In efforts to spur lending and increase the rate of inflation, central
banks in the US, EU, and Japan have engaged in dubious tactics.
Every time their actions fail, they double down in failed strategies.
The Bank of Japan and ECB are now running out of bonds to buy. To
circumvent the imagined problem, the former is already buying
equities. Will the ECB follow? Does it even matter?
Let’s address those questions with an eye on social mood.
The Wall Street Journal writers Brian Blackstone and Tom Fairless ask Could the ECB Start Buying Stocks?
By failing to properly analyze social mood, they come to the wrong
conclusions.
Some central banks already invest in equities. Switzerland’s central bank
has accumulated over $100 billion worth of stocks, including large holdings
in blue-chip U.S. companies such as Apple and Coca-Cola.
If the ECB decides to raise its stimulus by extending its current bond
program, as many analysts expect, fresh questions will be raised about how it
will continue to find enough bonds to buy. The bank is already purchasing €80
billion ($89.2 billion) a month of corporate and public-sector bonds to
reduce interest rates across the eurozone. Its holdings of public-sector debt
reached €1 trillion last week, the ECB said Monday.
With a key policy rate already below zero, ECB officials hope that buying
bonds with freshly printed euros will reduce interest rates further. But
policy makers face a practical constraint: The ECB is running up against
self-imposed limits on how much of a country’s bonds it can hold.
“The obvious reason for the ECB to buy equities is they have almost run
out of German bonds to buy,” said Stefan Gerlach, chief economist at BSI Bank
and a former deputy governor of Ireland’s central bank. “The basic idea
is that the central bank can put essentially anything on its balance sheet
and there is no reason to be straight-laced about this.”
When policy rates approached zero, central banks in the U.S., the U.K.,
Japan and the eurozone turned to bond purchases to reduce long-term interest
rates. Buying equities would likely yield some of the same effects in
terms of encouraging consumption and investment through higher household
wealth and lower cost of capital.
“I don’t see a reason not to do this,” said Joseph Gagnon, senior fellow
at the Peterson Institute for International Economics. “It isn’t obvious to
me why a central bank wouldn’t always want a diversified portfolio, including
equities.”
Straight Laced
Indeed, central banks can put anything on their balance sheet. But there
is no reason to be straight-laced about how counterproductive the concept is.
If buying bonds stimulated inflation, Japan and the ECB would have it in
spades.
Spotlight on Social mood
With round after round of QE, central banks have accomplished nothing but
a reinforcement of already negative social mood.
Peter Atwater discusses social mood in his excellent column Why Central Bank Stock Purchases Are a Really Bad Idea.
“Buying equities would likely yield some of the same effects in terms of
encouraging consumption and investment through higher household wealth and
lower cost of capital,” [say Blackstone and Fairless] …
While there are many reasons for the disparity in moods today, I am
afraid, the decoupling of Main Street mood from Wall Street mood will
represent a clear headwind to the economic thinking behind today’s proposed
central bank actions. Based on what I see, little will be gained by additional
asset purchases, especially stocks. In fact, as I discuss below, I think we
have now reached the point where further asset purchases risk derailing
confidence rather than boosting it.
Underlying today’s central bank actions and the sentence offered above by
Blackstone and Fairless is the “wealth effect” – “a psychological phenomenon
that causes people to spend more as the value of their assets rises. The
premise is that when consumers’ homes or investment portfolios increase in
value, they feel more financially secure, so they increase their spending.”
(Investopedia) To believe the principle, for individuals, higher asset prices
lead to a positive wealth effect that, in turn, leads to greater consumption.
To be clear, I think economists have it backwards. As a socionomist, I
believe that increases in confidence boost both financial asset prices and
consumption simultaneously. Mood precedes action, rather than lags it. We act
as we feel, driven by our level of confidence. With high confidence we see
permanence to our financial condition expecting it to continue long into the
future.
Sadly, today’s central bankers don’t see confidence/action causality
operating this way.
Looking at today’s stock-hungry central bank plans, I see three problems:
First, unless Main Street sentiment changes dramatically, low confidence
by itself is going to continue to limit how much higher stock prices impact
consumption. Without greater Main Street confidence there simply won’t be a
positive wealth effect – a necessary requirement for increased spending.
Second, the further central bankers decouple the markets from the broader
economy, the more contradictory the mood “mirrors” will become to investors.
I think we are already seeing signs of this given the investor “anxiety”
referenced above. While they may not be able to put their finger on it,
investors know something is wrong.
Rather than the mood “mirrors” offering cognitive ease as they did at the
peak in 2007, today’s “mirrors” are offering cognitive strain.
