Asset prices may have risen because the global economy is looking stronger, and that strength may in part be credited to stimulative monetary and fiscal policies around the world. Alternatively, the economy may have nothing much to do with it. Financial markets may be strong because those stimulative policies have put more cash in investors’ hands. In truth, no one knows what’s really going on.
There’s no doubting the market’s direction. American and European stock markets, iron ore, copper and oil are all 15-25 percent higher than last October. The stimulus is equally clear. There has been cheap and unlimited long-term bank financing in the euro zone – with more to come next week – plus more quantitative easing on the way in the UK and Japan and some easing in China.
But the relations between the two phenomena are murky. As Dylan Grice of Societe Generale points out, there’s no way to predict where the credit and money created by monetary and fiscal authorities will be spent. It can stimulate economic activity, as in Keynesian textbooks. That’s what policymakers hope is happening. And there are certainly signs of economic strength, or at least of lesser economic weakness compared to what was expected late last year.
Alternatively, the extra liquidity can also mostly sit inert in bank accounts, as in Japan for the last two decades. Or it can create retail inflation, as in the last few years in the UK. Or it can mostly just push up the prices of many financial assets, as in the run-up to the 2008 collapse of Lehman Brothers – and perhaps now.
Investors now live in a sort of fairground hall of distorting monetary mirrors. Their perception and motions are twisted by negative real policy interest rates, by topsy-turvy government bond markets, by fiscal deficits which range from large to enormous and by a financial system still considered so fragile that it needs extensive official support. Until the mirrors are straightened – a process that will take years – it would be dangerous to feel too happy about rallying markets.