It’s a Central Banker’s World now! Buy the dips! Or maybe not…


It always amazes me that most people think that the effect of central bankers on the global economy is small. Its not just our resident critic here @ BATG. I went to a conference last year where a very conservative Christian financial advisor told me that the stock market was basically just about the great earnings. Bubble? I don’t see no stinkin’ bubble! Yet virtually daily other players say the most important thing to follow in markets is the lead of the central bankers (and oh BTW, none of these are Austrian economists).

This world is one in which central bankers are “all in,” said Katie Nixon, CIO of Northern Trust Wealth Management, on Friday.  Earlier on Friday, China’s central bank cut interest rates for the sixth time since November in another attempt to jump-start a slowing economy.  “Things aren’t so good in China, which is why they [central bankers] are being very proactive and very aggressive with a sixth rate cut in a matter of 12 months….So I think it sends a message to investors that central bankers will do what it takes to stabilize economic growth and to try to inflate economies.”

She is not alone; another suggests that any dips are just opportunities to buy since the central banks are basically guaranteeing the market:

Krishna Memani, Oppenheimer Funds CIO, called it an “adjustment process for the global economy that is going to take time and continue for a while.”  His advice for investors is to take advantage of lower interest rates. “That means owning equities and risky assets, and when you have corrections in the marketplace, like you did in August, you have to go in a bit more,”

China is aggressively moving in their own market, and the ECB is once again signaling they will extend their QE.  Even if the Fed tightens (which I don’t expect), global liquidity will continue to rise.  This global liquidity tends to result in imbalances, like record debt issuance by corporations (much of this to repurchase shares of stock to artificially increase earnings per share–i.e., financial engineering).

In a similar recent post, our resident critic says:

If you believe that interest rates are “too low,” I would ask, “How do you KNOW that? ”  If interest rates are too low, then you MUST have some preferred, even “natural” level in mind. What is that level? If you cannot articulate that level, then you have no reason to claim that they are too low. Too low compared to what?

I would once again refer our readers to an excellent economic educational resource, found here, :-) that answers this question, but I’ll copy it over for the BATG readers

Screen Shot 2015-10-26 at 10.45.37 PM

When the Federal Reserve provides additional reserves into the system, the effect on the loanable funds market is an increase in the supply of loanable funds as the Fed-created money appears to be additional savings.  This necessarily lowers the interest rate.  How much we cannot know, but we know that any Fed stimulus takes the interest rate below its natural rate.  So our critic’s comments are misguided; there is no doubt that the Fed is artificially driving interest rates lower than they would otherwise be.  A better question would be, “ok Haymond.  I’ll buy that the Fed’s actions are distorting the market, but since they are always distorting the market, and we don’t always have bubbles, why are you concerned now?”  This would be a more insightful and legitimate critique.

I must be much more cautious on answering this question, as we’re basically trying to ask when does the straw break the camel’s back?  Or in more contemporary language, where is the tipping point?  Another fundamental economic concept can help us think about this.  The concept of present value teaches us that any series of future cash flows becomes more valuable the lower the interest rate, since the interest rate is found in the denominator or the equation:

Screen Shot 2015-10-26 at 10.58.44 PM

When the Fed lowers interest rates, that makes every financial asset worth more (to the extent that the Fed-targeted interest rate affects the whole complex of interest rates, which is generally true). So we know that Fed policy is responsible for driving asset prices higher (which increases income inequality), after all Mr. Bernanke said this was part of his goal.  So when my friend the financial advisor says that the fundamentals and earnings are driving the market, one has to consider how much of the fundamentals are simply a reflection of the artificiality of the interest rate regime?  These are all counterfactual questions, i.e., they are unknown.  So when does this become a bubble?  My best answer is to look at this historically.  I get concerned when I see financial variables go “where no man has gone before,” (yes, that’s for you original trekkies).  Like the debt levels cited above.  Like the Chinese market doubling in the last year (and now halving).  Like the Fed keeping real interest rates negative for the last 6-7 years–something unprecedented in monetary history.

So no, I don’t know what will happen–nobody does or can.  But history and theory suggest it won’t end well.  Beyond the question of government management of the economy, and even beyond the bubble, I assert that there is still a question of morality:  monetary policies that help those with significant financial assets while harming those that need to earn small returns on savings accounts seem to me to be unjust.  But if you’re concerned about hedge fund managers, you can help them out by guaranteeing that any market instability will be met with more easy money.

9 thoughts on “It’s a Central Banker’s World now! Buy the dips! Or maybe not…”

  1. Jeff:

    Thanks for the insight. I love to read your posts and enjoy your bits of humor. Just a quick reminder for those like you that put their trust in Christ no matter how bad it ends for the markets those who invest their silver and gold in the kingdom of God will always get a good return. I have a question though. When things go south will there be a flight to safety and what will that be? Gold, Land…??

    Have you heard the joke about the rich guy who sold every thing he had and bought Gold so he could take one item to heaven? When he got there St. Peter opened his trunk full of gold and exclaimed, “Pavement…why would you bring pavement to heaven?”. Now that’s prospective.

