Easy Money Policies Encourage Financial Risk Taking; NOT Capital Investment

by Victor Sperandeo with
the Curmudgeon

Disclaimer: As usual and unless otherwise noted/attributed, all opinions expressed herein are those of Victor Sperandeo (called “the man for all markets” in a 1983 Barron’s interview).


Victor expresses his view that central bank easy money policies have ended free markets as we know them and he explains why companies don’t invest in their own business.’  He also speculates as to when the financial mania “free money” policies, which have sparked several asset bubbles, may be soon coming to an end.  Note that the Curmudgeon’s companion article (published earlier today), cites three reputable sources which come to similar conclusions.

Ineffective Monetary Policies Carry High Risk:        

We have written critically and at great length about the unconventional monetary policies of the Fed/FOMC, ECB, BoJ and other central banks in the last 7.75 years.  In the US, it’s hard to imagine the mentality of the FOMC to risk the unknown consequences of rounds of QE and maintaining ZIRP for so long and to such an extreme?  All this reckless policy propped up financial assets, but resulted in the lowest GDP growth of any economic recovery in the history of the US (2% annual GDP growth from the end of the “great recession” in June 2009). 

In my humble opinion, that is more than irresponsible, it is risking a political and economic cataclysmic endgame. 

Asset Markets Way Up while Capital Investment Lags Badly:

So why are the stock, bond, and real estate markets being bought in lieu of starting new or expanding old businesses?  In an environment that has interest rates at the lows for 5000 years?  Taxes and regulations, or an anti-business agenda is my answer.  Fiscal policies have not only been ineffective; they’ve been counterproductive to real economic growth.

Except for an occasional new dot-com firm like "Snapchat," start-up companies, or business expansions are as rare, as seeing a mountain lion in Manhattan.

First, the "Dodd Frank" legislation has made it very onerous to loan money to new firms. Also regulations are “over the top” business killers.  For example, to get a Cosmetologist License in California takes 1600 hours / 3200 Apprenticeship + 220 related training hours and 400 hours! 

Second, the ACA/Obamacare was (and is) a tax redistribution scheme made to look like health care. It has caused a complete change in the way business is done from full time, to part time work, without benefits. As former President Bill Clinton said last week: "It’s the craziest thing in the world."

So why start a business or expand an existing one?   Instead, why not buy Amazon, or your favorite company/portfolio, which already has lobbyists, lawyers, and all the legal registrations to do business in all 50 States.

An investment in a listed stock requires no management time, board meetings, legal filings, compliance with environmental laws, regulators to deal with, union problems, lawsuits, or investors to answer to. Also it is 100% liquid.

In addition, if you sell stock (or other asset) at a profit in 1 year +1 day you get favorable US income tax treatment (20% long term capital gains tax + medical excise tax of 3.8%, but there may be State Income Tax owed).

Meanwhile, US Corporate Income Taxes are the HIGHEST in the developed world1 at a 39.6% average, which includes State income taxes.

Note 1.  The US has the third highest general top marginal corporate income tax rate in the world at 39.1% (consisting of the 35% federal rate and a combined state rate), exceeded only by Chad and the United Arab Emirates.  Source: Wikipedia

The "Tax Foundation" ranks the US # 31 of 35 countries for overall score and 34 of 35 in "International tax rules rankings." The US tax code remains uncompetitive globally, while Estonia's again earns the distinction of being the most competitive tax code in the developed world.

Global Central Banks Have Destroyed Free Markets:   

The essence of what global central banks are effectively doing is ending Capitalism and Free Markets. When you peg or force an outcome, like Japan’s Central Bank (BoJ) just did at targeting their 10 year JGB interest rates at zero, the free market has ended.                                                             

Martin Enlund, Chief FX strategist at Nordea said:                                                                                                                                      

"The Bank of Japan's new framework is more significant than commonly appreciated. BoJ has voluntarily given up control of its balance sheet. Real rates will eventually plunge, prompting both bond sales to BoJ as well as JPY negative outflows. Should more stimuli be required, the Japanese government has now been given a ‘helicopterish’ carte blanche by the BoJ."

Apparently, central bankers have no concern that a free market's purpose is to determine price discovery. This ends what markets are meant to do, and puts a man/group of central bankers in charge of the impossible!

