Market Overview

Is the Table Set for the Next Financial Crisis?

Is the Table Set for the Next Financial Crisis?

Last week, the Federal Reserve announced its third-round of quantitative easing, whereby the bank essentially prints money and then buys assets with it in order to add liquidity to the financial system and bring down interest rates. The ultimate goal of this monetary policy tool is to spur economic growth and lower the unemployment rate.

The Fed also changed the language of its interest rate forecast and now sees the Fed funds rate remaining exceptionally low through mid-2015. Previously, the Fed had said that the rate would remain near zero through at least 2014, so the change in language extends the forecast by roughly half a year.

The announcement of QE3 is wearisome for many reasons. When the Federal Reserve and Treasury started down the path of radical market intervention, many enlightened investors opined that the intervention may go on into perpetuity. By all accounts, this prognostication has been borne out thus far.

The counter-argument to the incessant monetary and fiscal machinations of the policy makers is that these actions have fundamentally changed the nature of global markets. The effect of the bailouts, stimulus and quantitative easing could be argued to have prevented the economy from a natural re-set.

While the stimulative policies are temporary and artificial, the laws of economics are not. Asset prices have not been able to reach an equilibrium level as a result of overwhelming intervention. Mal-investment and bad debt has been subsidized, and market prices have become distorted. In such a scenario, it would seem there is no solid foundation upon which a strong recovery can be sustained.

Asset prices have been artificially manipulated and do not reflect long-term economic reality. Consider for example, the U.S. Treasury market. The yield on the 10-year note is currently around 1.84 percent. Is this an accurate reflection of the credit-worthiness and fiscal situation of the U.S. government? Does it accurately reflect inflation expectations?

Nearly all asset classes have become distorted in the wake of the unprecedented market intervention that has taken place to combat the fallout of the financial crisis. Last week, once again, commodity prices rose as investors sought to hedge themselves against a falling U.S. dollar. Quantitative easing serves to dilute the money supply, and naturally the value of the money declines.

The trend of a falling dollar and rising commodity prices may continue to cause dire consequences across the world. It is devastating to savers who keep money in conservative, low-yielding assets. Even more harmful, it has forced the price of essential commodities such as food and energy higher at the worst possible time for most global citizens.

In a low-growth environment with sky-high unemployment levels, the effect of rising costs for essential items such as food and gasoline is extremely destructive to the economy. This is a global phenomenon, as the stimulative measures taken by the world's central banks do not seem to be having the intended effect.

Instead of citizens noticing the effects in more jobs and a strengthened economy, they see them at the gas pump and in the grocery store. What appears to be happening, is that the United States and other developed nations are creating catastrophic systemic risks as a result of the policies intended to engender an economic recovery.

During financial times such as these, it may be useful to take a step back and evaluate how this has happened. In 2007, the U.S. mortgage market melted down, triggering a devastating global recession. The very same policy-makers upon whom our economic future relies were caught completely by surprise.

Former Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, Congress, corporate CEOs -- they all were tantamount to deer in headlights when the mortgage tidal wave hit. Yet, these same people (in particular Ben Bernanke and the Federal Reserve) purport to have the solutions to the problems that they never once saw coming.

The reality is that the central planners across the world have very little visibility out of the windshield, and the effectiveness of their reactionary measures has been dubious at best. The former statement has been proven time and again, and the latter is fairly obvious given the state of the economy. Unfortunately, the policy makers cannot admit this and act accordingly -- i.e., with a more hands-off approach.

What is even more disconcerting than the realization that the authorities continue to operate with the idea that they can manipulate, control and accurately forecast the economy, is that their policies are heaping risk onto an already fragile system.

If they are in fact incapable of accurately forecasting the economy and achieving the desired outcomes through their policies, then what is the benefit of the massive risks being taken in that quest?

Readers should consider what another severe recession could look like in light of what has occurred since the financial crisis. Between 2007 and the present, governments have taken on crushing debt loads by transferring private liabilities onto the public balance sheet. The balance sheets of global central banks have also ballooned to grotesque levels as a result of stimulative policies.

The consequences of these actions are abundantly clear as a global sovereign debt crisis continues to unfold. These consequences are most obvious in Europe, but they could envelop the entire developed world.

So, here is the question -- what if these policies fail and the economy takes another nose dive? The position of governments and central banks will be exponentially weaker than they were in 2007, and the likelihood of currency and sovereign debt implosions will be multitudes higher across the world.

It is a very real possibility that the fiscal and monetary policy actions taken in the wake of the Great Recession have set the scene for a far greater crisis in the not too distant future.

Posted-In: Bonds Commodities Politics Forex Psychology Topics Economics Markets Best of Benzinga


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