Fiscal Policy, Elections and the Market

[brettc4]

In Trading for a Living, Elder writes

"The ruling party inflates the economy going into the presedential election once every four years. The party that wins the election deflates the economy when coters cannot take revenge at the polls. Flodding the economy with liquidity lifts the stock market, and draining liquidity pushes it down. This is why the 2 years before a presidential election tend to be bullish, and the first 12, 18 months following an election tend to be bearish."

I am willing to admit that my economics is not great, but if the government starts spending money to expand the economy, geenral inflation will increase and the reserve bank (fed, central bank, whathaveyou) will then remove money from the economy lifting interest rates. As the RBA is a nuterual body, I would believe these effectively negate each other.

Are their any economists out there.

Secondly, if the statement by Elder is true, how does this work for our economy when we are so heavy affected by the US and China. We don't need to worry about elections to much in China but with the US election after ours, what does this mean to our market after the election later this year, will spending decrease and therefore lower the market?

I'm glad I am not an economist because then I would also have to think about what the future fund and super rule changes will also mean as there will be additional money out there.

Brett

 

[lakemac]

Elder is a wise (and rich) man. Take heed of his comment.

Ok first up - central banks are neither benign nor neutral. They were created by bankers for bankers under the guise of stabilising the markets. They are not, repeat not, part of the government.

Second point - as long as a government does not borrow money, its effect on an economy is neutral - a best it only moves money from one area to another - it can't, unlike a bank, create or destroy credit.

Third point - some definitions:
cash - paper/plastic and coins you hold in your hand/wallet/purse/mattress
money - that which you have as deposits with banks etc.
credit - the goodwill of a bank that they are willing to extend to you because they trust you (see my other recent posts on this).
currency - the sum of the above.
In general terms the ratio of the above is 1 : 10 : 1000.
Credit has the biggest impact on ANY economy.

4. If a government DOES borrow money then watch out particularly, if in the usual case, they borrow it from a central bank.

5. All banks create credit out of thin air - after all credit is really just a bank's goodwill.

6. When a bank (central or otherwise) creates credit ie. issues goodwill there will be an increase in the number of currency units in circulation. If that happens particularly where the underlying intrinsic value of an item has not changed ie the amount of time and materials it takes to make something has not changed, then with more currency units in play the "sticker price" you pay will go up (assuming a constand supply/demand). If demand goes up and you have more currency units in circulation eg. credit from lenders, then watch "sticker prices" skyrocket. This increasing "sticker price" which is really the debasing of a currency is what the correct definition of inflation is.
Put more crudely: "too much money chasing too few goods".

7. So the only time a government will affect inflation directly is if they borrow from a central bank which will create credit for them (the government issues bonds which the central bank buys with its newly created thin air credit).

8. Given the ratio of credit to money (100 to 1) increasing interest rates to remove currency units out of an economy has little to no effect. Remember central banks are not there to help you or the economy - they are there to help member banks. The way currency units are taken out of circulation ie. deflation, is by banks withdrawing credit or better said as the withdrawal of their goodwill because they no longer "trust" each other. Hence a "credit crunch".

8A. Thus a central bank raising interest rates does not affect inflation. Inflation (the debasing of a currency) is only affected when either credit creation stops or goes backwards (credit reduction) or it eventually washes through to everybody. Note the extra credit takes time to get down to the people at the bottom - but ultimately it always does cf. the price of bread or milk and the current political football regarding pensions.

8B. Raising interest rates only makes more money for the banks. However those banks that have been imprudent and lent too much have to balance their goodwill every night. If they can't find that balancing goodwill/credit they are in trouble. They can borrow it from the central bank but that creates a whole other set of problems. The headline interest rate you see on the news is in fact the "intra-bank lending rate" ie. the interest rate one bank will lend to another overnight to perform the balancing act. If the trust of one bank's goodwill (remember that is all that credit is) breaks down - guess what you have a melt down in the likes of Lehman et al. Consider that sub-prime is really low trust mortgages. Any wonder any bank that has them is now toxic.

8C. Since interest rates are not directly related to credit creation (ie inflation) you can see why raising one does not affect the other. It is, to quote Morpheus in The Matrix, "...had the wool pulled over your eyes".
Consider Japan. It had zero interest rates during the 1990's, but because it had little credit (window guidance - google it) its economy went nowhere. Only time (washthru) or credit reduction affects inflation in any meanful way. Thus why they don't "negate" each other.

