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Is the stock market rally for real or will the bubble burst soon?

bubble

The BSE Sensex closed at 28,177 points on November 17, up by around half a percent from its last close. Its been good going for the Sensex, having rallied by 33.3% since the beginning of this year. This probably led to a reader asking me on Twitter whether the stock market rally was for real or would the bubble burst soon?
These are essentially two questions here. First, whether the current rally is a bubble? Second, how long will it last? These are not easy questions to answer. Also, instead of trying to figure out whether the current rally is a bubble or not, I will stick to answering the second question, that is, how long will the current rally last.
As I have written on a few occasions in the past, the current rally is being driven by foreign institutional investors (FIIs). The domestic institutional investors(DIIs) have had very little role to play in it. The FIIs have made a net investment of a little over Rs 68,000 crore since the beginning of the year. During the same period the DIIs have made net sales of Rs 32,468 crore.
This data makes it very clear who has been driving the market up. Given this, instead of trying to figure out whether the current market is a bubble or not, it makes more sense to figure out whether the FIIs will keep bringing in fresh money into the Indian stock market.
The foreign investors have been borrowing money at very low interest rates and investing it in financial markets all around the world. They have been able to do that because Western central banks have been printing money to maintain low interest rates.
The Federal Reserve of the United States (the American central bank) recently decided to stop printing money and almost at the same time, the Bank of Japan decided to increase it. The Japanese central bank will now print around 80 trillion yen per year. The central bank had been printing around 60-70 trillion yen since April 2013, when it got into the money printing party, big time.
Like other central banks it pumped this money into the financial system by buying bonds. Interestingly, the size of the balance sheet of the Bank of Japan stood at around 164.8 trillion yen in March 2013. Since then, it has increased dramatically and as of October 2014 stood at 286.8 trillion yen.
The Bank of Japan hopes that by printing money it will manage to create some inflation. Once people see the price of goods and services going up, they will go out and shop, in the hope of getting a better deal. Also, with all the money printed and pumped into the financial system, interest rates will continue to remain low. And at low interest rates people were more likely to borrow and spend. Once people start to shop, it will lead to economic growth. Japan has had very little economic growth over the last two decades.
The trouble is that the Japanese aren’t falling for this oft tried central bank formula. And there is a clear reason for it. James Rickards in his book The Death of Money explains the point using what Eisuke Sakakibara, a former deputy finance minister of Japan, said in a speech on May 31, 2013, in South Korea.
As Rickards writes “Sakakibara…pointed out that Japanese people are wealthy and have prospered personally despite decades of low nominal growth. He made the often-overlooked point that because of Japan’s declining population, real GDP per capita will grow faster than aggregate GDP. …Combined with the accumulated wealth of the Japanese people, this condition can result in well-to-do-society even in the face of nominal growth that would cause central bankers to flood the economy with money.”
The question to ask here is will the Japanese continue to print money? The answer is yes. The Japanese politicians are desperate to create some inflation and the central bank has decided to get into bed with them. Also, more than that the Japanese government spends much more than it earns and needs to be bailed out by the Bank of Japan.
