Why has the stock market rallied so strongly.
Here is why, the stock markets rise is a consequence of the Federal Reserves huge inflation of its balance sheet.
A lot of commentators have been mind-boggled by the Federal Reserve and now that discombubulations has reached new heights. The Federal Reserve balance sheet is truly astronomical and hard to conceive in concrete terms. Lets call it $1000 for every human alive on earth.
As a side issue this is the first time I’ve seen an axis expressed in Millions of Millions. These are times of ‘water shed.’
This balance sheet expansion is the sole cause of the bounce in the stock market but whether it will make a bounce in economic activity when the lockdowns end, is yet to be seen. Likely it will only be part of the prevention of an acute and vicious meltdown of the US economy.
The first spike on this curve is the initial intervention in the ‘global financial crisis’ the so called ‘great recession’ ‘credit crunch.’ This time however while the cure is the same, the disease is different.
If I sneek into your house, find your stash of cash and burn it in the stove, you have and the world has less money. In the UK you used to be able to fish out the metal strips, take it to the Central Bank and they would replace your cash for free. The money is resurrected. This is what the Federal Reserve and other Central Banks did back then. Money got vaporized by a financial crisis and the Federal Reserve stepped in and backstopped the value of assets and thereby prevented the destruction of oceans of money. It makes sense to do that in those cases and it works.
This time no one has destroyed money because of a malfunction of the financial system. This time people have been incarcerated and forced not to produce or consume. Rather than burning your pile of dollar bills, it is akin to locking you in your basement a hard tack rations and then vandalizing your vegetable patch. The lost work and consumption cannot be replaced or substituted. The assets that would have been created from the investment that was made has been destroyed and the investment lost. Even if you get an insurance payment its not a like for like. The best that can be done to remedy the situation is to bridge the situation over the period necessary to get back to normality.
This is where we are now.
Can the market go up if the Fed stops inflating its balance sheet? That doesn’t seem likely. Can the market stay afloat when the Federal Reserve stops? Possibly, but it doesn’t seem that likely. IThe Federal Reserve simply cant keep growing its balance sheet forever, it must stop at some point. Otherwise it will nationalize the assets of America. Worse things than that could happen but the core problem is we know these liquidity actions are not the solution to the underlying problem as opposed to 2008 when they were actually the cure. The Federal Reserve is delivering palliative care. This liquidity is a pain killer, not a cure.
This calls on an ugly analogy from the days of Spanish Flu for what could happen in this situation. Aspirin, the newly invested pain killer, was recommended by the US Surgeon General to the Army, in high doses, as a cure for the Spanish Flu Pandemic and the recommended dose level led to many deaths from overdose. This is the sort of outcome risked here.
Luckily the Federal Reserve are very, very, smart. They will stop growing their balance sheet but when they do, the market will stop levitating. I believe it must then fall but they will try to keep it trading sideways. I do not think they will succeed but they might. It will be a battle and we will be able to judge how it is going as the months pass.
The trick in the aftermath of the pandemic will be spotting opportunities and getting the timing right. This will be horribly difficult. It will be the core challenge now for a very long time because the trend is no longer our friend but getting back out there and getting busy will be our best contribution to the recovery most of us can make.