Paul Craig Roberts June 20 2013
One of the myths of economics is that markets are rational. Theories are based on this assumption, and the belief that markets are rational fuels the argument against regulation. The market response to the Federal Reserve’s June 19 statement that it will taper off its bond purchases if its forecast comes true is unequivocal proof that markets are irrational.
The Federal Reserve’s statement that it “currently anticipates that it would be appropriate to moderate the monthly pace of purchases [of bonds] later this year” depends on a very big if. The if is the correctness of the Fed’s forecast of moderate economic growth and employment gains.
The Fed has not stopped purchasing $85 billion of bonds each month. So nothing real has changed. Indeed, there was no new information in the Fed’s statement. It has been known for some time that, according to the Fed, its bond purchases will gradually cease.
In response to this repeat of old information, the stock and bond markets sold off in a major way on June 19-20. This market response to the Fed’s statement indicates that the Fed’s forecast is unlikely to come true. Low interest rates and a high stock market are totally dependent on the liquidity that the Fed is injecting by printing $1,000 billion per year. If this liquidity is not injected, what will sustain the markets? If the markets crash and interest rates rise, how can the Fed expect recovery?
In other words, the participants in the stock and bond markets know that the markets are bubbles created by the printing press. There is no real basis for the high stock and bond prices. The prices are an artificial reality created by the printing press. Rational markets would take into account the printing press element and would price stocks and bonds at a much lower level.
Zero real interest rates mean that there are no risks. But how can there be no risk in Treasury bonds when the debt is growing faster than the economy?
Normally, high stock values mean strong profits from strong consumer income growth and retail sales. But we know that there is no growth in real median family income and real retail sales.