As analyst John Mauldin wrote in a recent column titled The Last Argument of Central Banks “According to my friend Nouriel Roubini, in 2013 Japan’s total tax revenue fell to a 24-year low. Corporate tax receipts fell to a 50-year low. Japan now spends more than 200 yen for every 100 yen of tax revenue it receives. It is likely Japan will run an 8% fiscal deficit to GDP this year, but the Bank of Japan is currently monetizing at a rate of over 15% of GDP, thereby theoretically reducing the level of debt owed by government institutions other than the central bank.”
Fiscal deficit is the difference between what a government earns and what it spends.
What Mauldin basically means is that a part of the debt raised by the Japanese government is being repaid through the Bank of Japan printing money and lending it to the government. With all this money continuing to float around in the financial system, interest rates in Japan will continue to remain low.
This will allow large financial institutions to borrow money at low interest rates in Japan and invest it in financial markets all over the world, including India.
The European Central Bank (ECB) also seems to be in the mood to start quantitative easing (QE, i.e. printing money to buy bonds). As Mohamed A. El-Erian, Chief Economic Adviser at Allianz wrote in a recent column “In fact, ECB President Mario Draghi signaled a willingness to expand his institution’s balance sheet by a massive €1 trillion ($1.25 trillion).”
While the United States might have decided to stop printing money, Japan and the Euro Zone, want to take a shot at it. Interestingly, chances are that the United States might go back to money printing in the years to come. As Niels C. Jensen writes in The Absolute Return Letter for November 2014 “If my growth expectations are about correct, QE is far from over – at least not in some parts of the world, and it is even possible that the Fed[the Federal Reserve of the United States] will come creeping back after having distanced itself from QE recently.”
The Federal Reserve of the United States has been financing the American fiscal deficit by printing money and buying treasury bonds issued by the government. In mid September 2008, around the time the financial crisis started, the Fed held treasury bonds worth $479.8 billion dollars. Since then, the number has shot up dramatically and as on October 29, 2014, it stood at $2.46 trillion dollars.
The fiscal deficit of the United States government shot up in the aftermath of the financial crisis. It was financed by more than a little help from the Federal Reserve. Nevertheless, the fiscal deficit has now been brought down. As Mauldin points out “The 2014 government deficit will be only 2.8% of GDP (it last saw that level in April 2005), the first time in a long time it has been below nominal GDP.”
The bad news is that the fiscal deficit will start rising again in 2016. “It is projected to fall again next year before rising in 2016. For the United States, this represents a reprieve, allowing us some time to deal with potential future problems before government spending rises to a proportion of income that is impossible to manage without severe economic repercussions. Government spending on mandated social programs will rise more than 50%, from $2.1 trillion this year to $3.6 trillion in 2024, potentially blowing the deficit out of control,” writes Mauldin.
The Federal Reserve might have to start printing money again in order to finance the government fiscal deficit.
Moral of the story: There are enough reasons for the Western nations to continue printing money and ensuring low interest rates. This means, FIIs can continue to borrow money at low interest rates and invest it in financial markets all over the world, including India.
The easy money party hasn’t ended. The only condition here is that the current government should not create a negative environment like the previous one did.
To conclude, the difficult thing to predict is, until when will this easy money party continue. I don’t have any clue about it. Do you, dear reader?

