In one of the most unusually difficult market conditions to call, many investors who have sought safety and reliability in traditional stores of value such as gold bullion have been sorely disappointed by recent bearish trading activity. Even more disconcerting is the rise of the U.S. dollar. With gold’s nemesis, the so-called “greenback,” leading the charge, it logically suggests the illogical: the Federal Reserve has successfully printed its way out of the worst financial crisis in modernity. Have fundamentals become so disjointed that they can no longer be trusted?
The oft-cited and equally hated phrase in Wall Street during the prior year was “good news is bad news and bad news is good news.” Simply put, investment managers were waiting for news items, often with pessimistic implications, to incentivize the Fed chairman at the time, Ben Bernanke, to continue unleashing the torrent of monetary surplus under the quantitative easing initiative. With the economic maestro openly flirting with the idea of reigning in the bond and asset purchases by the world’s biggest central bank, there were (reasonable) fears that the punch bowl would soon be taken away from the U.S. equities market.
Such a potential move was especially disconcerting for gold and resource investors. A tapering of QE would correlate with higher interest rates as the supply of bonds available to the public would abruptly increase. This shift in supply demand dynamics would also increase the valuation of the U.S. dollar as currency is taken out of the market due to the selling of the bonds. The one over-riding factor that kept the monetary spigot running for so long was the labor market, which had suffered tremendously under the weight of the 2008 financial crisis, and various data engineering by government agencies had to be implemented in order make employment statistics look somewhat respectable.
While employment and related wage growth data failed to meet benchmark targets, it was clear that Bernanke’s Fed would stay the course. But over the years, it was also quite lucid that job trends from a nominal basis were improving, and so, the seemingly indefinite reality crashed back hard into its eponymous paradigm. The chairman was replaced by a hand-picked successor in Janet Yellen, who ushered in an ambience of marked restraint.
The main fallacy, however, is the belief that the underlying economy is strong enough to survive without the spigot. Bernanke may be the most popular figure to employ artificial means to reinvigorate a fundamentally sick financial system, but he is not the first. Several policymakers in years past have attempted a “trade-off” of economic growth in exchange for higher inflation, noting groundbreaking research by A.W. Phillips that confirmed that inflation rate and unemployment are negatively correlated. In the short-term, an economy can be “shocked” into improvement via monetary policies but in the long run, documented failures have indicated that employment trends eventually finds its natural equilibrium.
When that equilibrium swing will occur is anyone’s guess, although historical data suggests that economic undertones can be manipulated successfully for no longer than five or six years. While the current presidential administration may be basking in the glow of improving job statistics, the reality is that this growth has been unnaturally shifted due to unprecedented financial engineering. The economic provenance tells us that we’re nearing the point when the markets must return to normalcy.
Should that time come, the market could correct violently to the upside.