  2. I really don’t have time for this, but I like to think myself as a nice guy…

    I think you are confused as to what I mean by a natural rate of interest. Your definition, which a reader has to infer, is far too simplistic and fails to account for desired rates of employment, commodities prices, demand theory, etc. As if the Fed were the only thing that can “distort” levels.

    As for that graph from your Godenomics like textbook, I think you would need more to persuade someone who does not accept your ideology. There are MANY other alternatives, starting with Wicksell’s…

    If the Fed has “distorted”[quotation marks are there for a reason] interest rates for so long so they are now “too low,” why is inflation so rock-bottom low?

    Why have all of the predictions regarding hyper-inflation over the last many years have been laughably wrong?

    Before you talk about the morality of penalizing savers, as if they didn’t freely make their own choices, think about how this country might be in the Fed hadn’t intervened during the financial crisis. It is pretty cold, if not immoral, to think that deflation and depression are good cleansing things, that the early 30’s were the good old days.

    If YOU believe that the Fed action has made interest rates too low, fine and dandy. I invite you to put your money where your mouth is by shorting government paper (long-term over many years, NOT a trade).

    Talk, after all, is cheap. Have FAITH in your ideas. If you are right, the market will demonstrate that such confidence is well-placed, since in time interest rates will move to a level of equilibrium, right?

    if you have faith in the market, go for it. Fight the Fed. And if you do, good luck out there!

    Back to my bunker, where I have far, far too much work to do in the time remaining this year.

    1. You say,
      As for that graph from your Godenomics like textbook, I think you would need more to persuade someone who does not accept your ideology.

      You continually denigrate substantive posts with false pejoratives in ad hominem fashion. This is yet another example. While it is true that my economic textbook is written from an explicitly Christian worldview, the technical content is from the best of economics and has nothing to do with my ideology. That particular chart can be found in almost any textbook on economics. The loanable funds framework would be accepted by almost every economist as the best conceptual way to think about interest rates. Yes there are alternative frameworks, including Keynesian liquidity preference theory, that would likewise agree that additional monetary stimulus will lower the interest rate from what it would otherwise be. We can disagree about the implications of lower than natural (i.e., outside what the market would do) rates, but you should not try arguing at the level of the Fed doesn’t lower the interest rate below what the market would do. That is simply in error. Even the Post-Keynesians had to finally agree the Fed can lower the interest rate at pretty much any level they want.

      You also continually bring up “hyperinflation” claims. I’ve challenged you repeatedly to NAME ONE Austrian monetary economist that has written warning about hyperinflation (George Selgin, Larry White, or Steve Horwitz) from the Fed’s QE. You have singularly failed to do so. And that failure is because almost all of us that approach monetary economics from an Austrian perspective begrudgingly held our nose with QE1, while condemning subsequent QE. I don’t care about newsletter writers or someone that once read something by Murray Rothbard–I’m interested in seeing a serious representation of Austrian scholarship that has said what you assert they continually do. Name one or stop the ad hominem.

      Finally, as for shorting, if you have ever shorted the market, you would know that TIMING is everything, and as I’ve repeatedly said, I am unable to time the market–short or long. As Keynes once said, “the market can stay irrational longer than you can stay solvent.” I may again short the market, but not until I see real monetary tightening. Right now the central bankers are truly “all in,” as the video above described, so its a bit early.

  3. Unfortunately, the Fed’s policies with regards to interest rates are not likely to change anytime soon. It is very easy to see the effect that the Fed’s actions have on the stock market, as announcements of new policies can change the outcome of day’s trading. Although it’s important to note that the Fed is not the only central bank that has an impact on interest rates and the global economy. The ECB pursues policies that are similar to those of the Fed. Additionally, the Chinese government manipulates the value of their currency to increase the value of their goods and economy as a whole.

  4. What would be the best course of action for the Fed now? While keeping interest rates low artificially has contributed to income inequality, what would increasing the interest rates do to those that are the poorest?

    1. First, there are no good actions because they’ve dug themselves a really big hole. But as always, the best option is to stop digging. So I would encourage the Fed to let their balance sheet roll off. As their short term debt instruments expire, don’t buy more. And then allow the market interest rate to adjust to what it would do with normal S&D considerations.

      As for the poorest, if interest rates rise, they would have have increasing incentives to save and a slight discouragement to consume (the opportunity cost of saving). That’s probably a good thing in general.

  5. Could you go into a little more of how these monetary policies are helping those with significant financial assets?

  6. I find myself having mixed feelings about Krishna Memani’s quote. I agree that investors, if they have the capacity, should look to invest more money into the market place after a correction occurs. This is consistent with general rule of thumb to investing: buy low and sell high. My disagreement with Krishna is because of the advice to take advantage of lower interest rates by owning risky assets. It is essential for investors to have a balanced portfolio that best fits their person needs. Investor also need to make sure that they do back ground research on stocks before making purchases and not just listening to what your Uncle Bob tells you to purchase at Thanksgiving dinner.

  7. The raw amount of power that the Fed wields over the American and world economy to a degree never ceases to astonish me. We know their specific abilities, but it is the power of influence that troubles me the most. Simple off-hand statements made by the chairwoman or other members appear to have the ability to turn whole markets upside down. I think it is always best to cautious when investing, especially when the words coming from the Fed might suggest otherwise.

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