MarketWatch reports today that the Fed chairman vows to act aggressively until central bank confident the economy is ‘solidly on the road to recovery’.
According to the Federal Reserve, apparently the only function of the capital markets worth considering is that of providing returns to investors. More specifically, returns in the form of price appreciation. Income via interest and dividends is of no moment. The Fed will do whatever it takes to get stock and bond prices higher, but does nothing to help them pay interest and dividends. This reduces the yield of these investments, and the earnings they produce for each unit of price, making them less valuable to investors even as their prices rise.
Nor do capital markets play a role in allocating capital to those projects that most efficiently provide the goods and services people want at the least cost to resources. The possibility that this function has underpinned the success of the US economy in producing some of the highest living standards in history seems not to have occurred to the Fed, because it is determined to “act aggressively” to make sure that all projects get capital, regardless of merit. Since the Fed can produce no real capital, only paper claims on capital, this necessarily means that projects with greater merit will go wanting.
Guggenheim CIO Scott Minerd summed it up neatly on Twitter today:
“The Fed has made it clear that it will not tolerate prudent and responsible investing.”
Social Capital CEO Chamath Palihapitiya said on CNBC:
“On Main Street today people are getting wiped out. Right now, CEOs are not, boards that have horrible governance are not. People are … What we’ve done is disproportionately prop up poor-performing CEOs and boards …”
The Fed’s delusion is all the more apparent in Powell’s statement that “We entered this turbulent period on a strong economic footing and that should help support the recovery.”. Comments like these can only be made by excluding debt from consideration. Anyone can temporarily look prosperous by maxing out their credit cards.
As it turns out, corporate America’s balance sheet was extraordinarily weak entering this period. Goaded by years of ultralow interest rate policy, corporate debt grew to its highest level in history as corporations borrowed and bought back stock, diverting a disproportionate share of corporate wealth to insiders with stock option compensation packages. This is why the financial and economic reaction to the COVID-19 is so much larger than it was to the even more deadly 1918 Spanish flu pandemic. Given the Fed’s role in hollowing out corporate America’s balance sheet and blowing out the wealth gap, it’s understandable that it may want to promote the narrative that the economy was strong going into this, but until there are signs the Fed is considering a different policy paradigm than what created this weakness in the first place, it’s not at all clear why we should be so confident in our economy’s future.
So what does the market think about this? On the surface, it looks like it thinks the value of corporate America rose by 1.87% today (US Total Stock Market fund VTI). That means it likes what Powell had to say, right? But wait … remember that the price of anything is just the ratio of its value to whatever unit you’re pricing it in. So did stocks increase in value, or did dollars decrease? No way of knowing … unless we look to other forms of money.
As it turns out, the value of gold rose by 2.55% today … in dollars, that is (iShares gold fund IAU). Or looked at the other way around, the value of dollars fell a like amount … in gold. Either way, though, the value of corporate America decreased by 0.68% relative to mere chunks of inert metal.
Let me say that again: On this supposedly economy-supporting announcement from Fed Chairman Powell, the market value of corporate America decreased by 0.67% relative to mere chunks of inert metal.
But it’s just one day, right? A fluke.
Yet that didn’t stop financial media from cheering the Fed’s announcement as having raised stock prices. We’re just pointing out that stocks actually fell in terms of real money.
But let’s take a longer view. The first twenty years of this century, from 2000 0101 to 2020 0101. That also lets us exclude the destructive effects of the new coronavirus, yet it spans a period in which central bank market interventions were greater than ever before.
How did the Fed’s support of the economy over twenty years work out? In dollar terms, gold rose from $288.44 to $1531.55. That’s 5.31 times. Let’s compare that with US stocks (Dow Jones U.S. Total Stock Market Total Return Index). To be generous, we consider the total return of stocks, including dividends. The total return of the US stock market was 3.45 times. Again, that’s in dollar terms. So in terms of something the Fed can’t devalue, however – gold – stocks fell to less than 0.65 of their market value twenty years earlier. That’s a decline of over 35%.
So over twenty years of Federal Reserve economic support, the market value of corporate America decreased by over 35% relative to mere chunks of inert metal. All while the corporate elite has feasted as the average American gets crumbs.
No thank you Mr Chairman. We would do better with less, not more, of that kind of support.