In a free-market economy, with a stable currency, bank lending would be for the purpose of financing production of real goods and services, not to fund leveraged buyouts or stock repurchases by corporations to pump up earnings per share artificially. Long-term investors such as insurance companies and pension funds would use the savings of individuals to fund expansion of corporations’ plant and equipment, based on rational expectations of long-term profit generation.
Of critical importance, in a free-market economy individual and corporate debt would be limited by the borrower’s actual, not imagined, ability to repay the debt.
Increasingly since the October 19, 1987, Black Monday stock market crash, the stock market has become a forum for rampant speculation and imprudence on a massive scale. That turn away from fundamentals is the direct product of the Federal Reserve’s flooding the financial markets with liquidity to buoy the stock market averages. Since then, in the 1990s dot.com speculative boom-and-bust and the Long Term Capital Management collapse in 1998, through the implosion of the housing bubble and the bankruptcies of Bear Stearns and Lehman Brothers in 2007-2008, the pattern has been the same: whenever the stock market dives or financial institutions waver, the Fed immediately endeavors to rescue them with massive infusions of monetary liquidity through book entries on the Fed’s books of account, i.e., via creation of money out of thin air. Needless to say, the Fed’s money creation vastly outstrips the growth of America’s real production of goods and services.
Today, even after the cold-water bath of 2007-2008, individuals, financial markets speculators, and especially the Federal government, continue to live on borrowed money, in amounts that far exceed their capacity to support the prodigious amounts of debt. Before the 2007-2008 economic crash, the Fed held a bit less than $800 billion in Treasury securities. Through artificial creation of dollars, the Fed today holds more than $3.2 trillion of Treasuries and mortgage-backed securities, a four-fold expansion, with little to show for it outside Wall Street.
Evidencing the stock market’s dependence on the Fed’s loose money policy, today’s Wall Street Journal notes that, “Stocks were dragged down by concerns over what stronger-than-expected U.S. growth might mean for Federal Reserve policy…” In other words, improvement in the real economy is a negative factor for stock and bond market speculators. At today’s market close, the S&P 500 index was 1747.15, a 132% increase from its 2008 low of 752.44. Wall Street speculators have been well rewarded by the Fed, but inflation-adjusted income of Main Street workers has risen hardly at all. In the case of retirees living on fixed-income investments, incomes have dropped sharply because the Fed is suppressing interest rates far below real market levels.
In all the events answered since 1987 with the Greenspan put, the Fed appears to have assumed that the stock market is the same thing as the underlying real economy. Little attention was paid to what was happening in the latter, as skyrocketing debt financed huge imports of cheap merchandise from China and Southeast Asia, driving non-government employment and real (inflation-adjusted) wages down in the United States. Market analyst Jim Grant noted during the last Bush administration that annual increases in consumer goods imports from China were financed by the boom in home equity loans, which in turn were fueled by the Fed-created housing price bubble.
Meanwhile in the real world, as inflation-adjusted family income declined, we became less able to support mounting personal, corporate, and government debt.
Fed chairman Alan Greenspan, during the dot-com stock market run up, did caution Wall Street against “irrational exuberance,” but quickly backed off when the stock market averages declined. Similarly, in May of this year, Fed chairman Bernanke hinted that the outlook for then-anticipated improvement in the real economy might lead to tapering off the Fed’s monetary policy of quantitative easement (QE3). When long-term interest rates jumped sharply and the stock market cratered, Bernanke too backed off, and the Fed Board voted to continue inflationary monetary expansion indefinitely. The stock market, of course, responded with a resumed upsurge.
Highly-regarded market strategist Byron Wien recently, in Barron’s website, wrote, “…unemployment is likely to remain high and capital spending, ordinarily contributing importantly to growth at this stage in the cycle, will remain low. Operating rates in the U.S. are below 79%; capital spending picks up when they are in the mid-80%–90% range. Consumer sentiment is likely to remain unenthusiastic in this environment, preventing retail sales from reaching a robust level.” He expects, nonetheless, that the Fed’s continued market support will lead to higher stock market averages.