The US stock market rose 2% last week based primarily on the perceived wisdom of various central economic planners around the world. Mario Draghi announced a new bond buying program in Europe designed specifically to circumvent the verdict of the market and prop up the governments of the peripheral countries. There are conditions which the beggar countries must meet before the ECB will enter the market for their bonds but ultimately what the program does is substitute the wisdom of the ECB for the wisdom of the market. Not an even trade in my opinion but one traders seemed to like a lot. European stock markets were up roughly double the US market. That the program does nothing to solve the long term problems facing Europe was apparently lost in the rush to buy stocks.
China’s central planners were also busy last week and sustained the rally Friday even after a US jobs report that was pretty awful even by recent standards. The Chinese government approved a slew of new infrastructure projects totaling $158 billion that will be built over the next few years to complement the infrastructure they’ve built over the last few years that largely stands idle. The Chinese have apparently rediscovered the formula for stagflation with industrial output slowing while inflation most certainly is not. The modern day pyramid building in China lit a fire under the stocks of all manner of companies that will provide the raw materials needed to rebuild the Road to Serfdom. Emerging markets rejoiced, up over 5% in two days.
The lousy US jobs report Friday was embraced as further evidence, if any was needed, that our very own Federal Reserve will join in the central planner party by announcing another round of quantitative easing at this week’s meeting of the FOMC. Whether they do or not really makes little difference. The mere expectation of further Fed action has already had an impact with the dollar falling against most everything in sight, including the hapless Euro. In other words, the easing – or more accurately, the inflation – has already occurred. The CRB commodity index is up nearly 17% since its late June nadir while gold is up 14% from its low. That it has happened in the context of a slight contraction of the Fed’s balance sheet is irrelevant. The Fed may yet announce further measures that continue the inflation but the market isn’t waiting on the details.
And so, even as markets rejoice at the renewed application of the Keynesian prescription, we at Alhambra mourn that the day of true recovery has been delayed once again. One of the central insights of Friedrich Hayek was that government interventions cause distortions that lead to more interventions to correct the distortions of the previous interventions. We are so far along the spiral of the Road To Serfdom that a reversal of course at this point would likely involve considerable pain but the current path is far from pain free and will in the end cause even more pain. For those who own stocks or commodities or the other objects of desire that encompass the central planners plan, the benefits of further “stimulus” far outweigh the costs. For those who are the nominal targets of such plans, the costs – of most everything – rise while the benefits remain elusive.
The employment report that turned up the volume of calls for QE 3 starkly demonstrates the ineffectiveness of the current economic program. The unemployment rate dipped to 8.1% but that hardly tells the whole tale. We are 3 years into a so called recovery and the monthly job figures are still within the margin of error of 100,000 jobs per month and not even enough to offset population growth. The unemployment rate dipped because more people gave up looking for a job than found one, a trend that is now well established and disturbing to say the least. I have often compared this period to the 1970s and while there are differences between the two periods, the workforce participation rate is not one of them. We have well and truly wasted all of the progress of the last few decades in the short period of two Presidencies. We have spent 12 years devaluing the dollar by spending beyond our means and to believe that the solution is more of the same is insanity.
More appalling is the moral bankruptcy of both our major political parties who are separated on economic policy merely by the form of their economic delusions. Mitt Romney has vowed to attack the Chinese for manipulating their currency for a trade advantage that is now all but gone. As I’ve said in the past, there are consequences for any country that adheres to bad economic policies and the Chinese are reaping the stagflation whirlwind of their past currency excesses. Anything else of value in the Romney plan would likely fall victim to the fallout of a trade war he promises to start on his first day in the Oval Office.
President Obama’s only plan appears to be to continue doing what he’s done for the last 4 years only with more taxes. He promised that “over the next few years, big decisions will be made in Washington, on jobs and the economy; taxes and deficits; energy and education; war and peace”. That all these decisions being made in DC might be part of the problem is not something that would occur to a President whose confidence in his own abilities is undiminished by the ineffectiveness of his policies. He merely promises to make these decisions better than his counterpart as if either has sufficient knowledge to make them at all.
Stocks have reacted positively to these pronouncements of more central planning but in the end it cannot last. Higher levels of government spending are associated with weaker economic growth and higher levels of inflation. Neither condition is positive for the long term valuation of stocks as weak growth limits the top line and inflation ultimately erodes the bottom line. As for the short term, central planning, whether monetary or fiscal, affects the markets and the economy by distorting prices. As investment advisers we have to take these effects into account and try to position our portfolios accordingly. It is an exercise in wealth preservation rather than wealth creation and that should tell you all you need to know about the current state of global economic policy.
P.S. I’ve just read through this and I know it is more depressing than what you are accustomed to hearing from me. I am an optimist by nature. I blame it on the just finished political conventions neither of which offered much hope for those of us who believe in liberty. It is disheartening to believe that Obama and Romney are the best we have to offer for the job of President. America faces a choice in November of big, crony capitalist government or bigger, crony capitalist government. It is hard to maintain my optimism knowing that no matter who gets elected, our economic problems are unlikely to be solved anytime soon. Having said that, I believe there will always be innovative companies and individuals who will see through the distortions of government intervention and succeed. It is our job as advisers to find them and rest assured I will continue to do my best to do just that.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: email@example.com or 786-249-3773.
Click here to sign up for our free weekly e-newsletter.