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Dramatic Stock Market Selloff

The New York Fed Confirms U.S. Economy Runs on Zombie Money

Stock-Markets / Quantitative Easing Jul 18, 2012 - 03:22 AM GMT

By: Raul_I_Meijer

Stock-Markets

Best Financial Markets Analysis ArticleThe world is waiting for more of those cryptic messages from the head of the Fed, who today listens to the name Ben Bernanke and speaks on Capitol Hill. Today may not be an FOMC announcement occasion, but there's still the eternal hope that Ben will give a sign, even though it will undoubtedly be excruciatingly small and ambiguous, that more free public money is on the way for the financial system. There's a nice report out on how and why that works. But first, to give some perspective, here's this from UPI today:


Bernanke likely to point to new stimulus

Ben Bernanke was expected to tell U.S. lawmakers Tuesday the Federal Reserve is poised to embrace new stimulus measures but won't say when, economists said.

Bernanke's message to the Senate Banking Committee at 10 a.m. EDT is expected to be that the Fed is "prepared to take further easing action as appropriate, but will give no indication that such action is imminent," economists at Barclays Investment Bank said in a research note ahead of the Fed chairman's semi-annual report to Congress. Bernanke is to testify before the House Banking Committee Wednesday.

Minutes of the Fed's June meeting, released last week, indicated "a few" of the 12 officials who vote on Fed policy thought quantitative easing and other stimulus measures "likely would be necessary to promote satisfactory growth." Several others said they would consider such steps only if economic conditions deteriorated, the minutes indicated.

The Fed announced after its June 19-20 meeting it would continue until year's end an effort to reduce business and consumer borrowing costs by rearranging its portfolio.

Not that everyone is equally sure about the inner workings of the process, mind you. Take Paul Vigna at WSJ's Marketbeat:

We Know What Ben Bernanke’s Going to Say (Because He’s Said it Before)

Ben Bernanke, the Fed chairman, trudges up to Capitol Hill this morning with the fate of the world resting upon his shoulders. Or at least the fate of today’s trading session.

We’ll save you the trouble. Bernanke’s such a broken record these days — given the current political environment who can blame him – we can tell you ahead of time what he’ll say.

Here’s the bottom line: Bernanke’s been jawboning about policy and levers and QE3 for more than a year now, but hasn’t acted. He knows better than the market the limits of the Fed’s powers. If things get much, much worse, he’ll hold his nose and “do something,” but until that time, it’s just more jawboning.

So here’s our take on what you can expect Bernanke to say in little less than an hour (if you want a more straight-up take, head over to Real Time Economics):

• First off, you can expect a lot of on the one hand, on the other hand (expect some variation of this theme about 400 times. On the other hand…)

However, at first superficial glance Vigna's convictions on Bernanke at least seem to be quite bluntly contradicted (though Ben just almost literally said: "The pace of job creation remains frustratingly slow" , by the report I mentioned. It came from The New York Fed, no less, last week. John Melloy summarized it for CNBC:

Market Savior? Stocks Might Be 50% Lower Without Fed

A report from the Federal Reserve Bank of New York suggests that the bulk of equity returns for more than a decade are due to actions by the US central bank.

Theoretically, the S&P 500 would be more than 50% lower—at the 600 level—if the bullish price action preceding Fed announcements was excluded, the study showed.

Posted on the New York Fed’s web site Wednesday, the study sought out to explain why equities receive such a high premium over less risky assets such as bonds. What they found was that the Federal Reserve has had an outsized impact on equities relative to other asset classes.

For example, the market has a tendency to rise in the 24-hour period before the release of the Fed’s statement on interest rates and the economy, presumably on expectations Chairman Ben Bernanke and his predecessor, Alan Greenspan, would discuss or implement a stimulus measure to lift asset prices.

The FOMC has released eight announcements a year at 2:15 ET since 1994. The study took the gains in the S&P 500 from 2 pm the day before the announcement to 2 pm the day of the statement and subtracted that market move from the S&P 500’s total return over that time span.

