Friday, March 8, 2013

American Paradox

Today The economist published an article entitled Rally Drivers.

It was writing about central bank strategy - QE and reviving the American Economy against headwinds of over-priced equities and bonds while profits are starting to stall.

They concluded:

The central banks are pursuing the right policy for a weak world economy, but it has risks... The kind of high-risk securities that marked the credit bubble are starting to reappear.
And there are reasons to worry that stocks may be overvalued... indeed, profits growth has been slowing in recent months. For the current quarter, ending March 31st, profits of S&P 500 companies are expected to be only 1.2% higher than the previous year—and only 0.1% if financial companies are excluded from the total. All that leaves American shares looking off-puttingly expensive, with valuations around 40-50% above the long-term average (see article)... central banks can be excused for sitting back and enjoying the bull run, especially as any action they could plausibly take to halt it would damage a still-fragile economy.
A different paradox of thrift
...American pension funds should be aware that, with bond yields low and equity valuations high, future investment returns are likely to be low. They need to contribute more if pension deficits are to be reduced. Similarly, employees who are responsible for their own pensions via plans such as 401(k)s need to stump up more if they are to retire in comfort.
But here is the paradox. To rescue economies from the doldrums, central banks want companies and employees to save less in the short term, not more. Balancing the desire for short-term consumption and the need for long-term thrift is one of the trickiest issues for rich countries as they navigate their way out of the crisis.
Perhaps the Dow will resolve that paradox by continuing to soar. More likely, it will not.
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What are they thinking here?

If equities and Bonds are over-priced and this means that more should be saved then they will get to be even more over-priced, and the economy will not prosper.

On the other hand if these assets devalue so as to give a more meaningful return to investors, then it might be sensible to invest more in pension funds. And pension funds should then be lending to and investing in new enterprises and creating more jobs.

The facts are that there are too few people employed and for that reason there is too little spending in the economy and too little tax revenue to support the government's borrowing.

Normally when equity prices are high Rights Issues and New Issues come and mop up the surplus money, new jobs are created, and the stock market sinks. But that sinking process is blocked by QE.

QE and cheap money and over-valued assets is in fact the whole problem and always has been ever since the Chinese began buying USA Government Debt in large quantities making money cheap, interest rates low, and inflating every kind of asset value from property to bonds to equities.

Once you create a distorted economy, nothing works the way it should until the distortions unwind.
It is taking away the confidence people have in their savings and investments, because everyone knows, as the article started out by saying, things are not as they should be. They are wary of spending and they are wary of investing. The cash pile is mounting.

The longer this continues, the higher the price will be for unwinding.

I have put forward proposals on my Blogs and in my draft book which readers of the Blogs are welcome to read.

I need your email address, sent to me at:
eingram@ingramsure.com

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