VIX is the index of volatility derived from options prices on the S&P 500 index. It is widely followed as a barometer of market anxiety and jubilation. It is now at a low of 17%. To put this number in perspective, this index topped 80% in September 2008. The S&P 500 stock index is up nearly 7% (only 2.3% in Singapore dollar terms). European stock indices have done far better (e.g., Germany). Gold is up more than 10% in dollar terms (5.76% in Singapore dollar terms) from year-end levels. The price of Brent crude oil is up 6% in US dollar terms. The S&P Goldman Commodities Spot index is up 15% from its October 2011 lows.
The stock markets that have done well in January are the ones whose economic fundamentals are dicey at best and unhealthy and unsustainable at worst. Essentially, the indices that performed poorly in 2011 are now in the top of the league in 2012 in January. There are both uncharitable and charitable explanations for this change in sentiment. One is that sentiment had reached such high levels of pessimism that it had to rebound. Even then, for some of the indices to recoup almost half the loss of 2011 in barely one month is a bit much. The uncharitable explanation is that the big difference between 2011 and early 2012 is the copious flow of money that the world’s two major central banks have provided.
This story has played itself out countless number of times that it is tiresome. Liquidity-driven rallies are an insult to human intelligence while attempts to explain them in fundamental terms betray the lack of it. Let us examine recent data from two key countries to substantiate the point.
On Friday, the US department of labor released the monthly payroll number. On the face of it, the numbers were impressive. The US non-farm economy added 243,000 jobs in January on top of the 203,000 jobs created in December. The private sector added jobs and goods-producing sectors, in particular. In the last two years, manufacturers of durable goods have added little over 400,000 jobs. The unemployment rate has declined to 8.3%. However, look closely. Seasonal adjustment factors have played a major role in the January payroll data. America has had the second warmest December in its weather history and the third lowest precipitation in January. Second, over the last one year, the fundamentals of the labour market have worsened.
The percentage of the population participating in the labour force (the proportion of the population aged 16 years and above, either working or looking for a job actively) has declined from 64.2% to 63.7% in the last one year. The ratio of employed-population (only those above 16 years are counted in this population universe) has improved only marginally from 58.4% to 58.5%. The participation rate is down for both whites and blacks and the number of people who have left the labour force has gone up both among whites and blacks.
Clearly, there are two elements to the US labour market. One is the short-term cyclical element. That is stable to improving. The other is the structural labour market problem. It is simply not creating enough jobs on the scale that is required. Monetary policy cannot fix this problem. However, the Federal Reserve balance sheet has expanded 17% and that of the European Central Bank by 37% in the last one year. This has once again stoked asset price speculation and breathed new life into commodities. That will take the life out of the incomes of poor households in many developing countries.
However, what we are witnessing is the self-serving cheer-leading of the weather-distorted data combined with malignant neglect of fundamental problems such as banks’ size and fiscal deficits. American complacency is diabolical (yes, diabolical).
One of the countries that has seemingly benefited from this renewed monetary accommodation is India. The Indian stock market is already up more than 20% in dollar terms in 2012. The Indian rupee is up nearly 9% against the dollar. In the meantime, the government of India announced that the national savings rate has dropped over 4% in the last three years to around 32% now. The government wants to rebalance the economy away from consumption to investment. Investment needs are met by savings and for the savings rate to rise, real incomes have to rise. Real incomes rise with lower inflation and for that, one needs to rein in the fiscal deficit. Subsidies have to be removed, reduced and retargeted. The government is expanding them instead. India is being bled dry and investors are willing accomplices.
The damage that has been done to the integrity of capital markets globally since the beginning of the new millennium is immense. The tragedy is that investors have stood shoulder-to-shoulder with governments on their myopia. However, policymakers and politicians will retire with book contracts and charge hefty speaking fees. Investors will pay the price for their myopia.
V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Comments are welcome at firstname.lastname@example.org
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