by Mish
The Bank of Japan and ECB are now running out of bonds to buy. To circumvent the imagined problem, the former is already buying equities. Will the ECB follow? Does it even matter?
Let’s address those questions with an eye on social mood.
The Wall Street Journal writers Brian Blackstone and Tom Fairless ask Could the ECB Start Buying Stocks?
By failing to properly analyze social mood, they come to the wrong conclusions.
Some central banks already invest in equities. Switzerland’s central bank has accumulated over $100 billion worth of stocks, including large holdings in blue-chip U.S. companies such as Apple and Coca-Cola.
If the ECB decides to raise its stimulus by extending its current bond program, as many analysts expect, fresh questions will be raised about how it will continue to find enough bonds to buy. The bank is already purchasing €80 billion ($89.2 billion) a month of corporate and public-sector bonds to reduce interest rates across the eurozone. Its holdings of public-sector debt reached €1 trillion last week, the ECB said Monday.
With a key policy rate already below zero, ECB officials hope that buying bonds with freshly printed euros will reduce interest rates further. But policy makers face a practical constraint: The ECB is running up against self-imposed limits on how much of a country’s bonds it can hold.
“The obvious reason for the ECB to buy equities is they have almost run out of German bonds to buy,” said Stefan Gerlach, chief economist at BSI Bank and a former deputy governor of Ireland’s central bank. “The basic idea is that the central bank can put essentially anything on its balance sheet and there is no reason to be straight-laced about this.”
When policy rates approached zero, central banks in the U.S., the U.K., Japan and the eurozone turned to bond purchases to reduce long-term interest rates. Buying equities would likely yield some of the same effects in terms of encouraging consumption and investment through higher household wealth and lower cost of capital.
“I don’t see a reason not to do this,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics. “It isn’t obvious to me why a central bank wouldn’t always want a diversified portfolio, including equities.”
Straight Laced
Indeed, central banks can put anything on their balance sheet. But there is no reason to be straight-laced about how counterproductive the concept is.
If buying bonds stimulated inflation, Japan and the ECB would have it in spades.
Spotlight on Social mood
With round after round of QE, central banks have accomplished nothing but a reinforcement of already negative social mood.
Peter Atwater discusses social mood in his excellent column Why Central Bank Stock Purchases Are a Really Bad Idea.
“Buying equities would likely yield some of the same effects in terms of encouraging consumption and investment through higher household wealth and lower cost of capital,” [say Blackstone and Fairless] …
While there are many reasons for the disparity in moods today, I am afraid, the decoupling of Main Street mood from Wall Street mood will represent a clear headwind to the economic thinking behind today’s proposed central bank actions. Based on what I see, little will be gained by additional asset purchases, especially stocks. In fact, as I discuss below, I think we have now reached the point where further asset purchases risk derailing confidence rather than boosting it.
Underlying today’s central bank actions and the sentence offered above by Blackstone and Fairless is the “wealth effect” – “a psychological phenomenon that causes people to spend more as the value of their assets rises. The premise is that when consumers’ homes or investment portfolios increase in value, they feel more financially secure, so they increase their spending.” (Investopedia) To believe the principle, for individuals, higher asset prices lead to a positive wealth effect that, in turn, leads to greater consumption.
To be clear, I think economists have it backwards. As a socionomist, I believe that increases in confidence boost both financial asset prices and consumption simultaneously. Mood precedes action, rather than lags it. We act as we feel, driven by our level of confidence. With high confidence we see permanence to our financial condition expecting it to continue long into the future.
Sadly, today’s central bankers don’t see confidence/action causality operating this way.
Looking at today’s stock-hungry central bank plans, I see three problems:
First, unless Main Street sentiment changes dramatically, low confidence by itself is going to continue to limit how much higher stock prices impact consumption. Without greater Main Street confidence there simply won’t be a positive wealth effect – a necessary requirement for increased spending.
Second, the further central bankers decouple the markets from the broader economy, the more contradictory the mood “mirrors” will become to investors. I think we are already seeing signs of this given the investor “anxiety” referenced above. While they may not be able to put their finger on it, investors know something is wrong.
Rather than the mood “mirrors” offering cognitive ease as they did at the peak in 2007, today’s “mirrors” are offering cognitive strain.
Those contradictory mood “mirrors” run in both directions. If investors are strained by the messages out of Main Street, voters on Main Street are irate at the contradictory images the financial-elites are reflecting back on them. From $100 million condominiums to super-sized, stock-driven compensation packages, consumers are having a difficult time reconciling their own post-banking crisis personal experiences with what they see among the moneyed class.
