Bubbles

The Chinese are discovering that the stock market falls as well

chinaThe Shanghai Stock Exchange Composite Index is one of the premier stock market indices in China, like the Bombay Stock Exchange Sensex is in India. And it is not having a good time of late.

Between August 20, 2015, and today, the index has fallen by 21.8%. On August 20, the stock market opened at 3744.25 points. As of close today, it was down to 2927.29 points.

In the aftermath of the financial crisis which started in September 2008, the Chinese government resorted to bubbles to keep the economy growing. First there was an infrastructure bubble, which was followed by a property bubble and then a stock market bubble.

Between June 2013 and June 12, 2015, the Shanghai Composite Index rose 153.5%. The government successfully managed to divert a part of around $20 trillion savings into the stock market, and pushed it to astronomical levels. This was just as the property bubble was starting to burst. Since peaking in June 2015, the stock market has fallen by 43%, wiping off a major portion of the gains (as the old adage goes, a 50% fall, wipes a 100% gain). In order to prevent the fall, the Chinese government has done many things.

It has pushed big government financial institutions (or their equivalents of Life Insurance Corporation of India) to buy shares in the stock market. Investors who own more than 5% of shareholding in any company have been banned from selling these shares for a period of six months. Initial public offerings have been banned as well, so that investors invest only in the shares that are already listed and this pushes up the stock market. Many shares have not been allowed to trade at various points of time, as well.

Further, continuing with these measures, the People’s Bank of China, the Chinese central bank unleashed another round of easy money, yesterday. It cut the reserve ratio requirement (RRR or what we call cash reserve ratio or CRR in India) by 50 basis points (one basis point is one hundredth of a percentage) to 18% for most big banks.

This cut will be effective as of September 6, 2015, and is expected to add 700 billion yuan (or around $109 billion at today’s exchange rate of one dollar equals 6.42 yuan). Over and above this, the one year deposit and lending rates were cut by 25 basis points, to their lowest level ever.

The idea is to flood the financial system with “easy money”, and hope that some of it goes into the stock market and the market rallies all over again. The trouble is that Chinese politicians are not democratically elected and in order to appear credible they need to ensure that the Chinese economic growth story continues, as it has all these years.

As John Plender writes in Capitalism: Money, Morals and Markets:  “Unelected Chinese politicians may put the interests of the Communist Party elite before those of the nations. Their legitimacy, after all, rests chiefly on the continuation of high rates of economic growth.” Ensuring that bubbles continue are an important part of this story. Any bubble burst will drive down economic growth. The economic growth has already fallen from more than 10% to around an “official” rate of 7%.

What has helped the Chinese government up until now, is the belief among the Chinese that the government can engineer any economic outcome that it wants. And it is this belief that has allowed the Chinese government to engineer the economic outcome that it wants. Nevertheless, in the process it has ended up with big bubbles—be it in the stock market, the property market, infrastructure, or total amount of debt in the financial system.

The interesting bit is that the Shanghai Composite Index barely responded to yesterday’s decision of the People’s Bank of China to cut the reserve ratio requirement. The index fell by 1.27% during the course of the day today. Of course, if the reserve ratio requirement had not been cut, the market would have fallen more.

The point is that the Chinese over the last one week have discovered that the stock market does not always go where the government wants it to go. And it can have a mind of its own. The market simply does not keep going up, it falls as well.

The situation is a tad similar to what happened when the erstwhile Soviet Union was just coming out of communism and its people were essentially shocked at encountering a system that functioned according to a completely different set of rules.

This is best explained by a question that the British economist Paul Seabright was asked by the director of bread production of the city of St. Petersburg. This gentleman was trying to understand how the new system (which wasn’t like the old system) worked.

As Felix Martin writes in Money—The Unauthorised Biography, the director of bread production asked Seabright, “Please understand that we are keen to move toward a market system … but we need to understand how such a system works. Tell me, for example who is in charge of the supply of bread to the population of London?”

In this context, the point is that the Chinese government would like its people to believe that it is in-charge of the stock market, but it seems to be gradually losing control over it. And that can’t possibly be a good thing for either the Chinese or the world at large.

The column originally appeared on Firstpost on August 26, 2015

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

Property prices must fall: Rajan reads out the riot act to real estate wallahs

ARTS RAJAN
Vivek Kaul

Raghuram Rajan, the governor of the Reserve Bank of India (RBI), merely stated the obvious when he said today (August 20, 2015): “It would be a “great help” if realty developers sitting on unsold stock bring down prices…Once the prices stabilise, more people will be keen to buy houses.”

