Saturday, August 13, 2011

Is the World Ending?

A maddening week in the world economy has come to a close, and we stand at levels that are not so distant from what they were at the beginning of this week. Of course, ignoring how we got here is simply ignorant and misses some large points. Money market funds, funds of short-term government securities that offer virtually no return or yield, saw inflows of around $50bn this week. This is one week after those some funds posted enormous outflows. Money markets are considered to be very risk-less investments, hence their low yields. So are we seeing pessimism about the world economy from all this risk aversion?
While all this money flows to these funds, equity markets finished the week rallying. Looking at the starting and ending points of the major indexes that week, one might be tempted to say it was relatively low-key. That person would also have to have lived under a rock, because anyone paying attention would have noticed the crazed volatility of the market. As the Financial Times reports, “… the Dow Jones Industrial Average recording for the first time seven straight sessions that alternated between ending the day higher one day and lower the next.”
For those who like to judge the state of the economy by looking at markets, it will be very difficult to come to anything resembling a consensus this week. But let’s act like bigger picture people for a second and look at what’s actually going on. The Fed announced on Tuesday that rates were going to stay down for a good while more (till 2013) and left open the door for more maneuvering. Alright, so no surprises there. It seems that most investors have not lost their minds over the S&P downgrade. People recognize that the move is more a comment on the U.S.’s political situation than it is on our credibility, financially speaking. What’s cracking in Europe? Well, the ECB pulled the good old-fashioned “Buy the stragglers’ bonds” technique to stave off a bit of fear over Italy and Spain. At the same time, some European regulators introduced short-selling bans again. The latter is a somewhat trite move, and while I respect the goal of trying to stop a downward spiral, if certain companies are overpriced, then their share prices should fall. Yes, it's painful, but as the saying goes, "It's not nice to fool Mother Nature." Interfering in the stock market obfuscates investors' views of where prices REALLY should be. But that's a side point. The big picture is somewhat counterintuitive to what I stated at the beginning of this piece. Yes, ignoring the ups and downs of the week is silly, but the world looks very much the same as it did seven days ago. The day to day fluctuations of financial markets are NOT good indicators of the macroeconomic health of an economy. Remember, in economics, when we say “short-run,” we still mean longer than 24 hours.

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