The article originally appeared on www.equitymaster.com on Nov 18, 2014

Nifty 10,000: Coming soon at a stock market near you

bullfightingVivek Kaul

It is that time of the year when the stock market analysts get busy predicting what levels do they see Sensex/Nifty reaching during the course of the next financial year.
First off the blocks this year are Gautam Chhaochharia and Sanjena Dadawala of UBS Global Research, who have predicted that the NSE Nifty will touch 9,600 points by the end of 2015. As I write this, the Nifty is trading at around 8375 points. Hence, the UBS analysts are basically talking about the Nifty index, rallying by around 15% over the course of the next thirteen and a half months by end 2015.
The prediction of 9,600 points has been arrived at by making certain assumptions, including the expectation of earnings of companies growing by 15% during the course of the next financial year (i.e. the period between April 1, 2015 and March 31, 2016).
Over the next few weeks you will see a spate of analysts of making such predictions. And it won’t be surprising if someone comes up with a Nifty target of 10,000 points or more. For one, saying that Nifty will touch 10,000 points is inherently more sexier than saying Nifty will touch 9,600 points. A big round number always sounds so much better.
Further, Nifty at 10,000 points will be around 19.4% higher than the current level of 8375 points. It has rallied by 32.6% during the course of this year (from January 2014 to November 13, 2014). Hence, a rally of 19.4%, assuming that Nifty will touch 10,000 by end 2015, sounds pretty reasonable.
Nevertheless, the question is how do these analysts know? John Kenneth Galbraith explains this in his book The Economics of Innocent Fraud. As he writes “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future of economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more ample predictions but no firm knowledge.”
And why is that ?“There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known,” writes Galbraith.
Nevertheless, these predictions serve a useful purpose. They tell people what they want to hear, especially during a bull market, when share prices are going up and people are inherently optimistic about things. As Galbraith puts it “The men and women so engaged[i.e. the ones making the predictions] believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what others wish to hear and what they wish to profit or have some return from, hope or need covers reality.”
The stock market rally this year has been more about “easy money” from abroad coming into India, rather than any fundamental improvement in economic activity. Since the beginning of the year (and upto November 13,2014) foreign institutional investors have made a net investment of Rs 67,359.4 crore into the Indian stock market.
This has largely been on account of Western central banks maintaining low interest rates. Hence, foreign investors have been able to borrow money at low interest rates and invest it in the Indian stock market. The inflows have been particularly strong since May, when Narendra Modi came to power. Since May 2014, Rs 35,545.7 crore has been the net investment made by FIIs in India.
The basic point is that in an environment where easy money is essentially driving up stock prices, predictions are more about understanding investor psychology than the underlying fundamentals of the market.
An excellent analogy here is that of Henry Blodget, who used to work as a senior analyst with the Wall Street firm CIBC Oppenheimer, in the late 1990s. In October 1998, Blodget brought out a report on Amazon.com. In this report he had predicted that the stock would go past $150 in a year’s time. He had also added in that report that the stock was worth anywhere between $150 and $500. At that point of time, the stock was quoting at $80. The stock raced past Blodget’s one-year target within a few weeks, so huge was the flow of money into the stock market.
His sales team then began to pester him for a new target. By December 1998, the price of the Amazon stock had crossed $200. As Maggie Mahar recounts in Bull!—A History of the Boom and Bust, 1982–2004 “Privately, he[Blodget] was confident that Amazon would hit $400—he just didn’t know if he had the balls to say it. But as his very first boss on Wall Street had told him, “You’re not a portfolio manager—you‘re not trying to sneak quietly into a stock before someone else sees it. You’re an analyst: your job is to go out and take a position.”
And that is what Blodget did. He took the position that Amazon would hit $400 within a year’s time. There must have been hundreds of other analysts on Wall Street who could have said the same thing. It was just that Blodget had the balls to say the right thing at the right time. He told the stock market what it wanted to hear.
Blodget put out his recommendation of Amazon hitting $400 on December 16, 1998. Within minutes, his forecast was traveling around the world. A Bloomberg reporter got a tip and put out the story. Soon, CNBC picked it up. And in no time, the recommendation had hit the chat boards across the various internet sites. And once that happened, the stock simply went through the roof. Amazon, which had closed at a price of $242.75 on December 15, 1998, closed 19 percent higher at $289 on December 16, 1998.
After this, the price of Amazon went on a roll. The stock was split in early January 1999, and the price crossed the $400 level that Blodget had predicted in March 1999, in split adjusted terms. Blodget got the investor psychology right. At some level, Blodget understood that he was in the midst of a stock market driven more by emotion and momentum. Hence, more than the price of the stock, he had to predict investor psychology and where that could take the price.
The Indian stock market is going through a similar era of easy money right now, though of a lower degree in comparison to the dot-com bubble that was on in the United States in the late 1990s. Hence, making predictions is going to about predicting investor psychology than the underlying fundamentals.
Given this, it won’t be surprising to see forecasts predicting that Nifty will cross 10,000 points next year, coming out over the next few years. Of course all these forecasts will indulge in what American writer Steven Pinker calls “compulsive hedging”. As he writes in his new book The Sense of Style “Many writers cushion their prose with wads of fluff that imply that they are not willing to stand behind what they are saying.”
The UBS analysts do just that. After predicting that Nifty will touch 9600 points by end 2015. They go on to write “If our expectations of the earnings growth recovery are not met (with only 10-12% growth in corporate earnings)…the Nifty could decline to the 7,500 levels.”
So much for being in the business of making predictions.

