The Financial Markets Vs. The Real Economy: How Big Will The Gap Grow?

From Albert Edwards' most recent note:

Most economists see recessions causing increased saving by both households and companies, but I believe the causality has been reversed in the aftermath of Alan Greenspan’s bubble-blowing era - loose monetary policy drives asset prices, fostering increased private sector borrowing and spending. That was the disastrous policy that led to the unprecedented 2000 private (household + corporate) sector financial deficit of 4% of GDP (all corporate), and the same ruinous policy that drove the deficit up again to peak in 2007 (all households). The problem with using asset bubbles to drive an economy is that when the bubble bursts, private sector borrowers realise they have been taken for a mug and correct their savings behaviour aggressively, causing a recession. That same barbarically naive policy remains in place today.

His thoughts on corporations borrowing money to repurchase their own stocks:

Should we be less worried now that the US private sector surplus is 3% of GDP – ie an historically high level and less liable to spontaneous retrenchment? No. The decline from a 9% surplus at the end of 2009 to 3% of GDP now is precipitous and almost entirely driven by another corporate sector borrowing binge to finance activities in the financial markets. Another spontaneous recessionary retrenchment awaits.

My thoughts:

The current goal of the Federal Reserve is to drive the economy higher with asset bubbles in the financial markets (stocks, bonds and real estate). The Fed hopes euphoria in the markets will create a wealth effect, which will then stimulate the real economy, which will then provide a justification or real fundamentals behind the sky high asset values.

In the most recent cycle, from 2009 to present, only the first part of the plan has occurred; financial asset bubbles in U.S. stocks, bonds and real estate (particularly commercial real estate). The real economy has not yet gained traction. This has left the 1% who own the assets more wealthy than any time in history and the remaining 99% running in quicksand.

This perfectly sums up the Fed's dilemma, which was on full display this week. The Fed can see economic data is deteriorating across the board, other than the jobs number which the Fed has admitted is a rough determinant of what is really taking place with employment (i.e. jobs are being created but they are lower paying jobs while higher paying jobs continue to decline or stagnate).

In the meantime, the financial markets are booming and even the clueless Fed can feel the level of froth. Janet Yellen has comented on sky high valuations in biotech stocks, corporate bonds and commercial real estate. The Fed removed "patient" from their guidance this week, but they were clear in expressing their concern for the real economy.

I guess a positive you can take away; because the real economy has not recovered or been "pulled up" by the financial market bubbles, it will be impacted less when U.S. stocks, bonds and real estate finally enter back into reality (they collapse).