Wednesday may have seen a very important development for the financial markets
and, by extension, for the world economy. But before explaining what and why, it
is worth stressing that what is important for the markets is not necessarily
important for the real economy, and vice versa. There is a widespread tendency
to judge countries and regions on the basis of how their stock markets perform;
the most charitable explanation for this is that stock markets provide a quick
and easy method to measure what is happening.
But what is good for the
markets is not the true measure of economic health, at least for “the 99%” –
i.e., the general public. On the other hand, it is an excellent measure of the
well-being of “the 1%” – the rich elite who own pretty much everything and seek
to tell the “sheeple” what to think.
Nevertheless, there are times when
the markets do reflect the real economy, although these times have become
steadily rarer over recent years – and for a very good reason. As the degree of
central-bank intervention in the financial markets has grown, the ability of
those markets to fulfill their basic function of “price discovery” – meaning
what a financial asset, such as a company’s shares or a country’s bonds are
actually worth – has become increasingly impaired. To put matters plainly: The
financial markets are now warped, and the prices they generate are increasingly
distorted. Since this process of distortion is deliberate, it is not unfair or
inaccurate to say that the markets are rigged.
However, since the rigging
is being done by central banks and not individual speculators, it is not
politically correct or even polite to use words such as “rigged,” “manipulated,”
etc. Central banks are public bodies, key agencies of government that have an
added advantage over mere elected politicians in that they are “independent” and
are perceived as repositories of expertise.
Thus the policy pursued by
central banks since 2008, of massively expanding the quantity of money they pump
into their economies – via a combination of ultra-low interest rates and
“quantitative easing” (QE) – is seen as both necessary and sensible, mainly
because the respected central bankers experts say it is. It is also “good,” in a
policy sense, because it is aimed at improving the state of the economy by
generating faster growth, more employment and so on.
Which brings us to
Wednesday (midday in the US, evening in Europe and here), when the Federal
Reserve Bank’s Open Market Committee announced the results of its latest
deliberations. The announcement was that the Fed would buy $45 billion worth of
US Treasury bonds and another $40b. worth of mortgage-backed securities every
month during 2013 – a total of almost $1 trillion. But since this merely
extended what the Fed has been doing since September, and the continuation of
this program in 2013 had been universally expected, this announcement was not
the important event mentioned above.
The other element of the
announcement – that the duration of the Fed’s very expansionary monetary policy
would henceforth be defined in relation to specific levels of inflation
expectations and of unemployment, rather than in terms of time (such as “until
mid-2014”) – was surprising.
The formal adoption of this new approach had
been expected only next year. But the substantive shift is also potentially
significant, although economists’ views as to how important it is vary widely
But the truly important event was what followed: For the
first time, the markets failed to respond enthusiastically to the announcement
of a new Fed program of QE. After an initial jump up, on a very modest scale
compared to previous occasions (80 points in the Dow Industrial index, for
example), the markets retraced this and ended the day either flat or down. Once
again, although the share-market indices attract the most attention, they are
not the best indicators of relative importance.
Far more significant, and
potentially ominous for both the markets and the real economy in the US and
everywhere else, was the fact that Treasury bonds paid no attention to the
announcement. Bond prices fell on the day and yields rose, which, in the face of
an announcement of continued and expanded purchases of bonds, is strange, to say
The mainstream analysts glossed over the tepid and even
negative market reaction to Fed Chairman Ben Bernanke’s latest move. By
contrast, the anti-establishment bloggers saw it as a signal that the Fed has
“run out of ammunition.” It has done everything it could think of to stimulate
the economy, with very mediocre results, and has nothing left except more of the
same, which, given the very weak data relating to the real economy, is clearly
not good enough.
Who is right? The answer should not be long in coming.
If, over the next days and few weeks, yields on Treasury bonds of seven, 10 and
30 years’ duration continue to rise – to 3 percent and then 3.1% on the 30-year,
for example – then a fundamental change has occurred in the markets. This change
would signal that confidence in the ability of the Fed and other central banks
to push things in the right direction, even artificially, was eroding and would
be a grim portent for 2013.