Global Agenda: Orwellian markets

The most serious disruption of the market mechanism has been the deliberate holding down of interest rates at low levels.

By PINCHAS LANDAU
Euro symbol near European flags 311 (photo credit: REUTERS/Francois Lenoir)
Euro symbol near European flags 311
(photo credit: REUTERS/Francois Lenoir)
The adjective “Orwellian” refers primarily to the nightmare world the author created in his book 1984, a world defined by contradictory and illogical slogans such as “war is peace” and “freedom is slavery.”
This kind of logic is alive and well in the global financial markets today and seems to be the only way to make sense of them.
Markets, in economic theory, are mechanisms for collating and transmitting information about goods and services via the prices that they generate. It follows that if the mechanism is tampered with, the prices generated will be “wrong” (not the ones that would have been generated by the free interplay of unrestricted forces of supply and demand), and the information they represent will be faulty. Consistent and/or deliberate tampering with the mechanism will result in a flow of misinformation, which will cause market participants to make wrong decisions and thereby misallocate resources.
That is Economics 101 in one paragraph. In practice, of course, market mechanisms are subject to all kinds of disruptions and tampering, which, in the real world, participants have to live with. The largest single source of tampering is the modern state, which engages in intervention in almost every sphere of economic activity. Traditionally, market players view government intervention as a negative phenomenon. But, as we saw so dramatically in 2008, the big players assume that government will intervene on their behalf in times of crisis.
Since then, the scale and frequency of government interventions in the financial markets has reached unprecedented levels. To take one recent example: When the euro-zone crisis reached one of its periodic climaxes in late June, the authorities in several European countries issued a ban on short-selling of shares. Short-selling is the opposite of buying shares; the investor borrows the shares he wants to sell from someone who owns them and then sells them in the market, seeking to buy them back at a lower price and give them back to the entity who lent him the shares, thereby repaying his loan and pocketing the profit.
However, while buying shares is regarded as a legitimate activity, short-selling is viewed as “speculative” and is a frequent target of regulatory action in response to a market panic or crash. It can – and has – been demonstrated that this kind of ban is useless in the long run. But rational considerations are always cast aside when a panicking public is screaming for politicians to “do something.”
By far the greatest and most serious disruption of the market mechanism has been the deliberate holding down of interest rates at very low levels. However, this strategy has failed to achieve its declared goal of boosting investment and consumption and thereby restoring the developed economies to normal functioning. It has therefore been enhanced by “unorthodox measures,” primarily the buying of government (and sometimes non-government) bonds by central banks, a tactic known as “quantitative easing.” Here, too, the object is to increase the amount of money in the economy, reduce interest rates – including medium- and longer-term rates – and thereby “stimulate” economic activity.
Many independent analysts, now including the IMF, have voiced doubts as to the efficacy of QE in any form.
Almost everyone agrees it is damaging. The debate is over how damaging it is and whether the benefits it brings more than offset that damage. But even if the jury is out over the overall economic result, there can be no doubt that for the financial markets, the dominant consideration is now whether, when and how much “stimulus” will be provided by the Fed, the ECB, the central banks of England and Japan and the PBOC (People’s Bank of China).
The markets are far more concerned about what and when the various central banks might do than the regular macroeconomic data relating to production, employment, prices, etc. – and even to corporate earnings, which are supposed to be the decisive factor in the equity markets.

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In fact, the craving for QE is so great that the markets now use an Orwellian logic whereby “good is bad,” meaning that positive economic data are bad for the markets because they reduce the likelihood of another round of QE soon. By the same token, “bad is good” because signs of weakness in the economy will push the central banks to act sooner and/or on a larger scale.
The repeated use of monetary stimulus has thus subverted the normal market mechanisms because prices do not reflect “fundamentals,” but rather expectations and/or disappointments as to decisions regarding more stimulus. The financial system, in short, has become a junkie that without periodic “fixes” of new money from the central banks will suffer withdrawal symptoms such as illiquidity, price drops and even crashes – and a more severe and profound loss of confidence than it already labors under.
landaup@netvision.net.il