The article originally appeared on www.FirstBiz.com on Nov 15, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

Kaala Dhandha Gore Log – Why politicians are not serious about black money

kaala dhandhaVivek Kaul

Sometime in the mid 1980s, I vaguely remember spending a few days with my family, in one of the many small coal producing towns that dot what is now known as the state of Jharkhand. As was common in those days, we had hired a VCR and had decided to go on a movie watching spree.
One of the movies on the list was Kaala Dhandha Gore Log. The movie was directed by Sanjay Khan. That is the only bit about it that I still remember. I don’t know why, but I found the title of the movie very fascinating and was really looking forward to watching it.
But the adults in the family threw a spanner in the works and banned us “kids” from watching the movie, without really going into the reasons for it. Around three decades later I can speculate as to why we weren’t allowed to watch the movie.
I guess the movie must have had a few scenes with the heroine mouthing the most famous cliché of the eighties,“mujhe bhagwan ke liye chhod do,” or it must have had songs we now call “item numbers”.
Those were days when cable television hadn’t come to India (that would happen only in late 1991, early 1992). Middle class India still hadn’t discovered The Bold and the Beautiful or Santa Barbara for that matter, two shows that went a long way in Indian parents becoming a lot more liberal in deciding what their kids could watch on television.
For some reason the title of the movie has always stayed in my mind, and I have speculated now and then, on its possible storyline. As the title of the movie suggests, the story could possibly be about businesses run by white people (meaning foreigners) which throw up black money.
Three decades later, reel life seems to have turned into real life. There is a great belief in this country that all of the black money generated over the years is now with foreigners. It has been transferred into foreign banks operating out of tax havens. The prime minister Narendra Modi has promised to get the money back.
In an earlier piece I had explained why getting this money back is not a feasible proposition, even though it might sound possible. And a better thing to do would be to simply concentrate on unearthing all the black money that is there in the country. I had also said that a lot of black money which has gone abroad over the years is possibly now being round-tripped to India, given that the chances of earning a good return are better in India.
Nevertheless, there are two questions that arise here? First, why has the black money problem been allowed to become so huge? Second, will the politicians choose to do anything about it? Let me answer the second question first.
Political analyst Mohan Guruswamy shared some very interesting data in a recent column in The Asian Age. Between 2004-05 and 2011-12, national political parties collected Rs 435.87 crore as donations. Of this the Bhartiya Janata Party received Rs 192.47 crore from 1,334 donors and the Congress Rs 172.25 crore from 418 donors.
Corporates made 87% of these donations. Interestingly, over and above this, the parties received donations from unknown contributors as well. The Congress party received a total of Rs 1,185 crore in three financial years (2007-08, 2008-09, 2009-10) and the BJP received around Rs 600 crore during the same period.
It is worth remembering that in the period between 2004-05 and 2011-12, there were two Lok Sabha elections and many elections to state assemblies. It doesn’t take rocket science to come to the conclusion that the amount of donations declared by the political parties were clearly not enough to fight so many elections.
In fact, a study carried out by Centre for Media Studies in March earlier this year estimated that around Rs 30,000 crore would be spent during the 16th Lok Sabha elections which happened in April and May 2014. Of this total, the government would spend around Rs 7,000-8,000 crore to conduct the elections through the Election Commission and the home ministry.
The remaining amounts would be spent by the candidates contesting the elections and the political parties they belonged to. Candidates standing for Lok Sabha elections are allowed to spend only Rs 70 lakhs for fighting an election in bigger states. For other states, the amount varies from anywhere between Rs 22 lakh to Rs 54 lakh.
These amounts are peanuts when it comes to fighting elections. Even candidates from major political parties fighting state level elections spend more money than this. Candidates stay within these limits officially, but political parties spend much more money outside the set limits, during the course of campaigning.
What this tells us clearly is that political parties have got access to funding beyond what they have declared in the public domain. This money that comes to them is black money. This black money can possibly be the money that politicians have accumulated through corruption or money handed over by crony capitalists looking at possible favours in the days to come.
Hence, a crackdown on black money within the country would lead to the major source of funding for political parties and politicians being impacted. Guruswamy put it very aptly in his column when he said “Their own taps will run dry.”
Now, let me try and answer the first question, which was that why has the black money problem been allowed to become so huge? Why has it been left unattended for so many decades? As Daron Acemoglue and James A Robinson write in Why Nations Fail—The Origins of Power, Prosperity and Poverty “Political institutions determine economic institutions…Extractive political institutions concentrate power in the hands of a narrow elite and place few constraints on the exercise of power. Economic institutions are then often structured by this elite to extract resources from the rest of the society. Extractive institutions thus naturally accompany extractive political institutions. In fact, they must inherently depend on extractive political institutions for their survival.”
So what does this mean in the Indian context? It means that the Income Tax department, which is supposed to be unearthing the black money in this country, is corrupt because the politicians running this country are corrupt. The way the economic incentives of politicians have evolved has led to a situation wherein they simply cannot become active in cracking down on black money.
It explains why only 3.5 crore individuals out of a population of 120 crore pay income tax in this country.
To conclude, the question worth asking is, what will it take for politicians of this country get serious about unearthing black money?

