Thursday, April 25, 2013

Central Banks buying equities: building a house of cards

Perhaps writing about it will help me with the potential consequences of Central Banks loading up on equities.  

As background: a central banks is defined by investopedia as:

The entity responsible for overseeing the monetary system for a nation (or group of nations). Central banks have a wide range of responsibilities, from overseeing monetary policy to implementing specific goals such as currency stability, low inflation and full employment. Central banks also generally issue currency, function as the bank of the government, regulate the credit system, oversee commercial banks, manage exchange reserves and act as a lender of last resort.

For example, the central bank for the United States is the Federal Reserve.  For Japan it is the Bank of Japan.  For the eurozone countries it is the European Central Bank (ECB).  For the UK it is the Bank of England.  These are the entities that create money out of thin air by 'printing' it.

These countries are all in debt.  How is it that they have excess money to invest in anything?  Presumably, they just printed more in order to invest it.  But, isn't this bad for an economy.  The excess money will be invested in things that are, at best not very productive.  So this money is just inflating the equity markets.  And, when more excess money is not available equity price will return to productive levels.  So the current equity market inflation is temporary, which seems to be the point.  Inflate the stock market long enough to make your millions or serve your term in office and let the next guy deal with the consequences.  And, kick the can down the road.  Some day this road is going to end.

Now let's assume that these countries actually have excess money to invest because they do not need to buy anymore of their government's debt and are not trying to depreciate their currency.  What to do with that excess money?  Invest it in equities!  That way if our industries go in to recession and start to fail, our country will lose a lot of value on its investments at the exact time our country can least afford it.  OK, let's invest it in other countries' companies to diversify.  Sorry that strategy will not help diversify the risk.  The economy and companies are global.  For example, when Apple sales slow it affects suppliers in Asia just as much as Silicon Valley.  And, 61% of Apple sales in FY2012 were international.

This is going to end badly.

Just to make sure: do you realize that if you have a 401k or IRA or pension plan with investments in equities, the value of your retirement assets is currently being inflated by this 'excess' money.  But, don't worry the Fed can always print enough money to keep the Dow around $15,000.  Of course by printing that much money a burger will cost as much as a share of Apple stock when you retire.  And, a prescription will cost . . . . never mind just enjoy your burger.

Central Banks load up on equities.

"Some day this war is going to end."

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