commentary
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Everybody knows what a market is, right? Wrong. Today we have market places that look and sound like the real thing. But they are not markets. A market place should be dominated by ‘economic players’.
These players buy or sell in the pursuit of profit. Their actions are rational. Normal-trade buyers and sellers share one thing in common with speculators – the pursuit of profitable outcomes. Normal-trade buyers and sellers and normal speculators are often joined by an uneconomic player – government.
Government generally seeks to distort markets and move prices to politically palatable levels. Herein lies the problem. Traditionally when government interfered in markets their actions were limited by their own financial resources. Therefore distortions were limited. Today governments appear to have unlimited financial resources – they print money. This leads to two interesting questions. Firstly, just how badly are markets distorted? Secondly how much longer can this go on for?
Most capital markets for corporate equities are severely distorted. The same can be said of many global property markets. However the capital markets for corporate bonds and particularly government bonds are clinically dead!
Distorted Markets - Stocks
The US stock market is a case in point. When the normal forces of demand and supply are inhibited prices become distorted. The actions of the US central bank (Federal Reserve) ensure that demand for stocks is bolstered and the financial regulatory framework enforced by US regulatory agencies ensures that the supply of stock in a market downturn is restricted. These regulations are often referred to as ‘circuit breakers’. Speculators and investors are encouraged to buy and prohibited from selling in a fast moving downward market. Put simply, the US stock market is gamed to bubble upwards.
The Federal Reserve has stated many times that it targets higher stock market prices. It is not a secret. Their view is that by cutting interest rates and buying bonds they will encourage funds into stocks. This will have a wealth and confidence effect on consumers. Thus it indirectly helps the economy. The Federal Reserve has in effect given market speculators an insurance policy. This policy is often referred to as the ‘Fed Put’. If the stock market looks like it is going lower the Fed will adjust its polices to encourage it higher. Thus speculators can borrow and buy.
Other Central Banks play more directly on their respective stock markets. The Bank of Japan (‘BOJ’) prints new currency and buys stocks. Their total spend of roughly $250Bn has actually made them a major shareholder in a large number of companies. The BOJ created (printed) the money to buy these shares.
Perhaps the strangest distortion in stock markets has been made by the Swiss Central Bank (‘SNB’). The SNB owns shares in 2500 companies in the USA. Its largest shareholding listed at the end of 2018 was $2.5Bn in Apple. The SNB created (printed) the money used to buy these shares. In fairness to the SNB their share purchases are incidental. In order to suppress the value of the Swiss Franc versus the Euro they created new francs and sold them for Euros. This left them with literally hundreds of billions of Euros, some of which they converted to Dollars and bought shares with.
The Peoples Bank of China (‘PBOC’) is a law onto its own. In combination with other government agencies it virtually directs and commands its stock markets.
Suffice to say that central banks are large players in global stock markets. But they are unlike all other players. They are not motivated by profit and loss. They are not constricted by the normal laws of economics such as supply and demand. They conjure up money out of thin air to support stock markets broadly and in some cases they buy stock directly.
I think it is safe to conclude that most of the world’s major markets for shares are distorted by government interference. Furthermore it is reasonable to speculate that were it not for central bank activity stock market prices would be lower.
Clinically Dead Markets - Bonds
Bond markets are where governments really come into their own. Bonds are instruments that governments use to borrow money. They issue them into the market place in exchange for cash. They are usually created and issued by the finance ministry. Large public corporations also issue bonds for cash. All of these bonds can be exchanged many times by buyers and sellers in the market place. If prices are bid upwards, interest rates decline and vice versa.
Central Banks buys bonds and they buy lots of them. The ECB is a major player here. They buy governments bonds throughout Europe and they buy corporate debt as well. So much so, that they crushed the market place. Corporate and government bonds exchange hands at prices which equate to negative interest rates. There is no economic rationale for this. The prices for these bonds are not arrived at by an inter-play between normal rational buyers and sellers. Prices are effectively set by the ECB. This is no longer a market. The European market place for corporate and government bonds has existed for hundreds of years. It ended about 5 years ago.
The Bank of Japan is the major player in the market for Japanese government bonds. In fact they own 50% of all the bonds ever issued by the Japanese government! The prices paid for government bonds in Tokyo are not a function of any economic calculation by market participants. In affect prices are administered by a government agency – the Bank of Japan.
It sometimes appears as though the clever fund managers that buy bonds yielding negative interest rates on behalf of their clients are unaware that they could possibly lose money.
The Chinese and American markets have similar government interference. It is plain to see that some of the world’s largest and most important bond markets no longer function. Government interference has raised the price of bonds to economically impossible highs – negative interest rates! It is reasonable to speculate that without government interference bond prices would be lower worldwide and interest rates would be higher.
It should also be noted that international capital chases yield in low interest rate environments. This tends to bid up property prices around the globe. Property markets are not clinically dead, but they are manifestly manipulated upwards by central banks pushing interest rates lower.
Conclusion
Conventional investors in stock, bond and property markets are unaware of how manipulated they are. This makes them utterly unprepared for the next crash, and there is always a ‘next’ crash.
