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THE FED & THE LAW OF GRAVITY

THE FED & THE LAW OF GRAVITY
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Álvaro Martín

Álvaro Martín

Estudiante de economía internacional. Defensor del libre mercado desde que tengo uso de razón. Una sola frase para cambiar el mundo: "Laissez faire". Autor de "IN DEFENSE OF FREEDOM", prologado por Daniel Lacalle, a la venta en Amazon y en la tienda online del Club de los Viernes.
Álvaro Martín

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After the disastrous beginning of the 2008 global financial recession, stock prices dropped to the bottom finally in 2009, when stock-exchanges all around the world recorded the lowest prices and highest volatility of the last decade. But in the first week of February of the present year, stock-exchanges all around Europe and North America recorded unbelievable volatility results never seen before, followed by unconditional shrinks in the price of shares. To display some data, we can make reference to the Dow Jones Industrial Average, which fell more than 8.5% last week, which resulted in a contraction of 2,200 points in the overall value of the index. In consonance with these results, the S&P 500 tumbled 7.9% in contrast with the last week of January. But this contractions in the prices of shares should overall not be very worrying, as they have just returned to last year's stable levels.

We should let aside all this "fantasy novel" type of arguments, and centre our analysis in what really matters, which are fundamentals and historical causes, taking us back to how central banks, and not just the Fed, dealt with the period just after the beginning of the 2008 financial recession. During the economic collapse of the time, many of us were astonished by how central banks responded to the crisis, causing Krugman to applaud each of their policies, as we saw the biggest credit expansions in history at the same time interest rates reached bare minimum levels, and even turned negative in some cases as that of the ECB, converting us in the clowns of global financial markets. It can be admitted based on empirical evidence that this type of expansionary policies helped to boost growth and took us back to stable GDP variations of positive 2-3% per year, but at the same time, global debt jumped over 325%/GDP… so, did we condemn the future trying to save the present?

If we look at any of the post-2008 Fed balance sheets, we will be able to observe how while rates dropped to the bottom causing loans and credit to explode the markets and create millions of unprofitable business models, the same central bank continued directing trillions of homemade dollars into financial markets and banks, generating cheaper credit and boosting spending to unprecedent levels. Which was the results (clearly expected)? Well, debt, debt and even more debt, preceded by the lowest saving rates in deposits of the last years. This is not the customers' fault, as if prices of stocks and yields of bonds just kept up rising, this shifted their investments towards these securities and kept money out of deposits. This trend finally caused the main central banks in the world to keep on with their QE policy, as they knew that sudden tapering would cause tremendous contractions in the price of securities, and the public will (correctly) blame them for having increased an unnecessary bubble. Well, the public except for Paul Krugman, who will always defend intervention in financial markets independently of its causes and effects.

Market interest rates are necessary to balance supply and demand between the various interacting economic agents in financial markets, permitting them finally to reach a stable equilibrium. In a real market system, without state or central bank intervention (a complete utopia) low interest rates will generate an excess of demand which will finally consist in greater inflation, dropping demand back to normal levels and causing rates to rise consistently to reach an equilibrium where the majority of consumers and suppliers will be satisfied. This shows that interest rates are not just an indicator in a balancing act, but also a reference in financial markets for entrepreneurs and borrowers to judge which production and consumption levels they can reach while being able to pay all their liabilities in a determined and fixed future. This is the reason why when central banks generate outstanding levels of credit artificially through monetary expansions, it pushes interest rates down, and makes market look like having a greater number of saved resources and capital than they really have, shifting funds into new businesses and industries that will be inefficient at realistic market rates.

The final bust always starts when the non-stoppable printing press of central banks slows down its pace and allows people to see how inefficiently they have allocated their capital based on false approaches to interest rates and liquidity, expecting future profitability that will never come due to a return to realistic levels of demand. In this case, markets shouldn't be blamed for greater costs, but central banks should for falsifying market information as prices and interest rates.

We should prevent central banks from reflating markets and creating new bubbles, as they just incentivize the law of gravity applied to financial assets.

THE FED & THE LAW OF GRAVITY

After the disastrous beginning of the 2008 global financial recession, stock prices dropped to the bottom finally in 2009, when stock-exchanges all around the world recorded the lowest prices and highest volatility of the last decade. But in the first week of February of the present year, stock-exchanges all around Europe and North America recorded unbelievable volatility results never seen before, followed by unconditional shrinks in the price of shares. To display some data, we can make reference to the Dow Jones Industrial Average, which fell more than 8.5% last week, which resulted in a contraction of 2,200 points in the overall value of the index. In consonance with these results, the S&P 500 tumbled 7.9% in contrast with the last week of January. But this contractions in the prices of shares should overall not be very worrying, as they have just returned to last year's stable levels.

We should let aside all this "fantasy novel" type of arguments, and centre our analysis in what really matters, which are fundamentals and historical causes, taking us back to how central banks, and not just the Fed, dealt with the period just after the beginning of the 2008 financial recession. During the economic collapse of the time, many of us were astonished by how central banks responded to the crisis, causing Krugman to applaud each of their policies, as we saw the biggest credit expansions in history at the same time interest rates reached bare minimum levels, and even turned negative in some cases as that of the ECB, converting us in the clowns of global financial markets. It can be admitted based on empirical evidence that this type of expansionary policies helped to boost growth and took us back to stable GDP variations of positive 2-3% per year, but at the same time, global debt jumped over 325%/GDP… so, did we condemn the future trying to save the present?

If we look at any of the post-2008 Fed balance sheets, we will be able to observe how while rates dropped to the bottom causing loans and credit to explode the markets and create millions of unprofitable business models, the same central bank continued directing trillions of homemade dollars into financial markets and banks, generating cheaper credit and boosting spending to unprecedent levels. Which was the results (clearly expected)? Well, debt, debt and even more debt, preceded by the lowest saving rates in deposits of the last years. This is not the customers' fault, as if prices of stocks and yields of bonds just kept up rising, this shifted their investments towards these securities and kept money out of deposits. This trend finally caused the main central banks in the world to keep on with their QE policy, as they knew that sudden tapering would cause tremendous contractions in the price of securities, and the public will (correctly) blame them for having increased an unnecessary bubble. Well, the public except for Paul Krugman, who will always defend intervention in financial markets independently of its causes and effects.

Market interest rates are necessary to balance supply and demand between the various interacting economic agents in financial markets, permitting them finally to reach a stable equilibrium. In a real market system, without state or central bank intervention (a complete utopia) low interest rates will generate an excess of demand which will finally consist in greater inflation, dropping demand back to normal levels and causing rates to rise consistently to reach an equilibrium where the majority of consumers and suppliers will be satisfied. This shows that interest rates are not just an indicator in a balancing act, but also a reference in financial markets for entrepreneurs and borrowers to judge which production and consumption levels they can reach while being able to pay all their liabilities in a determined and fixed future. This is the reason why when central banks generate outstanding levels of credit artificially through monetary expansions, it pushes interest rates down, and makes market look like having a greater number of saved resources and capital than they really have, shifting funds into new businesses and industries that will be inefficient at realistic market rates.

The final bust always starts when the non-stoppable printing press of central banks slows down its pace and allows people to see how inefficiently they have allocated their capital based on false approaches to interest rates and liquidity, expecting future profitability that will never come due to a return to realistic levels of demand. In this case, markets shouldn't be blamed for greater costs, but central banks should for falsifying market information as prices and interest rates.

We should prevent central banks from reflating markets and creating new bubbles, as they just incentivize the law of gravity applied to financial assets.

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