The Socialist Captains of Capitalism!


Central banks of the world, unite!

First it was European Central Bank boss Mario Draghi, telling markets how determined he was not to let inflation get the upper hand. Look out for more money printing by March, he said.

China’s central bank ably supported Draghi, injecting $61 billion of liquidity into its market on Friday. Punters smelled a combined central bank rescue, and bid all riskier assets higher.

Bloomberg captured the sentiment:

The turnaround in sentiment came amid signs central banks may be prepared to act after $7.8 trillion was erased from the value of global equities this year on China’s slowdown and oil’s crash. Diminished inflation expectations and a strengthening yen are seen as increasing pressure on the Bank of Japan to enlarge stimulus at its meeting next week. China will keep intervening in its equity market to “look after” investors and has no intention of further devaluing the yuan, Vice President Li Yuanchao said.

The bastions of capitalism have clearly taken the world’s most recognisable socialist slogan. Central banks of the world are uniting, in a fight against…market forces!

Oh the irony. The socialists and central planners are in charge, and we all think they are the captains of capitalism! The mainstream media are especially complicit in all this. They slavishly report on every utterance, yet never question the actions and their usefulness.

Let’s see…who would you rather side with, socialist Ben Bernanke or capitalist George Soros?

Last week, I pointed out how Bernanke said investors had no cause to worry about China’s economy. It’s all good, he said, the planners have things under control.

But on Friday, in an interview with Bloomberg, George Soros was a little more bearish…

Billionaire investor George Soros said China’s economy is headed for a hard landing, a slump that will worsen global deflationary pressures, drag down stocks and boost U.S. government bonds.

“A hard landing is practically unavoidable,” he said in an interview with Bloomberg Television’s Francine Lacqua from the World Economic Forum in Davos on Thursday. “I’m not expecting it, I’m observing it.”

I’d back Soros over Bernanke any day. But that’s not to deny the power of central banks. The prospect of more intervention gave stocks a big boost on Friday and these hopes should continue to support prices in the short term.

Keep in mind though, markets were extremely oversold and waiting for an excuse to bounce. Once balance returns to prices, you’ll have a better idea of the market’s longer term health.

From a bigger picture perspective though, you have to wonder how long investors and speculators will keep the faith with central bank strategy. George Soros seems to think their words might not translate into actions big enough to have a meaningful effect.

And more broadly, I’m wondering at what point it will dawn on these people that perpetually low interest rates and money printing actually creates deflation in the real economy.

The reason is pretty simple. You just need to separate the real economy from the financial economy to see how.

Lowering interest rates and printing money leads to inflation in assets prices (for obvious reasons) but it exerts a deflationary force on the real economy.


Well, low interest rates reflect an abundance of capital. Businesses deploy this capital to create a vast supply of goods and services. Against this vast supply, you have only tepid demand.

We know demand is tepid because of the amount of debt in the world. A simple explanation for debt is that it is future demand brought into the present. In other words, the world’s huge outstanding debt reflects future demand already consumed.

But against this weak demand environment, you’ve got lots of supply, created by low interest rates and abundant capital. When supply exceeds demand, prices fall. Falling prices equal deflation.

The cure for deflation in a highly indebted economy is to reduce supply. But when interest rates are low and demand is weak, the only option is for businesses to produce as much as they can. This, of course, makes the situation worse.

Only higher interest rates will create inflation in the REAL economy. Higher interest rates would knock out the zombie companies creating excess supply. Lower supply would eventually work its way into higher prices, and voila, you get inflation.

But…but…central bankers will never accept this. While higher interest rates will eventually lead to inflation in the real economy, they will immediately cause deflation in the financial economy.

You’re seeing this now (following the US Federal Reserve’s recent interest rate hike). Central bankers, being the elite socialists that they are, think that increasing asset prices (the wealth effect) is the key to creating an economic recovery.

This fits with the socialist mindset. That is; create money without working and disperse it, thinking it will lead to sustainable growth. Growth off ‘other people’s money’.

It’s a pipedream. Their strategy is flawed.

The question is: how long it will take the market to work this out? Will it go along with another round of stimulus? Or will it start to call the central bankers bluff?

I don’t know the answer. As I’ve recently written, it feels like the mood of the market is different now. The bullish mentality has given way. I don’t think tough talking from Draghi will change that.

On the other hand, if the US Federal Reserve turns around and starts talking about more stimulus, that could fire markets up. But does the Fed want to look that panicked and indecisive, so soon after raising rates?

There are more questions than answers as we start another week, dear reader. My view is that stocks are just rebounding from an oversold level. It’s a bear market rally. Stay defensive.

Greg Canavan,
For The Daily Reckoning


Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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