Financial Market Russian Roulette

Monty Pelerin / EconomicNoise.com

The Dow-Jones dropped over 200 points yesterday. As explained by MarketWatch:

Benchmark indexes initially cleared their losses after the Fed’s policy statement, then fell hard as Bernanke said the Federal Open Market Committee currently anticipates moderating the monthly pace of purchases later this year, so long as incoming data support the Fed’s forecast.

Also from MarketWatch:

• Dow falls in 7th straight triple-digit move  
• Gold ETFs lowest since 2011
• Dollar surges as bond buys may slow this year 
• Emerging markets currencies dive on Fed 
• Treasurys tank as Fed signals tapering intent 
• Next 24: International markets react to Fed 

A couple of points are important:

1. The current level of the stock market is a function of quantitative easing. Neither fundamentals nor conditions in the economy justify financial asset prices where they currently are. Suggestions that QE is about to lessen or stop will produce sell-offs in markets.
2. If the Federal Reserve cuts QE, it will not be based on economic considerations. The government is illiquid without the Fed buying/underwriting their bond sales. QE, if it is to drop at all, will drop in line with shrinking federal deficits.

No market can remain overvalued forever. However, a market can remain overvalued longer than rationality suggests and even go higher from these levels.

The government is in a box. They cannot sustain the level of spending they are currently at with tax revenues or conventional borrowing. Government is dependent on the Fed to fund its deficits via the QE scheme of money creation. Politicians in Washington will not willingly cut spending. So long as the Fed continues to be The Great Enabler, the uncontrolled spending will continue.

The Fed knows its QE has no effect on the economy. All it is doing is providing the fuel for political excesses. Stopping QE causes government checks to bounce. The Fed is not an independent agency and will not cross its master by doing what should have been done a long time ago.

The economy is not recovering and cannot recover. Government is planning to increase spending even more. Incentives encourage more people to enter the welfare state. ObamaCare will overrun spending estimates. The passage of the immigration bill, so lusted for by the political class, has been estimated to cost an additional $6 Trillion in spending. Playing in Syria is not free. No future natural or terrorist events are budgeted for. So long as the Fed makes spending painless, no cuts in government are coming.

continue article at EconomicNoise.com:

http://www.economicnoise.com/2013/06/20/financial-market-russian-roulette/