Artificial sweeteners have been the subject of health concerns. Aspartame, for example, has been found to be a migraine headache trigger. Products containing it carry a health warning for PKU, a rare hereditary disease. Today we learn that diet sodas markedly increase the risk of pre-term deliveries. See Add Diet Soda to the List of Things to Avoid While Pregnant.
Similarly, the Federal Reserve and the Administration have not trusted that the economy can heal through natural market forces. Instead we have been served up the economic equivalent of artificial sweeteners. Concerned by slow growth, not even negative growth, the government again is firing up the machinery for money printing and stimulus.
- The Federal Reserve announced in the beginning of this month that it was going to use the principal and interest payments on its own portfolio to purchase US Treasury debt. What this really means is that by September it will own an additional $18b of debt. One suspects that this is the opening of a second round of Quantitative Easing; that is, the government purchase of its own debt. See New York Fed will Buy 18 billion of Treasury Debt in Nine Operations
- President Obama recently signed a $26b aid bill to the states to prevent public sector layoffs.
- The Administration has floated the idea of forgiving $1 trillion of Fannie Mae- and Freddie Mac-underwritten mortgages. See Obama Mulling Massive Debt Relief Forgiveness Program
- Alan Greenspan opines that a rising stock market will do wonders for the economic recovery. Once again, he is implying that government should stimulate the market. See Greenspan: New Stock Market Bubble Needed
In each instance, the government is intervening, distorting, and artificially “sweetening” the bond market, the housing market and, indirectly, the stock market. What are the consequences?
There is No Free Lunch
Martin Hutchinson in The Peril of False Bottoms targets faulty government policy as the reason for our anemic economic recovery. Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets. A false bottom is defined as a stabilized “price far above the likely long-run price equilibrium of the assets concerned.”
Bernanke has precedent for providing excessive liquidity and holding interest rates too low for too long. Greenspan reacted to the internet stock market crash by flooding the market with liquidity. Doing this drove the market to over 14,000 on the Dow Jones Index and created a housing boom. In the 2008-2009 real estate and stock market crash we learned how flawed this policy was.
More on False Bottoms
Hutchinson points out federally inspired housing market distortions:
House prices are currently 47% above their level in January 2000, according to the S&P Case-Shiller 20-city index, compared to a 49% rise in prices since that time – in other words, they are in real terms at the same level as at the top of an immense speculative boom.During the recent contortions, the U.S. monetary and fiscal authorities have established false bottoms in two markets. The first is housing, where subsidies to first-time buyers, ultra-low mortgage rates, government guarantees on $700,000 home mortgages and foreclosure-avoidance schemes have prevented the housing market from falling even to its average level where the average house price is about 3.4 times average earnings. The Peril of False Bottoms
These misguided policies have consequences:
…with additional buyers having been sucked into the market, it is now likely that house prices will fall further than this. Indeed, if the appalling suggestion put forward last week that the government through Fannie Mae and Freddie Mac forgive $1 trillion of defaulted home mortgages is put into effect, they will undoubtedly do so. Nothing could be more designed to destroy confidence in the housing market than a massive subsidy to the most foolish and improvident home buyers, at the expense of the thrifty and careful renters who are the major source of potential new demand for housing.
If the buyer pool is attacked in this way, or forced into unnecessary losses by being made to buy too soon, house prices may not bottom out at the market-clearing level … but may continue falling. The Peril of False Bottoms
Wither the Stock Market?
The stock market is the second false bottom:
Currently at 10,650 as I write, the market is 35% above its appropriate “middling” target. The “trailing” P/E ratio of 20.4 on the Standard and Poors 500 is also above its historic average, even though corporate and bank earnings are currently inflated by ultra-low financing costs and a steep yield curve. Thus at some point we can expect reality to intrude, and the market to drop to its likely cycle low in the region of 5,000 on the Dow Jones index.
Again market prices are too high for any intelligent buyer. And worse, buyers will then be unavailable to buy stocks at the bottom. The Perils of a False Bottom
Politics v. Economics
Politicians are worried about the next election. Thus, we see the desperation of the Administration to throw economic caution to the wind. Zero interest rates, forgiveness of imprudent debt, subsidies to overpaid public sector workers (with no corollary “give backs”) are all hallmarks of erratic and misguided government policy. They also sacrifice long-term prudence for the feel good of short term stimulus.
Who will pay this price? Unfortunately, it will be stock market investors, pension plans, life insurance companies and homeowners. Directly or indirectly, that is virtually all of us. We need to beware politicians handing out artificially sweetened candy. Just like aspartame and our physical health, artificial economic sweeteners can be harmful to our financial health.
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