The RBI governor added that property prices need to fall before interest rates on home loans come down, any further. “I think we need the market to clear. With growing unsold stock, we need to see the ways to do it. Some of it might be by making loans easier, but we also don’t want to create a situation where prices stay high at the level which means demand can’t pick up,” he said.

There are multiple points that need to be made here: First is that Rajan was essentially replying to all the real estate wallahs (real estate companies, lobbies and others associated with the sector) who demand interest rate cuts at a drop of a hat. The message from the RBI governor is loud and clear. The home prices are in a bubble zone and he does not want to inflate the bubble further by cutting interest rates. Home prices need to fall.

Also, it is worth mentioning here that even at high interest rates home loans given by banks continue to grow at a very brisk pace. The Reserve Bank of India (RBI) puts out the sectoral deployment of credit data every month. As per these numbers, the total amount of home loans given by banks grew by 15.6% to Rs 6,53,400 crore, over the last one year. In comparison, the overall lending by banks grew by just 7.3%. These numbers were as of June 2015.

How was the situation in June 2014? Home loans had grown by 17.1% to Rs 5,65,000 crore. In comparison the overall lending by banks had grown by 12.8%. What this clearly tells us is that even though the overall lending growth of banks has crashed from 12.8% to 7.3%, home loans continue to grow at a fairly brisk pace.
Further, banks have given out Rs 88,400 crore of home loans in the last one year. This formed around 21% of all the lending carried out by banks. For a period of one year ending June 2014 and June 2013, home loans formed around 12.7% and 12.2% of the total loans given by banks.

What this clearly tells us that banks are giving out a greater amount of home loans as a proportion of their overall loans, than they were in the past. And if this hasn’t led to a fall in inventory of unsold homes, the only reason is that home prices have gone up way beyond what most people afford. Hence, even though the total amount of home loans has gone up, the total number of home loans being given out may have even fallen (This data is not available).

The only way this situation can be corrected is if home prices fall, which is precisely what Rajan said.

The other interesting point that needs to be made here is that central bank governors normally stay away from calling a bubble, a bubble. Alan Greenspan, the Chairman of the Federal Reserve, from 1988 to 2006, was a pioneer in this school of thought. He told the US Congress in June 1999: “Bubbles are generally perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”

So, the Federal Reserve could not spot the dotcom bubble, explained Greenspan. But once it had burst, steps could be taken to ease its fallout, Greenspan felt. As he said in a speech titled Economic Volatility on August 30, 2002: “The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion. Instead, we noted in the previously cited mid-1999 con­gressional testimony the need to focus on policies ‘to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.’”

There is a fundamental problem with this argument. Greenspan was basically saying that the Federal Reserve could not recognize a bubble, but it could figure out when the same bubble had burst.

Raghuram Rajan exposes the flaw in this argument in his book Fault Lines. As he wrote: “This speech seemed to be a post facto rationalization of why Green­span had not acted more forcefully on his prescient 1996 intuition: he was now saying the Fed should not intervene when it thought asset prices were too high but that it could recognize a bust when it happened and would pick up the pieces.” Greenspan had used the term “irrational exuberance” to describe the dotcom bubble in a speech he had made in December 1996, and then chosen to do nothing about it.

Rajan clearly does not believe in the fact that a central bank cannot identify a bubble. What he said today regarding property prices being high and that they need to fall, before people can start buying homes again, clearly proves that.

Further, the real estate wallahs seem to have come up with a new explanation for why real estate prices cannot fall any further(they have barely fallen to start with). As Shishir Baijal, chairman and managing director of Knight Frank India, a real estate consultancy, told Mint recently: “Theoretically, if prices come down, perhaps the demand can increase. But I’m not sure if developers have any leeway left now for reducing prices. This is because input cost has increased quite a lot over the past few years— be it cost of labour, construction and material, or even the historical cost of land itself, which is very high. It does not look like there is any scope left for a serious correction in prices.”

This, after he had said: “there is a mismatch [between demand and supply] because people are finding it unaffordable (to buy).”And this came, after he had said: “If you look at investor demand, property is not their primary choice anymore. This is due to muted price appreciation, high level of unsold inventory, and the fact that there are other more lucrative financial instruments to choose from. Earlier, there weren’t any options as the equity market was not performing.”
So, investors are not buying because they are not getting high returns from investing in real estate, anymore. The end users are not buying because prices are high. But prices will still not fall, say the real estate wallahs. What sort of an argument is that?