The more – and more openly – central banks act to simultaneously boost financial asset prices and to press savings rates lower, the more voters have good reason to question the motives of the Federal Reserve, ECB and other central banks.
Third, the cognitive strain evident on Main Street and among a growing group of investors is even clearer in corporate investment decision-making today. While stock prices may be soaring, organic revenue growth is anemic. Many executives, like Starbucks’ CEO Howard Schultz, are openly worried about the impact consumer economic and political anxiety is having on business. While stock prices suggest it is the best of times, the cash register is saying something else, entirely.
While this morning the Wall Street Journal highlighted the benefits of central bank stock purchases, it is time to throw out those wealth effect dream-filled Econ 101 textbooks and replace that thinking with something more grounded in today’s reality:
“Buying equities will put additional pressure on corporate CEOs to cut expenses and to postpone investments, fostering even greater Main Street resentment toward the financial elite. Consumer confidence won’t rise as consumption and economic growth stagnate. Having so clearly sided with owners of capital, rather than the employees of capital, global central banks are likely to become an easy target for populist ire.”
Mish’s Rule of Social Mood
@Peter_Atwater @hussmanjp Central banks are not omnipotent. They cannot change social mood. They can reinforce mood, but not change it.
— Mike “Mish” Shedlock (@MishGEA) September 8, 2016
Think back to the housing bubble. By holding rates too low too long, the Fed certainly added fuel to the housing bubble. Baby step hikes by Alan Greenspan did not slow the bubble, they fueled it.
At some point, the collective wisdom of the masses changed, suddenly and without precedent. The event was totally expected in this corner, predicted in advance, and timed correctly.
Those seeking proof can easily find it here: US vs. Japan Land Prices Pictorial Update
In Winter of 2008 I had the housing bubble looking as follows: Housing Update – How Far To The Bottom?
In Spring of 2011 I even caught the bottom: Reader Seeks Help/Advice on US Housing/Economy; How Far to THE Bottom?
My analysis was far from perfect. I failed to predict the echo bubble in both housing and the stock market. If you believe anyone has all the answers you are mistaken.
Let’s return to social mood.
What Happened?
In a nutshell, the Fed fueled a housing bubble.
Social mood already embraced the notion “housing always goes up” and along comes the Fed holding interest rates way too low all the way.
Conventional wisdom and Greenspan apologists say the Fed was not to blame. They are wrong. While it’s true the Fed cannot change social mood, the Fed actually reinforced social mood.
Pool of Greater Fools
At some point, the pool of greater fools is guaranteed to run out. It happened with the Fed-sponsored dotcom bubble and it happened again with the housing bubble.
How did I time the top?
Time Magazine went gaga over real estate.
In December 2005 I wrote It’s Too Late.
When you see stuff like this, not only is it too late, it’s way too late.
“When you see stuff like this, not only is it too late, it’s way too late.”
People in were standing in lines, wrapped way around the corner, for the right to enter a lottery to buy a Florida condo.
That is extreme sentiment.
Timing Sentiment
Timing sentiment is extremely difficult. Those were obvious, but the Fed did not see what they had done.
They fail again now. So do central banks in general. Nonetheless, I can make a disturbing claim.
Social Mood Will Get Extremely Ugly
Actually, social mood is “already” extremely ugly. The powers that be do not see it for the simple reason they are not affected by it.
Murders in Chicago are at an all time high and Brexit was totally unexpected.
The rise of anti-establishment candidates and parties such as Donald Trump in the US, AfD in Germany, Beppe Grilllo in Italy, and Marine le Pen in France is proof enough of rising social anger.
Masking Social Mood
The only thing masking already ugly social mood is a high and rising stock market. It’s not only high, it’s in bubble territory.
Bubbles pop, by definition. Perhaps the bubble orderly deflates, like Japan, as opposed to a 1929-style crash.
That’s my prediction actually. But it won’t matter. If anything, an orderly asset devaluation over 7-10 years would be worse.
Perceived wealth will vanish. Pension plan promises will be exposed as lies.
Increasingly Worse Off
A McKinsey study shows 81% of US Worse off Than in 2005, France 63%, Italy 97%.
Social mood reflects that study. Sponsoring asset bubbles in hopes of trickle-down spending will do nothing but increase the anger.
There is not a damn thing central banks can do about this.
Central banks created the problem. Let me phrase that more accurately: Central banks and their bubble blowing tactics are the problem.
Mike “Mish” Shedlock