The column originally appeared on www.equitymaster.com on Nov 14, 2014

The Western growth model is broken and it ain’t getting fixed any time soon

3D chrome Dollar symbol

Everyone has a plan until they get hit in the mouth – Mike Tyson

In the aftermath of the financial crisis that started in September 2008, the central banks of Western countries started printing money and pumping it into their financial systems. The hope was that by flooding the financial system interest rates could be maintained at low levels.
At low interest rates people would borrow and spend more and economic growth would return. The Federal Reserve of United States led the money printing race. But money printing hasn’t led to people borrowing and spending as was expected, as can be seen from the accompanying chart.

Source: http://www.pimco.com/EN/Insights/Pages/For-Wonks-Only.aspx

The total loans in the United States currently amount to around $58 million. The loans have been growing at 2% per year in the last five years and 3.5% over the last 12 months. As can be seen from the accompanying graph this rate of loan growth is much slower than the growth in pre-financial crisis years, when the loan growth was at around 10% per year. It even touched 20% in 2007, a year before the crisis broke out.
Hence, economic growth in the United States was a clear function of the loan growth in the pre-financial crisis years. Now that the loan growth has slowed down so has economic growth. So what will it take to bring this growth back?
As Bill Gross who formerly worked for PIMCO, one of the largest mutual funds in the world, put it in a September 2014 column “Over the long term, however, economic growth depends on investment and a rejuvenation of capitalistic animal spirits – a condition which currently does not exist…The U.S. and global economy ultimately cannot be safely delivered with artificially low interest rates, unless they lead to higher levels of productive investment.”
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right people need to be encouraged to borrow and spend. The trouble is that it was “excessive” borrowing and spending that had led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales suggest this in a new afterword to Saving Capitalism from the Capitalists: “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
Interestingly, from 1900 to 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level that it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases that they used to in the past. This led to Western governments following an easy money policy, where they encouraged citizens to borrow and spend, and this ensured that economic growth remained strong.
But in the aftermath of the financial crisis this growth model has broken down with people not borrowing as much as they did in the past. So what is the way out? The way out is to create sustainable growth that is not financed through debt-fuelled consumption all the time. As Rajan and Zingales put it “The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts they will be saddled with. The best short-term policy response is to focus on long-term sustainable growth.”
Nevertheless that is easier said than done. A March 2011 working paper by Michael Spence and Sandile Hlatshwayo provides the reason for the same. As the economists point out “Between 1990 and 2008, jobs have seen a net increase of 27.3 million on a base of 121.9 million in 1990..Almost all of those incremental jobs (26.7 of 27.3 million) were created in the nontradable sector. In the aggregate, tradable sector employment growth was essentially flat.”
So what does this mean? Jordan Ellenberg defines the term nontradable sector in his book How Not To Be Wrong—The Hidden Maths of Everyday Life. Nontradable sector is “the part of the economy including things like government, health care, retail, and food service, which can’t be outsourced and which don’t produce goods to be shipped overseas.”
Hence, basically whatever could be outsourced outside the United States has already been outsourced. This is simply because it is cheaper to produce stuff outside the United States. And this is likely to continue in the years to come. Over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a further downward pressure on costs and prices. Hence, Americans will not really be in a position to demand pay increases as they could have in the past.
What is true about the United States is also true about other developing countries as well. Given this, the Western growth model is well and truly broken. And as of now, the way things stand, it doesn’t look like if it will be fixed any time soon.

