This site spends little time discussing and analyzing central banks’ policies. Some of the media’s preoccupation with central banks reflects an ideological endorsement of command and control SLL does not share. There are people, mostly well-educated, who actually believe that economies with millions of producers, consumers, and businesses, engaging daily in billions of transactions, can be directed by a group of central bank bureaucrats manipulating short-term interest rates and exchanging the government’s debt for their own fiat debt. Historically Efficacious Government and Central Bank Control of Economies is an even shorter book than The Humility of Donald Trump. The titles of both are longer than the contents, but while faith in central banks waxes and wanes, it never dies. Some of the aforementioned preoccupation is journalistic and analytical laziness: it’s easier to speculate and report on central bank statements and policies than it is to determine what’s actually going on with an economy.
SLL devoted two paragraphs to the Fed’s latest move, and the thrust of those paragraphs was that markets had already marked up rates for a substantial segment of borrowers, starting about six months ago, and the Fed, as it usually does, was following the market. The Fed’s zero rate federal funds target took short terms rates lower than they would have been absent that Fed policy. Europe and Japan’s negative interest rates are an even greater distortion from free market rates. However, the global economy was burdened with more debt than it could sustain back in 2008, when the Fed kicked off the global central banks’ easy credit campaign. That excess of debt ensured that interest rates would remain low by historical standards (for the most creditworthy borrowers), whether central banks intervened or not.
Credit expansion and contraction have two constituent elements: psychology and hard economic reality, and the former is more important than the latter. From too indebted in 2008, the global economy has gone to an even more indebted extreme, led by governments and central banks. The change from debt expansion to debt contraction is not based on some hard ratio of debt to ability to service it, but rather on the psychology of the herd changing from optimism to pessimism.
By late last year it was objectively clear that crashing commodity prices, particularly oil, would impair the creditworthiness of commodity producers (see “Oil Ushers in the Depression”). Every debt is someone else’s asset. Fraying creditworthiness, given this accounting identity and the inextricably intertwined nature of credit in the debt-based global economy, will spread from any significant part of the economy to other parts of the economy. Commodities qualify as a significant part of the global economy. They are certainly a bigger sector than the US housing and mortgage-finance market was in 2008, and we need no reminder that the housing implosion turned into the global financial crisis. So it was also objectively clear late last year that deteriorating creditworthiness in commodities would not remain confined to commodities.
Nevertheless, it has taken most of this year for the equity herd to get the joke. It has watched the hole of Fed policy and not the doughnut of the global economy and souring credit. Who says they don’t ring a bell at the top? Credit markets have been clanging since mid year. Interest rate spreads on commodity producers debt widened first, followed by financial stress and actual insolvency and bankruptcies in that sector. The stress has spread. What is erroneously referred to as “contagion,” is actually a widening margin call: deteriorating asset prices and shrinking economic activity pressure related industries, forcing cutbacks and asset sales. This contraction has been reflected in financial markets, where deteriorating liquidity for lower-quality credit of all issuers, not just commodity producers, has forced mutual funds and exchange traded funds that invest in those credits, faced with surging redemptions, to either sell at fire sale prices or bar redemptions until, they hope, prices improve.
Markets are nothing if not bipolar, so the stock market staged a euphoric rally after the Fed announced its rate hike Wednesday. However, with the Fed out of the way, it was back to the depressing reality of credit contraction and the shrinking global economy. Thursday the market gave back the entire rally, and Friday the Dow closed down 367 points.
On a day-to-day basis, SLL makes no attempt to predict what markets are going to do. However, if the ever-changing speculative psychology has switched from Fed-preoccupation to contemplation of the abysmal state of the global economy and the ongoing credit carnage, the next two weeks may be “interesting” in the sense of that old Chinese proverb. Many traders and institutions have already closed their books on the year and will not be transacting. Thus, a falling stock market may encounter even less buy-side liquidity than when the herd scatters during “normal” market drops.
Or perhaps the market just meanders, or rallies. Nobody is infallible in these matters, which is why it’s best to stay focused on economic and financial reality. Right now, regardless of what the stock market does before New Year’s, that reality looks bleak.
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