Those contradictory mood “mirrors” run in both directions. If investors
are strained by the messages out of Main Street, voters on Main Street are
irate at the contradictory images the financial-elites are reflecting back on
them. From $100 million condominiums to super-sized, stock-driven
compensation packages, consumers are having a difficult time reconciling
their own post-banking crisis personal experiences with what they see among
the moneyed class.
The more – and more openly – central banks act to simultaneously boost
financial asset prices and to press savings rates lower, the more voters have
good reason to question the motives of the Federal Reserve, ECB and other
central banks.
Third, the cognitive strain evident on Main Street and among a growing group
of investors is even clearer in corporate investment decision-making today.
While stock prices may be soaring, organic revenue growth is anemic. Many
executives, like Starbucks’ CEO Howard Schultz, are openly worried about the
impact consumer economic and political anxiety is having on business. While
stock prices suggest it is the best of times, the cash register is saying
something else, entirely.
While this morning the Wall Street Journal highlighted the benefits of
central bank stock purchases, it is time to throw out those wealth effect
dream-filled Econ 101 textbooks and replace that thinking with something more
grounded in today’s reality:
“Buying equities will put additional pressure on corporate CEOs to cut
expenses and to postpone investments, fostering even greater Main Street
resentment toward the financial elite. Consumer confidence won’t rise as
consumption and economic growth stagnate. Having so clearly sided with owners
of capital, rather than the employees of capital, global central banks are
likely to become an easy target for populist ire.”
Mish’s Rule of Social Mood
Think back to the housing bubble. By holding rates too low too long, the
Fed certainly added fuel to the housing bubble. Baby step hikes by Alan
Greenspan did not slow the bubble, they fueled it.
At some point, the collective wisdom of the masses changed, suddenly and
without precedent. The event was totally expected in this corner, predicted
in advance, and timed correctly.
Those seeking proof can easily find it here: US vs. Japan Land Prices Pictorial Update
In Winter of 2008 I had the housing bubble looking as follows: Housing Update – How Far To The Bottom?
In Spring of 2011 I even caught the bottom: Reader Seeks Help/Advice on US Housing/Economy; How Far to
THE Bottom?
My analysis was far from perfect. I failed to predict the echo bubble in
both housing and the stock market. If you believe anyone has all the answers
you are mistaken.
Let’s return to social mood.
What Happened?
In a nutshell, the Fed fueled a housing bubble.
Social mood already embraced the notion “housing always goes up” and along
comes the Fed holding interest rates way too low all the way.
Conventional wisdom and Greenspan apologists say the Fed was not to blame.
They are wrong. While it’s true the Fed cannot change social mood, the Fed
actually reinforced social mood.
Pool of Greater Fools
At some point, the pool of greater fools is guaranteed to run out. It
happened with the Fed-sponsored dotcom bubble and it happened again with the
housing bubble.
How did I time the top?
Time Magazine went gaga over real estate.
In December 2005 I wrote It’s Too Late.
When you see stuff like this, not only is it too late, it’s way too late.
“When you see stuff like this, not only is it too late, it’s way too
late.”
People in were standing in lines, wrapped way around the corner, for the
right to enter a lottery to buy a Florida condo.
That is extreme sentiment.
Timing Sentiment
Timing sentiment is extremely difficult. Those were obvious, but the
Fed did not see what they had done.
They fail again now. So do central banks in general. Nonetheless, I can
make a disturbing claim.
Social Mood Will Get Extremely Ugly
Actually, social mood is “already” extremely ugly. The powers that be do
not see it for the simple reason they are not affected by it.
Murders in Chicago are at an all time high and Brexit was totally
unexpected.
The rise of anti-establishment candidates and parties such as Donald Trump
in the US, AfD in Germany, Beppe Grilllo in Italy, and Marine le Pen in
France is proof enough of rising social anger.
Masking Social Mood
The only thing masking already ugly social mood is a high and rising stock
market. It’s not only high, it’s in bubble territory.
Bubbles pop, by definition. Perhaps the bubble orderly deflates, like
Japan, as opposed to a 1929-style crash.
That’s my prediction actually. But it won’t matter. If anything, an
orderly asset devaluation over 7-10 years would be worse.
Perceived wealth will vanish. Pension plan promises will be exposed as
lies.
Increasingly Worse Off
A McKinsey study shows 81% of US Worse off Than in 2005, France 63%, Italy 97%.
Social mood reflects that study. Sponsoring asset bubbles in hopes of
trickle-down spending will do nothing but increase the anger.
There is not a damn thing central banks can do about this.
Central banks created the problem. Let me phrase that more accurately:
Central banks and their bubble blowing tactics are the problem.
Mike “Mish” Shedlock
