The invisible hand of central bankers and government intervention

The financial markets are guided by supply and demand conditions for stocks and bonds. Historically, their fluctuations have been heavily influenced by business conditions and economic cycles. During the past 12-15 months something new and different has dominated the marketplace. Unorthodox governmental forces are the engine that drives the financial markets which seem totally insensitive to any negative economic developments.

Given numerous rounds of quantitative easing, bailouts, interventions and injections in Europe, Japan, China and the United States, the financial markets are closely correlated with the increases in banking reserves that are supplied by central banks. According to the central bankers, more inflation and higher stock prices would create a wealth effect to foster economic growth; it is no surprise that the central bank injected trillions of Dollars of liquidity into the financial system. The G7 countries are doing this on a coordinated basis.

Individuals, institutions and countries are desperately in need of earning a return on their savings in today’s zero interest rate environment. They are forced to make a major shift out of bonds into equities to accomplish such objectives. For example, in 2014, Japan's Government Pension Investment Fund, which has over $1.1 trillion in assets, came into the international equity and bond markets with hundreds of billions of Dollars to purchase foreign financial instruments including US stocks and bonds.

Taking advantage of the low interest rate environment, US corporate buyers are borrowing money by the billions to repurchase their own company stocks. In 2015, the European Central Bank cut its benchmark interest rate to a record low in an unprecedented attempt to stimulate the euro zone economy and it began charging interest on deposits held by the bank. This added more fuel to the fire. The ECB has created new money to buy bonds at a monthly rate of $60 billion euros from now till the end of September 2016.

I would like to tell our readers that most economists as well as investors are in fear of the central bankers losing control of the financial markets. It is highly abnormal for governments to interfere with market mechanisms which are totally unfamiliar to the bureaucrats. The question is what the central bankers will do if the economies of US, Europe and Japan encounter an unexpected economic slowdown in the future. The good news is that we have more time this year to come up with some answers because with the ECB and BoJ printing $120 billion/month, they are setting a floor for asset prices.

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"Janet Yellen - Caricature" by DonkeyHotey is licensed under CC BY 2.0

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About the Author: Samson Wang

Samson Wang


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