Fresh signs of a slowly healing U.S. economy – underscored last week by rising consumer confidence, climbing incomes and much stronger than expected auto sales – have convinced President Barack Obama that it’s safe at last to make the improving outlook a centrepiece of his re-election campaign. Combined with less dreadful news on the euro-zone front, the brightening picture has also buoyed equities, at a time when corporate profits appear to be losing steam.
In fact, apart from the occasional hiccup, the markets have been on a nice run for several months. The Dow Jones industrial average climbed above 13,000 last week for the first time since 2008, before ending up with a small weekly loss, only its third week in the red so far this year. And the tech-heavy Nasdaq composite index briefly flirted with 3,000, a level it last reached on its precipitous slide after the market bubble burst in 2000.
Investors in search of something more than zero real returns poured more than $3-billion (U.S.) into U.S. equity funds in the last days of February, and not even some downbeat remarks from Federal Reserve chief Ben Bernanke during his semi-annual congressional inquisition prompted any sort of rush for the exits.
It was all enough to prompt boisterous choruses of Let the Good Times Roll by those bullish market types who are always eager to extol the virtues of buying and holding stocks. It was also enough to stoke the ire of Satyajit Das, a genial permabear who makes his living advising financial institutions on how to handle risk.
“Humans being what they are, they are saying the rough times are over, the U.S. recovery is taking flight and happy times are here again,” the globe-trotting consultant and derivatives expert says from his home perch in Sydney, Australia.
In reality, the key problem of too much debt across the developed world has not been addressed, and we are still on the early part of a long, painful road to recovery. What’s worse, we are relying for solutions on policy makers, including Mr. Bernanke, “who have no control over any of this. They don’t know what they’re doing and they don’t really have any tools.”
Based on our previous conversations, I long ago concluded that the mild-mannered amateur naturalist is not the sort of person you want to meet after a tough day in the markets. But Mr. Das is a perfect antidote to the cheerleaders who bring out their pom-poms whenever economic soundings improve slightly and the market goes on something of a mini-tear.
In fact, the derivatives expert continues to dish up such a gloomy assessment of the state of the world that it’s advisable to steer well clear of sharp objects, rail tracks and speeding trucks after talking to him.
While we are chatting, Mr. Bernanke is laying out his case in Washington for keeping interest rates at rock-bottom levels and the European Central Bank is unleashing the second round of its costly effort to shore up the banking system, known as a long-term refinancing operation, or LTRO. Some 800 banks snap up a total of €529-billion ($690-billion Cdn) worth of three-year loans at the bargain-basement cost of 1 per cent annually.
Mr. Das derides both the perpetually low interest rates and the refinancing operations as dangerous, because they delay attacking the real problems of too much debt and not enough real growth.
“I’m kind of old-fashioned,” he says. “If you have a problem, you diagnose it and then you try and fix it, particularly if you think the problem’s serious. Whereas the modern approach is to cover the problem up.”
What central banks are doing – now that fiscal tools have mostly been removed from the policy makers’ equipment belt – is creating further distortions in the economy and making a full recovery more difficult. These include massive subsidies for the financial sector, through effectively zero borrowing costs. Mr. Das estimates that in the United States, the subsidies to banks total about $120-billion (U.S.) a year.
And in Europe, the central bank “has abandoned all pretence of monetary rigour.” To get around the rule barring the ECB from printing money, “they’re actually doing it in an ingenious way … by lending money to banks to buy government bonds. The money just round-trips its way around the economy.”
The monetary actions amount to “palliative measures” with potentially dangerous side effects – not least of which is that they undermine public trust in money, sovereign bonds and the central banks themselves.
Mr. Das acknowledges that policy makers had no option but to respond aggressively to the 2008 financial meltdown and the ensuing global economic slump. It’s the choices they have made since then that strike him as wrong-headed. Particularly when it comes to record low interest rates – and not only because they hurt savers.
But surely low rates are a logical response to tepid growth, encouraging people and corporations to spend more?
“I don’t buy that argument,” he says flatly. “The relationship between rates and economic activity is not necessarily as linear as one might assume. The cost of funds is only one factor in the complex drivers of demand” for such big-ticket items as housing. “We don’t know exactly how these relationships work. And we only find out 20 or 30 years down the track.”
What we’re facing now, he says, is a prolonged period “of what I would call trial-and-error [policy-making] So nothing will actually ever be resolved. Because there is no cure. Think of us as being in the middle of one gigantic thought experiment. Which may not be a good place to be.”Report Typo/Error
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