If home prices do not fall, the real estate sector will continue to remain in a mess for a much longer period of time. The market will go through what analysts call a longer time correction (i.e. prices will stagnate for a long period), if prices don’t fall. And this can’t possibly be good for anyone—buyers will continue to stay away, and sellers won’t be able to sell.

This will mean that the real estate companies will continue to hold on to unsold homes that they have accumulated over the years. Given this, Rajan was absolutely right when he said if the market has to function, and buy and sell transactions have to happen, home prices need to fall. The sooner the real estate wallahs understand this, the better it will be for all of us.

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

The article originally appeared on Firstpost.com on August 20, 2015

Chinese politicians will do whatever it takes to keep economic growth going

china“The one thing I know for sure about China is, I will never know China. It’s too big, too old, too diverse, too deep. There’s simply not enough time.”
Anthony Bourdain, Parts Unknown

Ideally, I should have written this column last week, but this trend isn’t going anywhere anytime soon.  On August 11, 2015, the People’s Bank of China, the Chinese central bank, engineered a 1.9% cut in the value of the Chinese yuan against the US dollar. This was the largest single day cut in the value of the yuan against the dollar in two decades. The Chinese yuan doesn’t move freely against the dollar. The People’s Bank of China controls its value. Before last week’s cut, 6.2 yuan equalled a dollar.

As I write this on August 17, 2015, around a week later, 6.4 yuan are worth a single dollar. The value of a currency is a big variable for exporters. But by ensuring the yuan had a fixed value against the dollar, the Chinese central bank took this variable out of the Chinese exporters’ equation totally. This helped Chinese exports and exporters flourish and has been a very important part of the Chinese economic miracle.

Nevertheless, Chinese exports have been falling lately. In July 2015, Chinese exports fell by 8.3% compared to a year earlier. Even in June 2015, the exports had gone up by only 2.8%. A major reason for this is that the Bank of Japan, the Japanese central bank, has rapidly driven down the value of the Japanese yen against the dollar. In October 2012, 80 yen made up a dollar. As I write this, around 124.5 yen make up for a dollar. This has made many Japanese exports more competitive than China’s. Further, it has made imports into Japan more expensive. This caused Chinese exports to Japan between January and July 2015 to fall by 10.5%.

So it’s not surprising that the Chinese authorities pushed down the value of the yuan against the dollar. Their goal is to boost Chinese exports while making imports into China more expensive, thereby pushing the sales of local Chinese made goods and boosting economic growth in the process.

The People’s Bank of China decreased its foreign exchange reserves by $300 billion over the last four quarters. In other words, in a bid to keep the yuan at 6.2 for every dollar, the Bank has been selling dollars from its kitty and buying up yuan, which is essentially money being taken out of the country.

The People’s Bank doesn’t have an unlimited supply of dollars. At some point, it had to let the value of the yuan fall against the dollar, which is precisely what it did last week. For years on end, China has grown at double-digit rates. But recently, as global demand has fallen in the aftermath of the financial crisis which started in 2008, economic growth has slowed to 7% per year. In fact, many China followers believe the official 7% figure is an overstatement.

For example, Ruchir Sharma, Head of Emerging Markets and Global Macro at Morgan Stanley, wrote in a recent column in The Wall Street Journal that: “While China reported that its GDP grew exactly in line with its growth target of 7% in the first and second quarters this year, all other independent data, from electricity production to car sales, indicate the economy is growing closer to 5%.”

Most China experts and analysts fail to mention this, but it is important to understand that economic growth gives legitimacy to the unelected communist government that runs China.

As John Plender writes in Capitalism: Money, Morals and Markets:  “Unelected Chinese politicians may put the interests of the Communist Party elite before those of the nations. Their legitimacy, after all, rests chiefly on the continuation of high rates of economic growth. If they fail to deliver, their survival in an economic crisis may depend on whipping up nationalist popular feeling against Japan, Taiwan or other Asian neighbours, intensive trade relations notwithstanding.”

This phenomenon was at play in the recent past, when the Chinese government tried to do everything to stop the stock market from falling. It banned investors with more than a 5% holding in a company from selling shares and it directed big financial institutions to invest in the stock market. These moves were to prop up stocks, but mostly to maintain political legitimacy.

