Stocks sold off a little yesterday, after hitting all-time highs on Tuesday.
Investors must feel confident; sentiment is overwhelmingly bullish. Investors don’t think the Fed will taper any time soon.
They’re right about that. The betting is that tapering will not occur before mid-summer or fall of next year. Our guess is that it won’t happen then either…
But who knows? We’re ready for anything… Boom? Bust? Bubble? Anything is possible.
This financial world that we live in is completely new. There are very few data points from history that help us understand it. And those there are tend to be incomplete and inconclusive.
The feds changed the money system 40 years ago. Thenceforth, we’ve been in a brave new financial world. From a gold-backed monetary system pre-1971, managed by nobody, they switched to a system based on paper money, managed by people with Ph.Ds. The idea was that rather than be stuck with a fixed quantity of money, economists could figure out how much money was needed and provide it as necessary.
This was not the first time the authorities had tried. Several times in history, nations found paper money a convenient way to pay their bills, typically when they were at war and had run out of real money.
But this was the first major episode — in peacetime — when the whole world’s financial systems had come to depend on a paper money controlled by a single nation, the United States of America.
Gresham’s Law tells us that ‘bad money chases out good money’. This means that if people have a choice between holding debased or deteriorating money (paper) or holding real money that is not losing value (gold), they will choose to hold the good money and pass along the bad stuff.
In effect, that’s what happened. The good money (gold) disappeared. The bad currency (dollars) became what everyone recognised as ‘money’. Central banks, too, generally decided that the prudent thing to do was to hold some gold…as well as US dollars.
And now that the developing countries are becoming more prosperous, not surprisingly, their central banks too are accumulating gold.
Dollars are not the same as real money. They are really short-term debt instruments – Federal Reserve Notes. The US government tells us to use them as ‘legal tender for all debts, public and private’. But it makes no guarantee of their value. They are really the opposite of money. Instead, they are debt instruments of immediate maturity.
Real money has value. It does not depend on the issuer to do anything more. Once a debt is paid in real money, the transaction is finished. Over. Completed. Not so with US dollars. They are debt. And debt depends on the debtor. If he defaults, his paper promises can become worthless…including his dollar bills.
As dollars replaced gold, the capitalist system became a strange and grotesque amalgamation of market-based transactions, but with less and less real capital. Real money was replaced with debt. Gradually, debt spilled over and saturated all sectors.
Households, business, finance — everyone became drenched in debt…from the recent college graduate with his student debt, to the young family with its mortgage and credit card debt…to the retirees, depending on the unfunded liabilities of the Social Security and Medicare systems.
And when this tsunami of debt threatened to drown millions in the deleveraging crisis of 2008–2009, the powers-that-be rushed to the scene with aid. But what help could they give? More debt!
There was no way they could afford to let so many debt-soaked institutions sink. They made it clear they would give the economy as much new liquidity as it needed.
And now…even the faint suggestion that they might be getting tired of pumping so vigorously — $85 billion a month — staggers the market for stocks.
But where does all this new liquidity go? No one knows. Some say it disappears, because the banks are unwilling to lend.
Others say it never comes into existence at all. And others maintain that it is preparing another tidal wave to wash over the markets; they expect to see stocks, houses…everything that can float…rise up to unheard of levels.
One way or another, it may be that Mr Market is preparing some real excitement. It will be fun to watch…from a distance.
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