This will always fail as central bankers cannot have the knowledge to replace a market. But it will cause buyers to bid 101 per par value (=100) bond so if yields go negative they will make a profit, if not they lose "1" when the bond matures. The market's function is gone. The supply and demand, or the desire of what investors and consumers want becomes a guess, left up to a bureaucratic czar. This is pure 100% Socialism. It eventually turns out like Venezuela – an economic basket case.

The goals and consequences of are suggested by the Financial Times (FT) on 9/24/2016 in an editorial titled: "The growing challenge to central banks' credibility." (on-line subscription required):

"Ever more radical policies are meeting ever greater skepticism…. For the past year, central banks have resorted to ever more ingenious methods to convince a skeptical public that they still have the ability to create inflation. This week, the Bank of Japan yet again broke ground in monetary policy, pledging to overshoot its 2% inflation target and adopting a new tool to do so, in the form of a promise to cap 10-year bond yields at zero.

BoJ has consistently failed to hit its existing target. And there is a widespread perception that the BoJ has decided to target yields chiefly because it will soon struggle to find enough bonds to buy under its previous strategy of asset purchase targets."                              

Does it take a PhD in Economics or Finance to see the incredible fallacy of this BoJ "plan?" The elephant in the room is Japan’s goal of 2% inflation? Why 2% inflation, which is a hidden tax to the public?  Answer: Japan’s debt would be cut in half in 37 years, which was the original plan.  The debt was NEVER INTENDED TO BE PAID BACK by the Japanese government at face value, but in devalued yen.

Another FT editorial, published 10/08/2016 and titled: “Bubbly finance and low inflation spark alarm” notes that central bankers haven’t learned from past lessons and are letting bubbles inflate.

There is an equally frightening disconnect in the world’s financial markets. Equity prices, which represent claims on the proceeds of future growth, have risen sharply in the past five years, even though growth expectations have been revised down almost everywhere.

Bond markets seem oblivious to risk: no matter how long the duration, or how dubious the credit, investors are buying securities with yields that are derisory or negative. House prices in the US are approaching their pre-crisis level. In the UK they are above that level. In Canada they are far above it.

The cause of this alarming froth is extraordinarily loose monetary policy. Nobody denies this obvious fact, but plenty of thoughtful commentators argue that central banks should nonetheless continue to create money. To a financial historian, unfortunately, this debate recalls an awful time. We have seen a version of this movie before. It did not end happily…

Central bankers must remember a basic lesson from history. It is always easy and tempting to find reasons not to act against bubbles. But financial stability matters at least as much as price stability. In today’s distorted markets, savers are paying borrowers for the privilege of lending, pension and insurance funds can’t earn the returns they need, and banks struggle to earn profits. All of which may threaten growth as much as very low inflation.

Victor’s Conclusions:

Does the "public have to be convinced central banks can cause inflation? The issue begs the question, why has the BoJ not met its goal?  My answer is demographics, high and rising taxes, and extreme regulations, present not only in Japan, but in every country that is not growing (e.g. U.S. UK, most of Europe, etc.).

What is rarely stated in the press is that the US and Japan, each have seven tax brackets.  Inflation not only diminishes purchasing power, it also forces you into higher tax brackets to pay more taxes.   Such a system will impoverish "the people" and create the end of the middle class (which has greatly decreased in the past decade).      

The endgame begins after US GDP is reported at the end of October.  It’s now projected to be 2.1% by the Atlanta Fed (down from 3.8% in late August). That’s followed by the US election on 11/8/16.  Who wins doesn't matter in the short run.  Lastly, the Italian Referendum (12/4/16) in which a NO vote (my call) on reforms would be a big problem for the President Matteo Renzi, and later for the EU.

Central Banks, especially the Fed, have lost credibility, and have no ammo left.  Only bull...talk on the dollar. I think the recession starts in the first quarter of 2017.  With few bullets left in their arsenal, will Central Banks only be able to watch it unfold?

End Quotes:

The future can be seen from the experiences of the past. Who better to lead the way then the man who wrote the Declaration of Independence: Thomas Jefferson -one of our founding fathers who served two terms as US president:

"The end of democracy and the defeat of the American revolution will occur when government falls into the hands of the lending institutions and moneyed incorporations."  Thomas Jefferson, speaking on the first attempt to establish a Central Bank in America.                                                                                                   

Lastly, a quote from “Anonymous,” that’s been incorrectly attributed to Jefferson:

“The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.”

Good luck and till next time...

The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

Copyright © 2016 by the Curmudgeon and Marc Sexton. All rights reserved.

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