US Stocks: Inflating Stock Market Bubbles Have No Economic Impact?

There is this impression that inflating stock market bubbles won’t have pernicious effects on the economy.

Such impression are likely manifestations of blindness from either (for bulls) overconfidence or (for bears) capitulation to current record stocks.

I have a simple example. I have X currency units. I have options. I spend these currency units on food, housing, or entertainment OR I can invest this in lemonade stand OR I can buy stocks. If I chose stocks over the rest, how will my choice affect price levels of the above variables? And now what if because of zero bound rates imposed by central banks such has induced a significant number of economic agents do the same way as I, how will these impact the economy?

Dallas Federal Reserve President Richard Fisher says that the above has a political economic context, it redistributes wealth in favor of asset holders or “a gift to the wealthy”…

you know that this gift of near-cost-free debt as measured in inflation- and tax-adjusted terms has thus far been used primarily to finance stock buybacks, increase dividends and fatten cash reserves, and recently, finance mergers by the most creditworthy companies. For those with access to capital, it was a gift of free money to speculate with. (One wag—I believe it was me—quipped that there was, indeed, a “positive wealth effect… the wealthy were affected most positively.”)…

Fed Chairwoman Janet Yellen says that such leads to overvaluations

Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year. Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of “reach for yield” behavior by some investors.

Aside from invisible confiscations, politically induced yield chasing in the financial markets engenders distortions in the economy. As example US 3Q economy has manifested doldrums in key private sector activities where much of the 3.5% growth has been due to a spurt in military spending, as business investment and consumer spending has been lackluster.

In addition, increasing engagement by firms in financial engineering via stock buybacks, M&A and or LBOs weakens corporation’s balance sheets which is even made pronounced by debt financing of such activities. Moreover systemic leverage which continues to mount poses as greater risks from a debt blowup. 

The misallocation of resources as Forbes’ columnist Michael Pollaro observed has been funneled to the financial markets which now serve as the epicenter of imbalances,

This current in-flight boom-bust cycle is fundamentally different. It has been largely about huge swathes of newly created money being injected directly into the pockets of financial market investors and speculators via the Federal Reserve’s asset purchase programs. Then, after levering up that swathe of money on the near zero rate financing orchestrated by that same Federal Reserve, those investors and speculators have largely been spending and re-spending that money in the financial markets. In other words, ground zero in this boom-bust cycle is the financial markets.

Even more interesting has been the results of the last US elections in the face of record stocks

Prior to the elections, surveys or polls like the Gallup suggested that the chief concern by the average American has been the economy. 

Yet even after elections, results from exit polls indicate that American voters were not as optimistic with the future. 

Notes the Wall Street Journal Real Times Economics Blog: (bold mine):Many American voters are wary of the current economic recovery, voicing concerns that an economy they find not so great won’t improve or could worsen in the next year, according to national exit poll data from Tuesday’s election. Voter concerns about the economy’s long-term trajectory were even more severe. Roughly half of the people interviewed as they left the polls said they expected life for the next generation of Americans to be “worse than life today.” White House officials have spent several months touting the economic recovery, noting the lengthy string of monthly job gains, two quarters of stronger-than-expected growth, and a shrinking budget deficit. The White House has tried to use these data points to draw a stark contrast between now and the state of the economy during the financial crisis. Likewise, many incumbent GOP and Democratic governors touted economic recoveries in their states.

Here is the outcome of the US congressional elections for both houses.

Senate election results (new york times)

House election results (new york times)

The outcome of the national elections has basically been a landslide for the GOP or Republicans in both houses which renders the POTUS a lame duck.

Curiously going into the eve of elections disapproval ratings for both parties were at either at record highs or near record highs. According to the ABCnews.com: Congress overall, for its part, has a 20 percent approval rating, one of its worst heading into a midterm election in polling dating back even farther, to 1974. With something there for nearly everyone to dislike, a bipartisan 77 percent disapprove of its job performance.

In sum, despite record high stock markets which has benefited mostly the elites who are most exposed to the stock market (see chart from zero hedge), the average American chose between the devil and the deep blue sea. The frustrated average voting Americans largely ousted the incumbents represented by the Democratic party because of economic issues. It can be read that such eviction signifies partly a backlash against record stocks. Let’s see what happens when the bubble implodes. 

