The Dow Jones Industrial Average has made multiple attempts to breach the key 27,000 mark in recent weeks. However, at this moment, the index remains slightly below this psychological threshold. In our view, this may actually be a positive development.
Although it may not always be visible, there is typically a loose connection between the stock market and the real economy. Over long periods, as indicated by the price-to-earnings (P/E) ratio, the market oscillates between phases of being undervalued and overvalued. Ultimately, the stock market tends to revert to its average P/E ratio, oscillating around that mean value.
Fiscal and monetary interventions can inadvertently disrupt this relationship. Stimulus measures designed to invigorate the economy often end up inflating financial markets instead. In some instances, these inflationary policies can entirely sever the link between stock prices and economic health.
Take, for instance, Venezuela’s Caracas Stock Exchange, which has skyrocketed by over 36,000 percent in just one year. Yet, aside from President Nicolás Maduro, no one would regard this dramatic rise as a sign of a thriving economy. In reality, the Caracas Stock Exchange reflects the disastrous economic policies in place in Venezuela.
Therefore, after a decade-long bull market in U.S. stocks that has driven the P/E ratio to unprecedented heights, we feel a sense of comfort and relief as the stock market remains stagnant or declines. Perhaps the U.S. market isn’t completely manipulated after all; it may just be partially so.
Nevertheless, we still harbor some concerns…
Creating a System of Disorder
When Alan Greenspan first initiated the “Greenspan put” in response to the 1987 Black Monday crash, financial markets were well-suited for such a centrally orchestrated intervention. Interest rates were still elevated after peaking in 1981, with the yield on the 10-Year Treasury note hovering around 9 percent. This created ample space for borrowing costs to decrease.
The mechanics of the Greenspan put are straightforward. When the stock market experiences a drop of around 20 percent, the Federal Reserve responds by lowering the federal funds rate. This typically leads to negative real yields and an abundance of low-cost credit.
This strategy has a dual effect that creates observable market distortions. First, the influx of liquidity establishes a higher floor, limiting how far the stock market can decline. This is the “put option” effect. Second, rate cuts drive bond prices upward, as bond values inherently move inversely to interest rates.
Since the late 1980s, the Fed has been implicitly running a program of countercyclical monetary stimulus via the Greenspan put. Ben Bernanke intensified this extreme market intervention with quantitative easing following the 2008-09 financial crisis, marking a significant escalation.
For those who remember, QE involves creating money out of thin air and loaning it to the Treasury. It has also included bailing out major banks by exchanging created money for toxic mortgage-backed securities. During the next market downturn, QE is likely to involve generating funds and funneling them directly into the S&P 500 or shares of government-favored companies.
Clearly, U.S. financial markets have been manipulated for at least three decades. One can only expect such chaos in a system built on artificial currency where immediate solutions take precedence over sustainable ones.
Fed Chair Powell’s Plan to Preserve a Distorted Economy
Bernanke, and later Janet Yellen, touted these unconventional QE measures as temporary, asserting that the expansion of the Fed’s balance sheet would eventually be normalized. Similarly, when Nixon suspended the dollar’s convertibility into gold on August 15, 1971, he stated it was a temporary measure.
However, once a cucumber is pickled, it can never revert to being a cucumber. Indeed, our financial markets have been irreversibly altered. Fed Chair Powell’s attempts to “unpickle” QE faced strong backlash from the President, Wall Street, and Larry Kudlow.
These criticisms persist, even as Powell has reversed his stance, declaring that unconventional policies are now the new standard. Just this week, Trump tweeted his evaluation: “They don’t have a clue!”
Meanwhile, Powell, ever the pragmatist, continues to concoct new solutions to further distort financial markets…
A decline in capital investments? Add more cider vinegar to the mix.
A downturn in retail earnings? Toss in more salt.
It’s clear that central planners have led us into this absurd situation. When the economy falters, GDP declines, and the stock market tumbles, Powell, with Trump encouraging him, will inundate financial markets with yet more stimuli. After all, this is deemed the expedient course of action.
In the end, however, the ramifications could be dire, leading to a degradation of U.S. financial, economic, and social systems akin to Venezuela’s predicament. By all reasonable assessments, we face a grim future.
Sincerely,
MN Gordon
for Economic Prism
Return from Fed Chair Powell’s Plan to Pickle the Economy to Economic Prism