The article originally appeared in www.FirstBiz.com on Nov 12, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

 

Federal Reserve ends money printing, but the easy money party will continue

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee(FOMC) which decides on the monetary policy of the United States in a statement released yesterday said “the Committee [has] decided to conclude its asset purchase program this month.”
What the Federal Reserve calls “asset purchase program” is referred to as “quantitative easing” by the economists. In simple English this is just the good old money printing with a twist. Since the start of the financial crisis, the Federal Reserve has printed around $3.6 trillion of new money.
This month the Federal Reserve has printed around around $15 billion. It has pumped this money into the financial system by buying government bonds and mortgage backed securities. From November 2014, the Federal Reserve will no longer print money to buy government and private bonds.
So why is the Federal Reserve bringing money printing to an end? The simple reason is that with so much money being printed and pumped into the financial system, there is always the threat of too much money chasing too few goods, and leading to a massive price rise in the process. Even though something like that has not happened the threat remains.
As John Lanchester writes in How to Speak Money “More generally QE[quantitative easing] taps into the fear that governments printing money always leads to dangerous levels of inflation, and that inflation, like a peat-bog fire, is all the more dangerous when it’s cooking up underground.”
There have been too many instances of money printing by the government leading to massive inflation in the past. And the Federal Reserve couldn’t have kept ignoring it.
Lanchester perhaps describes quantitative easing(QE) in the simplest possible way and what it really stands for by cutting out all the jargon in his new book How to Speak Money. As he writes “QE involves a government buying its own bonds using money which doesn’t actually exist. It’s like borrowing money from somebody and then paying them back with a piece of paper on which you’ve written the word ‘Money’ – and then, magically, it turns out that the piece of paper with ‘Money’ [written] on it is actually real money.”
Lanchester describes QE in another way as well. He compares it to a situation where an individual while looking at his “bank balance online” also has “the additional ability to add to it just by typing numbers on [his] keyboard.” “Ordinary punters can’t do this, obviously, but governments can; then they use this newly created magic money to buy back their own debt. That’s what quantitative easing is,” writes Lanchester.
This has been done in the hope that with all the newly money created being pumped into the financial system, there would be enough money going around and interest rates would continue to remain low. At lower interest rates the hope was people would borrow and spend more, and this in turn would lead to economic growth.
This did not turn out to be the case. What happened instead was that financial institutions borrowed money at very low interest rates and invested that money in financial markets all over the world. This explains to a large extent why stock markets have rallied all over the world in the recent past despite slow economic growth in large parts of the world.
So with the Federal Reserve deciding to stop money printing, will the era of easy money come to an end as well? The answer is no. For “easy money” junkies the party will continue. The Federal Reserve stated yesterday that “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial condition.”
What does this mean in simple English? The Federal Reserve has printed and pumped money into the financial system by buying bonds. It currently holds around more than $4 trillion worth of bonds. Bloomberg points out that this makes up for around 20% of all the bonds issued by the American government as well as mortgage backed securities outstanding. The Federal Reserve holds around $2.46 trillion of US government bonds.
In the days to come as these bonds mature, the Federal Reserve plans to use the money that comes back to it to buy more bonds. In this way it plans to ensure that the money that it has printed and pumped into the financial system, stays in the financial system.
Hence, Federal Reserve will not start sucking out all the money it has printed and pumped into the financial any time soon. And this means that the era of “easy money” will continue for the time being. The Federal Reserve also stated that fit plans keep interest rates low “for a considerable time following the end of its asset purchase program this month.”
