Blain’s Morning Porridge – June 5th 2019 – Memo to Chairman

Blain’s Morning Porridge  – June 5th 2019

“It is up to all of us to fight our unrelenting enemies – complacency, overconfidence and conceit…” 

In the headlines this morning:

US employment is at a high, the labour market is tightening, there is minimal real inflation and the stock market is off to the races because the Fed says its ready to ease if trade tensions impact the stock market economy.

In 35 years of markets, this is perhaps the stupidest moment I’ve ever seen.

On Friday we’re likely to see another decent US employment number – which should give lie to the illusion the US needs zero rates. But a strong US jobs report will cause the spoilt brat of a stock market to wail, in fear it might not get another lollipop of easing…

If I had any hair left to tear out… I would.

There is a danger Powell et al seem are confusing the Dow and S&P for the health of the economy, thereby making the Fed complicit in the ultimate market distortion that’s being going on since someone dreamt up QE. The World’s most important central bank is missing the point completely, and more or less promising to bail out stock markets if Trade Tensions causes them to weaken. That is an open cheque.

Memo to Powell:

Dear Chairman

The Stock Market is not a driver of growth – it is the price investors are willing to pay for their perceptions of the future value of stock market assets, a price which is relative to other assets, including factories, property, intellectual capital and infrastructure. 

Do not confuse the stock market with the economy. 

“Trade war” weakness may worry investors about the value of their stocks, but, should equally cause investors to finance and build new economic assets (ie factories, farms, infrastructure, schools, etc) to benefit from the opportunities “trade war” opens long term to the US economy. 

While reducing rates to near zero levels to finance a Trade War with China may seem a logical decision, experience shows the unintended consequences of zero rates will achieve sub-optimal results. Since 2009 “lower for longer” rates have not caused a regeneration of manufacturing, infrastructure or other productive assets. Instead, low rates have encouraged corporates to buy back their own stock, pay their owners larger bonuses and dividends, and fooled investors to buy these same stocks as the most attractive relative asset – which is distortion. 

A second unintended consequence is burdening the economy with unproductive assets and obsolete capital assets. Corporate borrowing to convert equity into debt raises systemic weakness across the economy. The Darwinian Selection process which drives growth and causes firms rise and fall according to their ability to manage themselves becomes distorted and lose momentum, leading to too many weak zombie indebted going-nowhere companies to block market niches more nimble new firms could more profitably fill. 

The long-term consequences are long-term rentier behaviour by owners, and declining real wages (and rising income inequality) as productivity across the nation slides as capital assets are not replaced and upgraded. 

Long term, considered fiscal and monetary policy, investment in replacing obsolete infrastructure, and the normalisation of interest rates to levels that create real returns to encourage real investments (into productive capital projects) rather than unproductive financial investments (such as already distorted stocks), would benefit the economy.

There is, however, a strong argument that 10-years of financial distortion through low interest rates, and the deliberate transfer of risk assets from the now heavily regulated banking sector into the more diverse investment management sector, now leaves the pension savings of millions of Americans vulnerable in the case of a stock market downturn. 

This is an issue for the committee to determine…   

The fact The Fed is feeding the stock markets addiction to low rates will also play to Trumps re-election is irrelevant(ish).

(I composed the above in my head while cycling into the office this morning. It was a bit of a struggle. I didn’t realise till I got to The Tower of London that my back tyre was flat!)

Short comment this morning as I’ve got to run to a meeting in West End..

Out of time – back to day job…

Bill Blain