued enthusiasm for corporate debt? It is not just that low interest<http://www.economist.com/news/finance-and-economics/21573112-striking-appeal-corporate-bonds-desperately-seeking-yield/print#>rates have made investors seek out alternatives to cash; they have also made it easier for firms to service debts. Data from Standard & Poors, a rating agency, show that the default rate for speculative-grade American bonds in the 12 months to February was 2.3%, well below the historic average. Furthermore, central-bank purchases of bonds have reduced the supply of debt available for investors to buy. Net issuance of new securities (deducting central-bank purchases) has fallen from $3.7 trillion in 2009 to $918 billion on a rolling 12-month basis, says Citigroup. This reduced supply has been met by voracious demand. According to Morningstar, a research firm, the average monthly inflow into American bond mutual funds<http://www.economist.com/news/finance-and-economics/21573112-striking-appeal-corporate-bonds-desperately-seeking-yield/print#>over the past three years has been $18.5 billion; US equity funds have seen average outflows of $7.2 billion. In January, despite much talk of a great rotation out of bonds and into equities, bond funds received inflows of $38.1 billion and equity funds (domestic and international) had inflows of $37.8 billion. There are a few signs that investors are demanding higher yields from corporate issuers in 2013 but nothing that indicates panic. As long as the return on cash is so low, it is unlikely that bond funds will see massive outflows. To the extent that investors are moving into equities, they are probably shifting out of cash and money-market funds, not bonds. So for a collapse in the corporate-bond market to happen there will either have to be a sudden reversal of central-bank policy or a wave of defaults. The former looks highly unlikely this year. The latter is most likely to occur if companies suddenly go on a wild spending spree with borrowed money. A recent pickup in mergers and acquisitions may eventually lead to the kind of excesses that have been seen in the past. But these are early days. If this is a bubble, it probably has a bit more inflating to do. Americas stockmarket Better than the alternatives The Dow reaches a record high Mar 9th 2013 |From the print edition<http://www.economist.com/printedition/2013-03-09> http://www.economist.com/news/finance-and-economics/21573114-dow-reaches-record-high-better-alternatives/print ONE more milestone has been passed on the road to recovery. On March 5th the Dow Jones Industrial Average closed at 14,253.77, a new high, finally surpassing the level reached in October 2007, just as the subprime-mortgage crisis really took hold. (The S&P 500, a more broadly based and better constructed index, stayed just shy of its record high.) Wall Street is not alone. Stockmarkets in the developed world have been in fairly buoyant mood since the start of the year with the MSCI World Index rising by 5% in the first two months of 2013, and the Japanese market gaining 13.5%. Emerging markets, in contrast, have been flat. It is tempting to attribute the strength of the Dow to optimism about the American economy. Tempting, but wrong. Studies have shown almost no correlation between GDP growth and equity returns. Indeed, the Shanghai stockmarket trades at less than half its 2007 peak, even though the Chinese economy has performed much more strongly than that of America since then. As the chart shows, this rally in the Dow has been accompanied by the weakest GDP growth of all the bull markets since the second world war. The main factors behind the current surge seem to be twofold. The first is a degree of confidence that some tail risks have been avoided, at least for now. The euro zone has not broken up and politicians in Washington, DC have not brought the entire economy to a halt over tax-and-spending policies. Hurdles remain (such as raising the debt ceiling) but investors assume a deal will be done. The second factor is that equities look better than the alternatives. Cash yields are puny and central banks have made it clear that interest rates will not rise for a while. Ten-year government bonds in much of the rich world yield 2% or less. Although there is no sign of the much-heralded great rotation out of bonds and into equities (see Buttonwood<http://www.economist.com/news/finance-and-economics/21573112-striking-appeal-corporate-bonds-desperately-seeking-yield>), there are signs that investors are putting cash in both asset classes<http://www.economist.com/news/finance-and-economics/21573114-dow-reaches-record-high-better-alternatives/print#>following a long period in which equity funds suffered withdrawals. Some think the bull market is bound to continue<http://www.economist.com/news/finance-and-economics/21573114-dow-reaches-record-high-better-alternatives/print#>as long as the central banks of America, Britain and Japan keep buying assets. There are three guys with cheque books<http://www.economist.com/news/finance-and-economics/21573114-dow-reaches-record-high-better-alternatives/print#>which matter in the world, and they will all have hand cramps in the coming quarters and years as they furiously accumulate trillions in securities, was the verdict of David Zervos, a strategist at Jefferies, an investment bank. The only safe asset, as these fiat cash and reserve liabilities explode higher, is the one that has at least a chance of generating positive real returnsequity capital. Can cheap money prop up share prices in the long run? Research by the London Business School shows that low real interest rates have historically been associated with low, not high, equity returns. Mohamed El-Erian, the chief executive of PIMCO, a fund-management group, said recently that: For the rally in equity markets to continue, the current phase of assisted growth, as anaemic as the outcome is, needs to give way to genuine growth. The stockmarket fundamentals are not that encouraging, however. Profit growth has been slowing. In the fourth quarter of last year, earnings per share of companies in the S&P 500 grew at an annual rate of 6%, according to Société Générale. The growth rate is expected to be just 1.2% in the first quarter of this year, and 0.1% if financial companies are excluded. Analysts are more optimistic about the second half of the year, but they usually are upbeat at this point in the calendar; reality kicks in later. The best long-term measure of value, the cyclically-adjusted price-earnings ratio (which averages profits over ten years), is at 22.9, around 39% above its long-term average, according to Robert Shiller of Yale University. An alternative measure, the Q ratio, which compares shares to the replacement cost of net assets, shows the American market as 50% overvalued, according to Smithers & Co, a consultancy. The dividend yield on the market is 2.6%, compared with the historical average of 4.1% (although share buy-backs partly compensate for this shortfall). Valuation does not often drive the market in the short term. *During the dotcom bubble investors were happy to buy shares on stratospheric multiples: the cyclically-adjusted p/e reached 44 in late 1999. But the aftermath of that bubble illustrated an **old rule. When investors buy assets at above-average valuations, they will suffer below-average future returns**.* *Given the current combination of low bond yields and high equity valuations, Antti Ilmanen of AQR, a fund-management group, calculates that * *the prospective return from a balanced American portfolio is the lowest it has been for a century*. That is not good news for American corporate-pension funds, which still have a $479 billion deficit even after the latest rally, according to Mercer, an actuarial group. For the moment, though, the bulls are happy to leave that worry for another day. _____________________________________________________________________________________________________________ -- JAI RAC-LA -- JAI RAC-LA -- JAI RAC-LA [Non-text portions of this message have been removed] ------------------------------------ --------------------------------------------------------------------------- LAAMN: Los Angeles Alternative Media Network --------------------------------------------------------------------------- Unsubscribe: <mailto:laamn-unsubscr...@egroups.com> --------------------------------------------------------------------------- Subscribe: <mailto:laamn-subscr...@egroups.com> --------------------------------------------------------------------------- Digest: <mailto:laamn-dig...@egroups.com> --------------------------------------------------------------------------- Help: <mailto:laamn-ow...@egroups.com?subject=laamn> --------------------------------------------------------------------------- Post: <mailto:la...@egroups.com> --------------------------------------------------------------------------- Archive1: <http://www.egroups.com/messages/laamn> --------------------------------------------------------------------------- Archive2: <http://www.mail-archive.com/laamn@egroups.com> --------------------------------------------------------------------------- Yahoo! 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