By doing this, the Federal Reserve is essentially buying time. Currently, it is very difficult to predict how exactly the financial markets will react if the Fed decides to start sucking out all the money that it has printed and pumped into the financial system.
As Lanchester writes “Nobody quite knows what’s going to happen once QE stops. In fact, the ‘unwinding’ of the QE is on many people’s list as the possible trigger for the next global meltdown.” Further, even though the American economy is doing much better than it was in the past, the recovery at best has been fragile. The US economy grew by 4.6% during the period between July and September 2014, after having contracted by 2.1% during April to June, earlier this year.
The rate of unemployment in the US has been coming down for quite a while now. In September 2014, it stood at 5.9% against 6.1% in August. This rate of unemployment is around the average rate of unemployment of 5.83% between 1948 and 2014. It is also below the 6.5% rate of unemployment that the Federal Reserve is comfortable with.
Nevertheless, even with these reasons, the Federal Reserve is unlikely to start sucking out money and raising interest rates any time soon. This is because the US has become what Lanchester calls a “two-speed economy”. Lanchester defines this as “an economy in which different sectors are performing differently at the same time”. In the American context, it is a matter of Texas and the rest of the country.
The state of Texas has been creating more jobs than any other state in the United States. As Sam Rhines an economist at Chilton Capital Management points out in a recent article in The National Interest “From its peak in January 2008 through today, the United States has created only 750,000 jobs. Texas created over a million jobs during that same period—meaning that the rest of the country (RotC) is still short 300,000 jobs. During the recovery, job creation has been all Texas or—at the very least—disproportionately Texas.”
This has meant that the contribution that Texas has been making to the US economy has increased over the last few years, from 7.7% in 2006, it now stands at 9%. So, if one takes Texas out of the equation, the United States still hasn’t recovered all the jobs it lost since the start of the financial crisis in September 2008. Further, if one takes out the Texas growth out of the equation, the GDP growth also falls considerably. As Rhines writes “From 2007 through the end of 2013, the U.S. economy grew by $702 billion, and Texas grew by $220.5 billion.”
Other than this the broad unemployment numbers hide the fact that the labour force participation rate has been falling over the years. Labour force participation rate is essentially the proportion of population older than 15 years that is economically active. The number for September 2014 stood at 62.7%. This is the lowest number since 1978. The number had stood at more than 65% before the start of the financial crisis. Hence, more and more people are now not looking for jobs and they are no longer counted as unemployed.
Further, a lot of jobs being created are part-time jobs. Also, with jobs being difficult to come by many people looking for full-time jobs have had to take on part time jobs. In August 2014, nearly 7.3 million Americans were involuntarily working part time, compared to 4.6 million in December 2007, before the financial crisis had started. In September 2014, this number dropped to 7.1 million. Even after this fall, the number remains disproportionately high. This underemployment is not reflected in the rate of unemployment number.
Janet Yellen obviously understands this. As she had said in a press conference in September 2014 “There are still too many people who want jobs but cannot find them, too many who are working part-time but would prefer full-time work.”
Taking all these factors into account the Federal Reserve is unlikely to start sucking out all the money it has printed and pumped into the financial system any time soon. Nevertheless, whenever it gets around to doing that there will be trouble ahead.
Lanchester perhaps summarises the situation well when he says: “If a medicine is guaranteed to make you very sick when you stop taking it, and you know that one day you’ll have to stop taking it, then maybe you shouldn’t start taking it in the first place.”
But that at best is a benefit of hindsight. The horse, as they say, has already bolted by now. Alan Greenspan, the former Chairman of the Federal Reserve, recently said that the next phase of Fed’s retreat would not be so smooth and the Fed would not able to avoid turmoil. “I don’t think it’s possible,” Greenspan said.

The column is an updated version of a column that appeared on October 29, 2014. You can read it here.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)