 

Without the gains in anticipation of a positive Fed action, the S&P 500 would stand at just 600 today, rather than above 1300.

“I would conclude that correctly analyzing Fed moves is much more important than stock picking,” said Brian Kelly of Shelter Harbor Capital. “If you want to generate alpha, you should trade the stock market 24 hours before an FOMC meeting. Simply follow the trend for that 24 hours and you will outperform.”

Here's the New York Fed report in question, written by David Lucca and Emanuel Moench. Click on the title to read the whole thing:

The Puzzling Pre-FOMC Announcement 'Drift'

For many years, economists have struggled to explain the “equity premium puzzle”—the fact that the average return on stocks is larger than what would be expected to compensate for their riskiness. In this post, which draws on our recent New York Fed staff report, we deepen the puzzle further. We show that since 1994, more than 80% of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)—a phenomenon we call the pre-FOMC announcement “drift.”

The conclusion is that 8 FOMC announcements a year are responsible for half the S&P number. Without them, it would presently be at 600 instead of 1200, as the graph clearly shows.

Hard to believe perhaps, but really, why should it be? What the report documents is the ever increasing reliance of the financial markets on public handouts. This reliance - dare we say addiction - came in the face of ever shrinking profits in the financial markets juxtaposed with ever growing gambling losses. Derivatives, don't you know...

Of course this addiction could only have grown into what it is today because the Fed and the government have consistently signalled their increased willingness to jump into holes caused by losses, with taxpayer funds.

And that's not all the Fed and successive governments had to offer the financial industry. They added another big present at the other end of the calculation: the erosion of accounting standards (re: FASB 157).

The combination of the two is what runs our economies today. What still keeps them running despite the reality they hide.

I labeled this zombie money a long time ago. There are tons of companies out there, quite a few of which are banks, that are allowed to continue to exist only because they are allowed to hide their losses. While that has certain advantages in the short term, like you still have a job and a home, though you're quite likely a zombie too, just like your bank, in the long term it's lethal to our economic system (and our political and social systems too).

Ultimately, losses will need to be recognized, and debts paid. The only point of contention is when. The path we're on now will mean those losses won't be recognized until they've all been transferred to the public account. Which will by then be unable to do much of anything about them, since all its firepower will have been transferred in the opposite direction, i.e. all available public funds - and then some -will have been used to bailout companies that hide their losses.

This is your double whammy: your money is used to bail out banks, while at the same their losses are transferred to your account. You're losing big time on both ends. Does that register yet? I'm sorry for asking, but I just don't know how many people have truly figured that one out.

If true losses would be out in the open, no-one would agree to using public funds for the bail-outs, since it would be obvious that they are nowhere near sufficient to "solve" the losses. The public “agrees" to have its funds used for bail-outs only because the impression is created that the funds may stabilize the banking system and stave off further crises.

This is an absolute illusion. But the public won't find that out until it's too late. This whole scheme can exist solely because, while governments give away trillions in dollars of people's money to the banking system, it's not "today's money". It is tomorrow's money, our tomorrows and our children's. And the human mind is famous/notorious for its ability to discount the future. In other words, while we may have an idea of what's going on, we dismiss it because it doesn't immediately affect us. And we have hope and faith in the future. Tomorrow will be better. All tomorrows. Every single one of them.

What the New York Fed report makes painfully clear is that the economy as we see it presented to us on a daily basis, for instance in the S&P 500, is not real. It is a zombie economy based on zombie money, and it's, as we speak, sucking the lifeblood out of our future existence, and, more importantly, our children's.

And if you would like to contest that assessment, you probably only have to imagine what would happen if the S&P were really at 600 today. In the present climate, it could mean only one thing: the Fed and the government would pour untold additional trillions of your dollars into the banking system. It's simply how the system works (and not just in the US).

Well, the S&P WILL go to 600. And it won't be long. So what do you suggest we should do?

By Raul Ilargi Meijer
Website: http://theautomaticearth.com (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)

© 2012 Copyright Raul I Meijer - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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