Divorced from reality

There is a pervasive complacency about the economy; this despite sub-par employment, which remains far below pre-recession levels.

Also, factory activity seems to he shrinking.

Nevertheless, in the face of these facts, consumer confidence is rising and optimism, in particular in the financial community, prevails. Central banks and their printing of money are responsible for this generally improving mood.

To lower interest rates, the Federal Reserve Board will buy mortgage-backed securities and other assets without limit, or at least until unemployment rolls receded significantly.

Then too, the European Central Bank promised to buy as much government bad debts as necessary.  Furthermore, the Bank of Japan is going to buy $28 billion of assets, and China is easing credit restrictions. Hence, are “happy days here again?”

Despite general misgivings, the booming stock market remains divorced from reality. It certainly is no barometer of the economy or corporate profitability.

Gamblers and speculators may delight in the roaring stock market, but like the cartoon’s Road Runner who eventually noted there was no ground underneath his feet, markets also must face reality before long.

An observer should see that economic growth has not rebounded very much.

Governments and consumers alike are afraid of debt after the credit binge that lasted since the end of the Second World War. Economies and individuals simply cannot indefinitely spend more than they earn.

Government efforts to lower interest rates will not help because  what ails the economy has nothing to do with high interest rates. In the wake of the debt-driven financial troubles, everyone, households and businesses, will spend years in reducing down their huge debts, and therefore will not be encouraged by the lure of low interest rates.

Furthermore, borrowers who would like to take advantage of the extremely low mortgage rates, find that they are stymied by more restrictive lending rules.

At some point, everyone from credit card issuers to sovereign bond investors will take the view that the gargantuan mountain of debt cannot be repaid. Then they will stop lending or lend only in terms that reflect the borrowers’ declining ability to repay.

This eventually entails less spending by governments and consumers; then the economy will weaken. It should be noted that the savings rate of consumers is rising, as at last it is realized that governments must retrench.

These certainly are negative factors for growth. At best this means a tepid economic recovery.

 

Bruce Whitestone

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