Naive Beliefs And Misplaced Fears
Readers suggested a topic on the latest Federal Reserve action. “Another morning but with a fresh dose of QE3. So what do we see from this recent injection and how it will impact our lives?”
One asked, “In addition to how it affects the economy monetarily anf fiscally, I would also like to see a discussion on how Q3 affects how people view the country and the world, both short- and long-term. What I find mind-boggling is the farce that government (i.e. taxpayer) spending is going to preserve the ‘wealth’ of housing. This time in the form of mortgage bond purchasing. The housing market is much beyond being saved through artificial means.”
“The real means of support are being destroyed (for starters, monetary wealth of consumers). I also wonder how this will affect the psyche of a people over the next 40 years. This is insanity. What happens when this doesn’t work?”
Another asked, “Who are they going to buy all these mortgages from? Are they going to take all the cr@p from fannie and freddie? This does nothing to help me or you. Continuous bailout of the big banks. Maybe you can invest in facebook since you cant get a yield anywhere else? 5 dollar gas on its way?”
Finally, “So let me get this straight: The Fed is gonna purchase $40 bn/mo in MBS until the jobs come back. Isn’t this something like the idiot who insists on pounding his head against the wall until the pain stops?”
The Associated Press. “The Federal Reserve wasn’t just trying to drive down interest rates when it announced a third round of bond purchases Thursday. It also wants to make people feel wealthier — and more willing to spend. The idea is for the Fed’s $40 billion-a-month in bond purchases to lower interest rates and cause stock and home prices to rise, creating a ‘wealth effect’ that would boost the economy.”
“And ‘if people feel that their financial situation is better because their 401(k) looks better or for whatever reason — their house is worth more — they’re more willing to go out and spend,’ Chairman Ben Bernanke told reporters. ‘That’s going to provide the demand that firms need in order to be willing to hire and to invest.’”
“Many economists worry that the Fed is reaching a point of diminishing returns after nearly four years of aggressive efforts to help the economy. Bernanke himself urged everyone to keep expectations in check. ‘I personally don’t think that it’s going to solve the problem,’ he said Thursday. ‘But I do think it has enough force to help nudge the economy in the right direction.’”
From CNBC. “The euro zone’s debt crisis is just the center of an ‘adjustment’ which is affecting all advanced economies, former European Central Bank (ECB) President Jean-Claude Trichet told CNBC. All the advanced economies are undergoing their first major adjustment since the Second World War, according to Trichet. ‘When you look with historical credit at what has happened since 2007, it was the start of the adjustment of the advanced economy. We have to understand– it’s our turn. We cannot ask the rest of the world to finance us eternally if we spend more than we earn. As simple as that,; he said. ‘We paid quite a high price for a dominant vision, which was too much benign neglect before the start of the crisis.’”
“He also highlighted several ‘naive beliefs’ from policymakers in the pre-crisis days, including the belief that the developed world’s financial and economic systems were ’stable and resilient’ because they absorbed the dotcom bubble bursting in the early years of the twenty-first century.”
“Central banks across the board in the advanced economies - including the Bank of Japan and the U.S. Federal Reserve, are engaged in ‘non-standard measures’ to protect their economies, he pointed out.”
From Macleans. “Four years after a major banking crisis rocked global finance, the economy seems stuck in a permanent state of pessimism and panic. Investors have taken to stashing their cash in government and corporate bonds, sending their prices skyrocketing and causing some analysts to worry that speculative bubbles are forming in what have traditionally been considered low-risk investments. Even farmland in Iowa has become a safe haven for worried investors, who have sent prices shooting up 24 per cent in the past year despite the worst drought in half a century.”
“‘It may sound odd, but we appear to be witnessing a speculative rush away from rational risks,’ Paul Justice, a director of research at Morningstar, wrote in an April report. ‘We are in a fear bubble.’”
“Granted, investors have plenty to fear these days. The eurozone appears on the verge of collapse. China’s growth is slowing. The U.S. seems incapable of reining in its debts. There’s the LIBOR scandal that saw global banks manipulating a key interest rate, casting fresh doubts on the strength of the financial system. The markets themselves seem hopelessly manipulated: by central bankers who print money like it’s going out of style and then use it to buy back their own debt; by automated trading systems whose software glitches have created and destroyed millions in artificial wealth; by Facebook and its disastrous IPO. But is the fear really justified?”
“The Bank of Canada has held interest rates at one per cent for the last two years—levels once thought reserved only for full-blown economic meltdowns—perpetuating the widespread belief that Canada’s relatively strong economy is perched on the edge of a precarious cliff.”
“So where is all the money going? Since 2007, nearly US$350 billion has left the stock market and nearly US$1 trillion has been stashed in bonds, according to the Investment Company Institute. Yields—the interest paid on the bonds—are at lows not seen since the 1940s. Germany, Denmark, Switzerland, Austria and Belgium have seen negative yields this year as European investors ran from sovereign debt crises in southern Europe.”
“Negative yields are exceedingly rare—with good reason. They essentially mean investors are paying for the privilege of lending money to governments. But they are becoming more common as investors risk everything to pay for the safety of the governments least likely to default on their debts. As the so-called bond bubble grows, it risks setting off a domino effect of other potentially troublesome and equally counter-productive trends. Low yields on government bonds have pushed investors into buying corporate debt, driving interest rates on corporate bonds to historic lows. That is sparking a wave of new issuances as companies jump on the prospect of being able to access cheap debt even as they stockpile huge sums of existing cash.”
“The glut of money piling into bonds and pushing interest rates down has also done nothing to encourage governments to rein in spending, since they can simply issue more cheap debt. Global public debt, according to the Economist’s debt clock, topped $48 trillion and counting this year, up from $29 trillion in 2007.”
“Carleton University economist Nick Rowe blames central banks for creating an atmosphere of uncertainty that has made it difficult for investors to know just how bad things might get before they start getting better. Investors who lock their money away in 10-year government bonds in the belief that the global economy is on the verge of a precipice can actually push the economy further into recession. Uncertainty is creating fear, and fear becomes a self-fulfilling prophecy. Rather than spurring economic growth, low interest rates have the added effect of forcing households to set aside even more cash for their retirement when they’re earning nothing on their investments.”
“But just as the U.S. real estate bubble was predicated on a belief that house prices only go up, bond investors are fooling themselves if they believe that bond prices—in the midst of a 20-year bull run—can never fall. Bond expert Marilyn Cohen warns the fear bubble building today will eventually burst. ‘I’ve lived through a lot of bear markets on bonds and it’s painful and terrifying, and people who thought if they were in bonds they couldn’t lose any money had their Jesus moment that they were wrong,’ she says. ‘When it comes unwound—and it will come unwound—it’s going to be one massive, ugly situation.’”
“So perhaps, after all, there is good reason for fear—it’s just misplaced.”
