When the news came out the other day that the economy contracted by a surprising 2.9%, the stock market seemed to defy common sense and rose to near all-time highs.
The reasoning is that stocks are forward-looking, and that Q1 is yesterday. But if that's true then when exactly did the stock market ever take into account the contraction? The stock market hasn't had anything approaching a correction since 2011.
If you are wondering why the stock market simply doesn't care about bad news anymore, you might want to look at this report.
Whereas 20 years ago only a small number of public investors carried genuine weight in investment markets, the proliferation of such institutions is now a fact of life. Central banks’ foreign-exchange reserves have grown unprecedentedly fast, especially in the developing world.That's $29 Trillion, with a 'T'.
The OMFIF research publication, Global Public Investor (GPI) 2014, launched on June 17, is the first comprehensive survey of $29.1 trillion worth of investments held by 400 public-sector institutions in 162 countries.
The most troubling part of this news is the entities that print money out of thin air, the central banks.
Rivaling NBIM is now the State Administration of Foreign Exchange (SAFE), part of the People’s Bank of China, the biggest overall public-sector investor, with $3.9 trillion under management, well ahead of the Bank of Japan and Japan’s Government Pension Investment Fund (GPIF), each with $1.3 trillion.The most obvious problem here is the conflict of interest that develops between governments and their assets, now major owners of multinational corporations. Remember that central banks are usually made up of private banks who speculate on those very same assets being purchased.
Another large public-sector equity owner is Swiss National Bank, ranked the world’s No. 10 GPI measured by market assets, with $480 billion under management. The Swiss central bank had 15% of its foreign exchange assets — or $72 billion — in equities at the end of 2013.
Those assets are being purchased worldwide, including in the United States.
One concern is that these central bank purchases have become a global asset grab.
Finance is the new form of warfare – without the expense of a military overhead and an occupation against unwilling hosts. It is a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means?Central banks are very secretive. In almost all cases, we are not allowed to look at their books.
— Dr. Michael Hudson, Counterpunch, October 2010
Central banks have always bought and sold assets, usually sovereign bonds, but Quantitative Easing is that action on steroids.
Lately there has developed a nagging fear that quantitative easing is itself the cause of global deflation.
Another obvious problem is that asset prices, $13 Trillion of which the wealthy hold in tax havens, are being bid up by institutions that can literally create money out of nothing.
Why is that troubling? Other than the inequality is pushes out on society. Other than the conflicts of interest involved. There is another troubling reason that may not have occurred to you - that asset prices are pushed far beyond their underlying values.
Why does that matter? It matters for reasons that John Maynard Keynes described 80 years ago.
Asset prices and reality
The best example of this can be seen in Japan.
Benchmark 10-year bonds failed to trade on April 14 for the first time since December 2000 and didn’t change hands during two morning sessions last week.The Japanese sovereign debt market is one of the largest debt markets in the world. The fact that no one, no one at all, was trading in it for days at a time should be a huge concern.
“It’s difficult because the business is shrinking,” Hiroshi Kunimura, the director of fixed-income trading in Tokyo at Barclays Plc, one of the 23 primary dealers obliged to bid at government bond auctions. “Because we’re in an environment where traders take positions at auctions only to sell them at BOJ buying operations, trading volumes with investors struggle to increase.”The Bank of Japan has become the market for sovereign debt. If the BoJ ever decided to stop buying, the market would collapse and interest rates would skyrocket. Even now, the BoJ is hinting that it won't ever be selling these assets. A nation carrying public debt to GDP of 230% cannot afford rising interest rates.
But if no one will purchase your debt except for your central bank, and your central bank backs and represents your sovereign currency, then it is only a matter of time before faith in your currency collapses.
Japan is trapped. Specifically, they are in a liquidity trap.
Major global economies find themselves caught in a worldwide liquidity trap.Dallas Federal Reserve President Richard Fisher said in a speech a few months back that depository institutions are sitting on $2.57 trillion in excess reserves, when the norm before the crisis was $2 Billion.
A liquidity trap occurs when a central bank feeds cash into the private banking system and that money is hoarded, rather than being put to constructive use, as a result of concerns about the likelihood of deflation or falling demand.
Our current situation results from the huge infusions of cash from the Federal Reserve by way of its quantitative-easing programs.
The Federal Reserve purchased 71% of all Treasuries for sale last year, and it now owns far more treasuries than China.
Like the Bank of Japan, the Fed has no intention of trying to sell these assets anytime soon.
“The rate of acceleration with which the Federal Reserve is purchasing Treasuries should be alarming to all Americans,” said Shelby.It's safe to say that most Americans are not alarmed by this, but bond traders are. This is being revealed in the derivatives trading desks.
The boom in fixed-income derivatives trading is exposing a hidden risk in debt markets around the world: the inability of investors to buy and sell bonds.This lack of trading volume, another way of saying a lack of liquidity, has many concerned. This is the reason why traders have poured into the derivatives market.
While futures trading of 10-year Treasuries is close to an all-time high, bond-market volume for some maturities has fallen a third in the past year.
“Liquidity is becoming a serious issue,” Grant Peterkin, a money manager at Lombard Odier, which oversees $48 billion, said in a June 11 telephone interview from Geneva. The worry is that when investors try to exit their positions, “there may be some kind of squeeze.”The drop in liquidity is not limited to just bonds. The drop in volume is spread far and wide and traders are simply leaving the markets. This creates the fear that there won't be anyone to sell to when asset prices begin to fall.
But what if the entities that are buying can create money out of thin air? What if the purpose they are buying is political, rather than for financial gain? What if their portfolios are opaque so that no one knows who owns what?
In other words, what if the price of assets all over the globe don't reflect their "use value"? In othere words, what if the price of these assets don't reflect what they are worth?
Neoclassical economists won't recognize that there is a problem, for starters. More importantly, they won't recognize that enormous and crippling inefficiencies are appearing in the global economy because neoclassical economists still believe in the efficient market theory - that price always reflects value.
A distorted price produces malinvestment, and it is the malinvestment that destroys value, not the price crash than comes later.