Since the financial crisis, the Chinese politicians have been able to maintain credibility by ensuring that the economic growth has not collapsed, as it has in much of the Western Word. This has been done by lending cheap money across various sectors. As Sharma of Morgan Stanley writes: “The problem is that China’s economic rise of late has been facilitated by a massive and unsustainable stimulus campaign. No emerging nation in recorded history has ever tacked on debt at such a furious pace as China has since 2008, and a rapid increase in debt is the single most reliable predictor of economic slowdowns and financial crisis. China’s debt as a share of its economy increased by 80 percentage points between 2008 and 2013 and currently stands at around 300%, with no sign of abating.”

This easy money first led to a property bubble, which was followed by an infrastructure bubble and a stock market bubble.
The point is that the Chinese politicians will do whatever it takes to keep the economic growth going. So expect the devaluation of the Chinese yuan against the dollar to continue, as China tries to push up its exports again.

As Albert Edwards of Societe Generale writes in a recent research note: “For although the PBoC [People’s Bank of China, the Chinese central bank] said the move was a one-time adjustment [the drop in the value of the yuan against the dollar] to reflect changes in the way it calculates the daily fix, it also said that the price would be set “in conjunction with demand and supply conditions in the foreign exchange market and exchange rate movements of the major currencies.”

What does this mean? Well, the race to the bottom isn’t exactly rocket science. With the yuan’s value now down against the dollar, chances are that the Bank of Japan will respond by printing even more yen, in a bid to further drive down the value of the yen against the dollar. The South Korean central bank may also do something along similar lines in order to drive down the value of the won [the South Korean currency] against the dollar to protect its exports. This in turn will lead to the People’s Bank of China to push the yuan down even further against the dollar. Rest assured, the currency wars in Asia will continue.

The column originally appeared in The Daily Reckoning on Aug 18, 2015

Global market bubbles: Raghuram Rajan will have the last laugh second time around

ARTS RAJAN

Vivek Kaul

The Federal Reserve Bank of Kansas City is one of the 12 Federal Reserve banks in the United States. Every year in August it organizes a symposium at Jackson Hole in the state of Wyoming. The conference of 2005 was to be the last conference attended by Alan Greenspan, the then Chairman of the Federal Reserve of the United States, the American central bank.
The theme of the symposium was the legacy of the Greenspan era. Those were the days when Greenspan was god, and hence, the economists who had turned up at the conference, were expected to say good things about him and his time as the Chairman of the Federal Reserve of United States, which had lasted close to two decades.
One of the economists attending the conference was Raghuram Rajan, who at that point of time was the Chief Economist of the International Monetary Fund. Rajan presented a paper titled “Has Financial Development Made the World Riskier?” at the conference. 
As Neil Irwin writes in The Alchemists—Inside the Secret World of Central Bankers “Raghuram Rajan presented a rare moment of clarity at the 2005 conference. Rajan indeed had an astute understanding of the ways in which the financial industry, with misguided compensation policies that encouraged risk-taking, was making the world a more dangerous place: Bankers were paid big bonuses for making money in the short run even if they were betting poorly in the long run.”

Rajan in his speech also suggested that banks were not in the best shape as was being made out to be. As he put it “The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis.”
In the last paragraph of his speech Rajan said that “One source of concern is housing prices that are at elevated levels around the globe.” Rajan’s speech did not go down well with people at the conference. This is not what they wanted to hear.
Rajan recounts the situation in his book Fault Lines – How Hidden Fractures Still Threaten the World Economy: “I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticized by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what going on before their eyes.”
Rajan’s prediction turned out to be right in the end and a little over three years later in September 2008, the world was in the midst of a full-blown financial crisis, the impact of which is still being felt, almost six years later. Banks and financial institutions about the go bust had to be rescued by governments all over the Western world. Also, in the aftermath of the crisis, Western governments and their central banks decided to print trillions of dollars in order to get their economies up and running again.
Now Rajan has sounded a warning again.
In an interview to the Central Banking Journal which was published a few days back Rajan said “The problems arising are not so much from credit growth, which is relatively tepid in the industrial markets and has been much stronger in emerging markets, but from asset prices due to financial risk-taking and so on. Unfortunately, a number of macroeconomists have not fully learned the lessons of the great financial crisis. They still do not pay enough attention – en passant – to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you. So it is not like economic growth, where unemployment offers a more continuous indicator.”
What Rajan is essentially saying here is that all the money printed and pumped into the financial system by the American and other Western governments has led to financial market bubbles all over the world. And these bubbles when they burst will lead to another financial crisis. As Rajan put it “We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”
Rajan went on to suggest that central banks have had a role to play in creating financial market bubbles all across the world. As he put it “The kind of language we hear is akin to gaming. Investors say, ‘we will stay with the trade because central banks are willing to provide easy money a
nd I can see that easy money continuing into the foreseeable future’. It’s the same old story. They add ‘I will get out before everyone else gets out’.”
In another interview to the Time magazine published on August 11, 2014, Rajan said “A number of years over which we, as central bankers, have convinced markets that we continuously come to their rescue and that we will keep rates really low for long — that we do all kinds of ways of infusing liquidity into the markets — has created markets that tend to push asset prices probably significantly beyond fundamentals, in some cases, and make markets much more vulnerable to adverse news.”
One of the reasons for the bubbles is the fact that compensation structures which encourage high financial risk-taking are back on Wall Street. The following table makes for a very interesting reading.bonus to profit ratio


