Effects of cheap funding

Mar 19, 2015

- By Bill Bonner

Bill Bonner
Gualfin, End of the Road, Argentina

Fatimah, our new 10-year-old student is a stranger to modern economics as well as vernacular English.

"What do you think of central bank policies," we asked.

"What's a central bank?"

"It's the bank that provides money to the whole country."

"Where do they get the money?"

"They just print it."

"Oh."

"Would you like some money from the central bank?"

"I guess so."

Fatimah must be aiming for a career on Wall Street.

Meanwhile, we promised clarification. We think the feds are desperately pushing up stock prices. At the same time, we have our "Crash Alert" flag flying over the ranch house.

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What gives? Which is it? Higher stock prices or lower?

The short answer: both.

Yesterday, the Dow rose 227. Gold was flat. What will it do tomorrow or the next day? It's up to Mr. Market. He will do what he wants in his own sweet time.

He must be deeply conflicted. On the one hand, central banks are tempting him to loosen up...to have some fun...to let stock prices fly. On the other hand, he remembers what happened the last time he did that; everybody was having a great time, until someone called the cops.

Over the last 6 years, it's been 'laissez les bons temps rouler.'

"Do you want some money from the central banks," asks the Fed.

"I guess so," answer banks, hedge funds, and speculators.

But as stock prices rise, the day approaches when they must fall. They cannot become infinitely expensive. And the more expensive they become, the less attractive they are to seasoned investors. Now, Mr. Market sees the smart money selling out, quietly, while the dumb money still makes its bets.

While stocks are still near record highs, the economy slips, slides, and slinks along. The latest disappointment comes from the housing sector. David Stockman:

    The "incoming data" was disappointing again this morning-----this time the culprit was housing starts which were off by 17% from January. But please don't blame the "weather" again. The data below is for single family starts which are less volatile than apartment construction. At an annual rate of 593k units in February they were almost exactly flat with last February at 589k.
Our guess is that in the not-too-distant future, stock prices will drop. Investors will run scared. And the central bank will panic.

What's an investor to do?

We'd stay out of stocks for now. Too dangerous. The day of reckoning is probably too close to make much money.

If we were a gambler, we wait for a few days of desperate selling. Then, we'd probably get back in. It won't take the Fed long to follow the Japanese example, and rush in to buy stocks itself. The Fed cannot make the economy function better (except by getting out of the way), but it is capable of goosing up the stock market. It has the money (unlimited) and the stupidity (profound) to do it

But we're not gamblers. We want our money in solid businesses bought at good prices.

Where can you find them? Tune in tomorrow...

But here's a more difficult contradiction. We've noticed that 1) cheap money seems to encourage cheap financing tricks - buybacks, mergers, carry trades, speculating and so forth. It also discourages savings, which deprives the economy of real capital formation - the key thing for making economic progress.

We've also noticed that 2) some industries and some companies seem to take the cheap funding and use it to add capacity. Housing in '04-'07. Energy, '10-'14. China, generally, until '14.

Which is it, 1 or 2? Is the cheap funding being used in place of capital formation? Is it adding to capacity or not?

We don't know. Maybe both things are true. Maybe cheap credit provides speculative funding - such as to Tesla, biotechs, and selected speculative ventures. At the same time, it seems to encourage short-term plays, self-serving scams, and gambling.

"There's a difference between money you work for and save, " says EB Tucker, visiting from Florida, "and money you get for nothing. You spend the money you work for carefully. You spend the money you get for nothing as though you had stolen it."

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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