Will there be riots, calls for secession? We will see.

The  spurious claim that inflating stock market bubbles have no or little impact to the economy would seem like “As economic booms progress, greed mounts and the excuses become thinner, more nearly gossamer bubbles” to quote historian Charles Kindleberger in his classic Manias Panics and Crashes A History of Financial Crises (p 191) .

As for the US Congressional elections I seem them as a farce, where both parties mostly share the same essence. To quote Judge Andrew Napolitano at the Lewrockwell.com

The two major political parties are more alike than they are different. On the two paramount issues of our day — war and debt — they are identical. With the exception of Democratic progressives and Republican libertarians, the two parties stand for perpetual war and perpetual debt. Both stances increase the power of the government, and each invites present and future destruction.

US Trembler: Volcker Rule or Bernanke Confirmation?

``What we do want, what we insist upon, is that no longer will decisions that carry so much economic weight be made in absolute secrecy. We want to know what arrangements the Fed makes with other governments and central banks. We want to know who is benefitting from the actions of the Fed and what deals are being made. The Fed is already reacting to pressure by scaling back its liquidity facilities and returning to more traditional monetary policy through direct asset purchases. With nearly $800 billion in mortgage-backed securities on its books already, $800 billion in Treasury securities, and no real limit to what the Fed can acquire, there is a tremendous opportunity for malfeasance. We need to know who the Fed deals with, what they buy, how much they spend, and who benefits. As good as any step towards Federal Reserve transparency is, anything less than full disclosure at this point is unacceptable.”-Congressman Ron Paul, Anything Less Than Full Disclosure is Unacceptable

The meltdown in the US market’s have largely been attributed to the proposed Volcker Rule, where US President Barack Obama endorsed Former Fed Chair Paul Volcker plan to overhaul the banking sector’s risk taking activities by restricting in house trading activities or proprietary trading and by preventing them from also investing in hedge funds or private equity operations.

While reducing the banking system to its original function of warehousing (deposit safekeeping) and loan services (acts as intermediary to finance business undertaking) would seem pretty ideal, the radical approach to “cleanse” the banking system of the so-called “greed” appears to be in reaction to the massive political capital loss suffered by President Obama at the hands of Republicans in the recent Massachusetts senatorial election, reportedly one of the main bailiwicks of liberal forces in the US.

The electoral loss signaled Obama’s health reform bill as losing popular support, which may likewise translate to a mighty comeback for the GOP (Grand Old Party) in the upcoming 2010 senatorial elections. The prospects of the Republicans back at the helm of the Senate risks enervating Pres. Obama’s programs, hence like all politics, desperate times calls for desperate measures.

The massive loss of political capital meant that President Obama had to piggyback on a popular issue, which at this point has been no less than to bash on the highly unpopular banking sector to regain some points.

Nonetheless while we mentioned that reducing the banking sector to its basic function should have been ideal, the Obama-Volcker tandem has merely been passing the buck.

They’ve fundamentally ignored the role of government failure that led to the recent two boom bust cycles, which essentially had been due to easy money policies, albeit for the recent housing bust these should have included the skewed capital regulations that encouraged excess leverage and regulatory arbitrage, housing policy that pushed home ownership by subsidizing mortgages and regulators sleeping at the wheel or in cahoots or captured by the industry, as well as, tax policies that encouraged debt take up.

Policymakers frequently deal with the superficial, it has never addressed the roots of “too big to fail” which is largely a product of crony capitalism emergent from bubble policies.

As per Constantino Bresciano-Turroni as quoted by Gerard Jackson ``The increase in banking business was not the consequence of a more intense economic activity. The work was increased because the banks were overloaded with orders for buying and selling shares and foreign exchange, proceeding from the public which, in increasing numbers, took part in speculations on the Bourse. The banks did not help in the production of new wealth; but the same claims to wealth continually passed from hand to hand.”

In other words, the so-called banker’s greed is a result of policy based support to the banking sector, and it’s kindda obvious where this leads to-another Potemkin village or poker bluff.