Source: The Office of New York State Comptroller

In 2007 and 2008, the Wall Street firms faced huge losses. But their employees still got their bonuses. In fact, in 2007, the total bonus had stood at $33 billion. This, when firms had faced losses of $11.3 billion.
In the year 2009, the Wall Street firms made a profit of $61.4 billion because of all the bailout money given by the government. Even during the heydays of the bull run between 2003 and 2006, the firms had not made that kind of money.
Interestingly, if one looks at the bonus-to-profit ratio between 2003 and 2006, it stands at 1.55. For the period after the financial crisis, between 2010 and 2013, the ratio stands at 1.48. There is not much material difference between the two ratios.
What this clearly tells us is that the bonus paid as a proportion of profits continues to remain high among Wall Street firms. Hence, the “risk” that these high bonuses built into the American financial system continues. As Michael Lewis writes in Flashboys: “Once the very smart people are paid huge sums of money to exploit the flaws in the financial system, they have the spectacularly destructive incentive to screw the system further, or to remain silent as they watch it being screwed by others.”
What Rajan had warned about in 2005 continues unabated and that has led to financial market bubbles all over the world. The real estate bubbles which played a major role in the financial crisis which started in September 2008, are also back with a bang. As Albert Edwards of Societe Generale wrote in a research note titled Here we go again…and once again no-one is listening “We are in the midst of the mother of all housing bubbles.
The economist Nouriel Roubini wrote in a November 2013 column “Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil.”
Over and above this the stock market in the United States continues to rise. As investment newsletter writer Gary Dorsch puts it in a June 2014 column “The “Least Loved” Bull market is still running on steroids, even at 63-months old. The median lifetime of the Top-12 Bull markets is 55-months. So it’s lasted 8-months beyond its mid-life. A -10% correction hasn’t happened for the past 34-months, far beyond the average of 18-months between corrections.”
And when these bubbles start bursting all over again, as they are bound to do, there will be trouble along the lines Rajan has been talking about. He might have the “last laugh” second time around as well. Though until that happens he may still be the “early Christian who [has] wandered into a convention of half-starved lions”.

The article was originally published on www.Firstbiz.com on August 14, 2014

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

With the Fed balance sheet at $4 trillion, Indian markets have become ‘more’ bubbly

