Charles Gave of GaveKal has a fascinating summary of where the nearly five-year long experiment in central-planning has taken the US, and by implication, global economy. To wit:
What kind of failure?
By propping up asset markets, the Fed has created an illusion that wealth is being created. The next step, according to Bernanke’s plan, should be for growth to follow. In fact, there is no reason why the rise in prices of financial assets should lead to actual investments or a rise in the median income. So far, it has not. There has been no real increase in the private sector propensity to borrow, and the danger may be that any further public sector borrowing will hasten the decline because of our “permanent asset hypothesis”.
This means that, should the Fed lose control of asset prices (is this what is now happening in Japan?), then the game will be up and the downside move in markets may well be terrifying. Most at risk would be low and medium quality credits, banks, commodity producers, and any companies with negative cash-flow.
It is obvious, then, that if Bernanke’s experiment fails, it will be a profoundly deflationary failure. The best hedges in a deflation and in financial panic are US long bonds and the US dollar. Renminbi bonds seem also to be developing safe-harbor status. In fact, we found it interesting how, in May, every bond market around the world sold-off, except for the RMB bond market.
We agree completely with Gave on his proposed “permanent asset hypothesis” (as explained further below) which is a simple derivation of what happens in a world in which the Keynesian multiplier is now negative. It is what we have been saying for over a year, namely that in an environment of permanent low interest rates there is no impetus on behalf of the private sector to spend for growth, either in the form of capital spending or the hiring of incremental workers. The only net money exchange is the issuance of debt to fund dividends and stock buybacks: or simple EPS-boosting balance sheet arbitrage as shown most recently here.