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Economic bad news is never good

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Saturday, June 22, 2013, 9:00 p.m.
 

Over the past few months, bad economic news has tended to boost financial assets such as stocks and bonds. Good economic news has resulted in a fall. This extraordinary phenomenon has stood the financial world on its head and has had many economists shaking their heads.

What took place, however, has been due to distortion induced by the Federal Reserve. The vast quantitative easing (QE) undertaken by the Fed distorted markets massively. And the sharp drop last week in the stock market showed what could happen when the Fed suggests it will ease off quantitative easing.

In essence, QE seeks to impose negative real interest rates and to boost asset prices through the infusion of trillions of dollars worth of synthetic money. It was designed to shield the financial world from the painful reality caused by a correction of the huge asset boom created by the Fed in the early 2000s. QE may be able to numb the pain but it cannot cure the root illness.

Some observers saw QE as a grossly irresponsible exercise of government overreach, with implications for the future that border on malfeasance. The postponement of a realistic economic adjustment pushes the problem into the future. But, without a cure, this delay merely magnifies the underlying problem. It is like putting off an urgent surgical operation while the medical problem worsens under the cover of pain-reducing drugs.

The more good economic news, the bigger the chance that the Fed decreases the dose of its massive economic painkiller.

Conversely, bad economic news tends to postpone the threat that QE will be reduced. Financial markets rise based on the assumption that further huge sums of synthetic money will be injected into the economy.

As the renowned investor John Hussman points out in John Maudlin's publication, “Outside The Box”: “...the last two 50 percent market declines — both in the 2001-2002 plunge and the 2008-2009 plunge — occurred in environments of aggressive, persistent Federal Reserve easing.” Further, “… these market collapses were preceded by overvalued, overbought over-bullish euphoria and then gave way to economic downturns. Though monetary policy certainly fed the preceding bubbles, monetary policy did not prevent or halt those recessions, and those recessions were not broadly recognized until stocks had already lost about 30 percent of their value.”

These counter-intuitive results bear repeated reading by investors seeking a return of their capital.

Common sense suggests that bad economic news cannot be good for assets over the long term.

In the short term, the Fed may be able to stall an eventual recession. But precedent indicates it will be unable to prevent the inevitable long-term effects of a recession like the one building worldwide.

History suggests that, by the time most investors have recognized the economic reality, they will have lost a third of their invested wealth. Worse still, many people, unwilling to accept the initial paper losses, will hold on only to eventually face far greater losses.

To preserve their savings, investors need to review investments that have grown on this backwards good news-bad news path. Now.

John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at johnbrowne70@yahoo.com.

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