Time article (economy)

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Time article (economy)

Postby Menelvir » Wed Sep 19, 2012 8:00 am

I found some points I liked in this article, 'The S&P soars, the Economy Snores', from the latest issue of Time magazine, 'The Curious Capitalist' column by Rana Foroohar, former Deputy Editor in charge of international business and economics for Newsweek, previously the London-based correspondent covering European economics and the Middle East.

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The markets hold many mysteries (insert image of Ben Bernanke, brow furrowed, gazing into a smoky crystal ball). Here's the biggest right now: Why the heck is the S&P 500, up by double digits this year, behaving as though we're living large when nearly every piece of real economic data is depressing? Europe is imploding. China is still growing but slowing. Manufacturing is down worldwide, as are exports. In the U.S., the workforce hasn't been this small relative to the population since 1981. Moody's is threatening (again) to downgrade our credit rating if Congress can't avoid the fiscal cliff next year. But while it is absolutely true that the economic fundamentals don't support bullish markets, it's also true that stocks aren't behaving irrationally. So, how to square the two facts?

First, there's the Occam's Razor explanation: U.S. stocks, as well as T-bills, are simply the nicest houses in the ugly neighborhood that is the global economy. "This year, for the first time since 2007, it's likely that U.S. growth is going to outperform global growth", notes Ruchir Sharma, head of emerging markets and global macroeconomics for Morgan Stanley Investment Management. Americans think the 2% economy is terrible; in Europe, it would be a gift. Investors may be raising their bets on an Obama re-election -- the S&P rises in line with prediction markets' views on his chances -- and thus more stimulus. The bottom line is that the year-to-date performance of U.S. equities has surpassed everything from gold to oil to bonds to any kind of emerging market stocks.

That's exactly what Bernanke wanted, and in fact, the Fed chairman helped create that outcome with asset purchases (known as quantitative easing, or QE) and very low interest rates, pushing bond yields down to multicentury lows and pushing people into riskier assets like stocks. It's obviously worked. Part of the point of QE is that low rates drive up asset prices, and higher asset prices make people feel richer. This "wealth effect" prompts people to spend, so companies start investing and creating jobs to meet rising demand. Or so the theory goes.

But not everyone owns stocks, and the richest 10% of the population owns 75% of them, so to the extent that anyone feels richer, it's those who already were. And you can't stage a true economic revival with only 10% of the country spending. There are many, like Sharma, who say that Bernanke has placed too much faith in a bullish market's ability to boost consumption and that the Fed has inadvertently exacerbated the inequality by trying to stroke the economy. The rich get richer. Everyone else has to deal with energy and food inflation paycheck to paycheck.

There's also the problem of the $2 trillion in corporate cash under the mattress. Just as QE has not sparked a private spending boom, it has also not yet ignited a large-scale corporate one. Some who take the long view, like Warren Buffett, see cheap money as providing a uniquely good moment for capital investment. His Berkshire Hathaway companies are investing a record $9 billion this year, 90% of it in the U.S., in areas such as railroads, construction, and utilities. But most Fortune 500 firms, if they are investing, are often doing it abroad, where growth potential is higher. Others are hoarding cash and enjoying the resulting stock price premium without risking any of it to create jobs.

Either way, the further a company is from the magic money wands of Bernanke and his European counterpart, European Central Bank chairman Mario Draghi, "the greater the asset-valuation drivers tip away from central-bank policy and toward economic fundamentals", says Mohammed El-Erian, the CEO of Pimco, the world's largest bond trader. "This explains why Chinese equities, for example, have so underperformed their developed-market peers."

None of this means that Bernanke was wrong to try and avoid trouble with a dose of QE. Things could have been much worse, as indeed they are in Europe, where austerity programs have delivered recession. But in game-theory terms, he got it wrong. Bernanke believed he was playing a cooperative game: if he did his part, politicians would do theirs, and no, I'm not talking tax cuts but tax simplification and investment in the stuff that creates a more attractive business climate, like education and infrastructure. Instead, Americans have had to deal with the most dysfunctional political environment in decades. And since most economists agree that the QE effect on markets is now largely tapped out, the outlook for investors is clear. Either we start seeing real economic good news or there will be no mystery about which way stocks are headed.
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