 bubbleVivek Kaul 
The Federal Reserve of the United States, the American central bank, has been rapidly expanding its balance sheet since late 2008. As on November 13, 2013, the size of the Fed’s balance sheet was at $3.907 trillion.
Now compare this to the size of the Fed’s balance sheet as on September 10, 2008, when it stood at around $940 billion. The investment bank Lehman Brothers went bust as on September 15, 2008, which led to the start of the current financial crisis.
Since late 2008, the Federal Reserve has been printing dollars. It has been pumping these dollars into the financial system by buying financial securities like American government bonds and mortgage backed securities. Currently, the Fed buys $85 billion worth of financial securities every month.
The securities that the Federal Reserve buys are reflected as assets on its balance sheet. Hence, the balance sheet of the Federal Reserve has increased in size by a whopping 316% in a little over five years. In fact, the balance sheet of the Federal Reserve should touch the size of $4 trillion sometime next month, given that it continues to print dollars and buy financial securities worth $85 billion every month.
At $4 trillion, the Federal Reserve’s balance sheet will be nearly 25.5% of the US gross domestic product of $15.68 trillion in 2012. In fact, if the Federal Reserve continues to print money at the rate it is currently, its balance sheet will cross $5 trillion in a year’s time. These are fairly big numbers that we are talking about.
The idea behind printing money was to ensure that there was enough money going around in the financial system and hence, the interest rates continued to stay low. At low interest rates people were more likely to borrow and spend, and this would help revive business growth and in turn economic growth.
But that hasn’t turned out to be the case and economic growth continues to remain low in United States and much of the Western world. Also, the prevailing belief seems to be that demand can be created by keeping interest rates low for a long period of time.
As investment newsletter writer and hedge fund manager John Mauldin writes in his latest report The Unintended Consequences of ZIRP released on November 16, 2013 “The belief is that it is demand that is the issue and that lower rates will stimulate increased demand (consumption), presumably by making loans cheaper for businesses and consumers. More leverage is needed! Butcurrent policy apparently fails to grasp that the problem is not the lack of consumption: it is thelack of income.”
People borrow and spend money when they feel confident about the future. Right now, they just don’t. A major reason for this is the fact that United States and large parts of Europe are in the midst of what Japanese economist Richard Koo calls a balance sheet recession.
In a balance sheet recession a large portion of the private sector, which includes both individuals and businesses minimise their debt. When a bubble that has been financed by raising more and more debt collapses, the asset prices collapse but the liabilities do not change.
In the American context what this means is that people had taken on huge loans to buy homes in the hope that prices would continue to go up for perpetuity. But that was not to be. Once the bubble burst, the housing prices crashed.
This meant that the asset (i.e. homes) that people had bought by taking on loans, lost value, but the value of the loans continued to remain the same. Hence, people needed to repair their individual balance sheets by increasing savings and paying down debt. This act of deleveraging or reducing debt has brought down aggregate demand and has thrown the economy in a balance sheet recession.
Koo feels this is what has been happening in the United States where people have been paying down their debts, by increasing their savings. In mid 2005, when the housing bubble was at its peak, an average American was saving around 2% of his or her personal disposable income. This has since jumped to nearly 5%. In this scenario, it is unlikely that many people would want to borrow more, even if interest rates continue to remain low.
Individuals may not be borrowing as much as the American government expected them to, institutional investors have more than made up for it. Borrowing dollars at close to zero percent interest rates, they have invested money in financial markets all over the world. The Dow Jones Industrial Average, America’s premier stock market index, crossed a level of 16,000 points for the first time yesterday. The BSE Sensex also continues to trade close to 21,000 points, despite the Indian economy being in a bad shape.
Since the beginning of this year, the foreign institutional investors have invested Rs 71, 308.51 crore, in the Indian stock market. This is a clear impact of the easy money policy being run by the Federal Reserve. During the same period the domestic institutional investors have sold stocks worth Rs 62,573.45 crore. These are clear signs of the stock market being in the midst of a bubble.
The Federal Reserve can keep printing as many dollars as it wants to, given that there is no theoretical limit to it. Also, money printing is not having the kind of impact it was expected to have to create economic growth. At the same time it has led to financial market bubbles all over the world.
As Mauldin puts it “they also know they cannot continue buying $85 billion of assets every month. Their balance sheet is already at $4 trillion and at the current pace will expand by $1 trillion a year. Although I can find no research that establishes a theoretical limit, I do believe the Fed does not want to find that limit by running into a wall. Further, it now appears that they recognize that QE(quantitative easing or the fancy name economists have given to the Federal Reserve printing money) is of limited effectiveness.”
The trouble is that if the Federal Reserve decides to go slow on money printing, there will be a sell off across financial markets all over the world. And that will have fairly negative consequences for the US and large parts of the world.
Also, the Federal Reserve has more or less run out of the tools that it has at its disposal to revive the American economy. As Ray Dalio of Bridgewater pointed out in a recent note. “The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up, in that interest rates are at zero and US asset prices have been driven up to levels that imply very low levels of returns relative to the risk, so there is very little ability to stimulate from here if needed. So the Fedwill either need to accept that outcome, or come up with new ideas to stimulate conditions,” writes Dalio.
The Federal Reserve is in a catch 22 situation right now. Should it continue to print money? Should it go slow? This is a question that Janet Yellen, the Federal Reserve Chairman in waiting, needs to answer.

The article first appeared on www.firstpost.com on November 19, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)