Unfortunately these desperate attempts by the US President risks unforeseen consequences, considering that major banks engage in these activities have been supported by the US government.

This translates to policy contradictions which increase the overall risk environment thereby heightening uncertainty, and thus, perhaps the market’s sharp reactions.

Figure 6: stockcharts.com: S&P ETFs By Sector

Well based on the sectoral performance by the S&P ETFs, the materials, financials and energy took the brunt of the recent selloffs, these implies that since China has emerged as a major force in the demand for commodities then the fall in materials and energy could have been construed as China related and the fall of the Financials as imputed on the Volcker Fund issue.

Figure 7: Danske: US treasuries

Moreover, this week’s meltdown didn’t come with higher interest rates. Therefore the issue wasn’t about funding, interest rate and or rollover risks. Instead the lower yields signaled a supposed flight to safety as Danske Team indicates above (right window) which has been corroborated by a rising US dollar.

Considering that the net supply of bonds have shriveled due to Fed QE purchases, the selloff wasn’t also indicative of concerns over exit plans.

One analyst offered a conspiracy theory and wrote that for the US to be able fund its intractable deficits she would need to engineer a stock market crash, as the frightened public (domestic and foreign) will likely buy into US treasuries. Although I would tend to dismiss this as normally outrageous, as any short term benefits will offset by medium to long term losses, desperate politicians may embrace almost anything silly for as long as it could preserve their privileges or power.

Lastly there is also the issue of the Ben Bernanke’s reconfirmation as the Federal Reserve chairman. Considering Mr. Bernanke needs 60 votes in the Senate to extend his term, the current anti-bank sentiment has prompted several Senators to cross partylines and move against extending Bernanke’s tenure which expires on January 31^st.

``According to a Dow Jones Newswires tally, 26 senators have said they will back him; 15 have said they will oppose him. The remaining 59 haven't said what they will do. Under Senate rules, the earliest a vote could come is Wednesday,” notes the Wall Street Journal.

So why could the market crash with Bernanke’s confirmation in the line?

Perhaps Connecticut Democrat Senator Christopher Dodd, a Bernanke backer, gives us an inkling of what Ben Bernanke may or may not do, "I think if you wanted to send the worst signal to the markets right now in the country and send us in a tailspin, it would be to reject this nomination."

In other words, there seems no easy or better way to get reconfirmed than by holding the market hostage!

Yet all these political muddling makes us wonder, why would US debt get supported when regime uncertainty appears to be snowballing? Why should the US dollar become the safe haven when the pillars of central banking appear to be in jeopardy?

Other than all three variables-China’s efforts to quash a homegrown bubble, the US Volcker Fund brouhaha or the Bernanke confirmation controversy and fears of default Greece default-the markets could be looking for an excuse to correct.

So who says the markets are solely about the economy?

Gallup Polls: Filipinos Say US Election Matters, McCain Slightly Favored

Politicking is the lifeblood of Filipinos.

So even US elections are considered to be an important issue to Filipinos. That’s according to Gallup Polls.

From Gallup, ``The Philippines and the United States share strong historical ties and maintain close bilateral relations, which President Gloria Macapagal-Arroyo seeks to further expand. The United States has also traditionally been the Philippines' largest source of foreign investment and is one of its largest trade partners, so Filipinos have a vested interest in the next U.S. president's policy toward their country and their economic and diplomatic partners closer to home.” (highlight mine)

The latest survey shows nearly a majority of 49% of Filipinos considers the US elections as important, the rest are distributed as 27% no difference and 24% undecided.

And when considering the preference for the next US President, among all the countries surveyed by Gallup, “only Georgia and the Philippines” appear to support Republican Candidate Senator John McCain in a world overwhelmingly dominated by Democratic candidate Barack Obama supporters. It’s a nearly a 4-to-1 margin for Sen. Obama! (Wow Filipinos as contrarians, incredible!)

Here are latest Polls results …

Broken into regions, the National Capital Region (NCR) seems always the hotbed for the opposition even during local elections and is the only region in the Philippines where the pro-Obama preference has a clear edge.

The rest of the survey you can find in the Gallup article here.

As for my choice: None of the Above.