There are two bits to your next question about the economic coupling.
Firstly - stock markets are driven by credit creation/destruction in the short term.
Secondly - the "real" economy ie. making things, doing things, depends on capital to buy the equipment required in order to do/make those things. Unfortunately we live in an age where capital is made up of credit rather than real savings. Reduce credit/goodwill and the ability to expand the real economy is affected albeit more slowly than the markets, but is still affected (think in terms of years rather than weeks).

So our market is made up of two things - one the speculative "credit" and the underyling "fundamental" capital. People need to eat, sleep and use cars. Technology will continue to deliver improvements in manufacturing (driving down the "cost" or underlying intrinsic value of goods - what economists call productivity gains) however any credit increase increase the "sticker price".
Most stock's "sticker price" is speculative relative to its intrinsic value (typically 15:1). So if credit is reduced the "sticker price" of stocks (and houses for that matter) will come down irrespective of the underlying productivity gains and operation of the "real" economy.

A note here - all government regulation reduces the productivity of a nation. Some regulations are good, a lot are bad. That is a whole other topic.
I mention this to point out that governments (ignoring them borrowing money) invariably don't improve productivity of an economy. Why because most of the time they add more legislation. It is rare to find a government reducing their legislation. So any government that says it helps an economy is basically lying to you unless they are actively removing legislation from their books.

Thus to ask if spending will affect our markets - only if that spending involves the creation of credit. I have said this before - watch the credit creation/destruction cycle and you will know what the stock market as a whole will do.

As to Future Fund and super - they can't (normally) borrow. So they can't affect inflation. They will have an effect on the stockmarket (forming a demand for shares) which will drive the "sticker price" up, but not as much as credit creation would. There is no additional currency out there because of super. It is just currency that you don't have the use of right now (see my comments about government legislation). So all super does is move value from one place to another. Nothing new is created.

On the issue of super also think of this. The so called "value" of a company, as reported in the press, is normally the number of shares on issue multiplied by the last price that shares changed hands. Now if super funds are buying shares (ie. them giving your real money to some other trader) over time at higher prices does this mean that the heap of money is getting any bigger in reality - of course not - it's a Ponzi scheme. Last one in loses - big time. So consider that when baby boomers start to retire (shortly) they are one very big population chunk. They start to draw down their super. That means some of that value MUST be taken out by selling shares (study how any allocated pension works). So guess what more sellers than buyers? Depends upon the government's upping the CONTRIBUTION rate to cover it. I am glad I am a baby boomer. Gen X and Y are paying for my drawdown in a couple of years.
Oh and of course the current baby boom. The baby bonus was a brilliant piece of government strategy. Think 20 years from now. Current baby boomers are in retirement and most don't have enough super so will need pensions and healthcare. How do you fund it - of course freshly minted tax payers - the baby boom happening right now. Brilliant, absolutely brilliant.

brettc4 you say you are glad you are not an economist. Tell you what, I am not either, but because I started to get interested in it (was thinking about my retirement actually about 8 years ago - still have a few year to go before I actually do...) it is now one of the most fascinating subjects I have ever come across.

Some suggested readings to turn you into an interested economist:
Princes of the Yen
The Money Masters (video)
Money as Debt (video)
The Rothschilds
and as I have said to one of my good mates "Google is your friend".

Hope this helped.

 

[troy81]

Lakemac,

Just wanted to say that was one of the most enlightening and informative posts I have read. I will be going through and looking at the references provided and have already looked at Money As Debt - very good by the way.

Just wondering on your quote below, if you use any kind of index, results or news that provides an indication of the state of credit creation/destruction?


Thus to ask if spending will affect our markets - only if that spending involves the creation of credit. I have said this before - watch the credit creation/destruction cycle and you will know what the stock market as a whole will do.


Troy

 

[jeflin]

The so called "value" of a company, as reported in the press, is normally the number of shares on issue multiplied by the last price that shares changed hands. Now if super funds are buying shares (ie. them giving your real money to some other trader) over time at higher prices does this mean that the heap of money is getting any bigger in reality - of course not - it's a Ponzi scheme. Last one in loses - big time.

I agree with most of what you say but I believe Ponzi schemes (robbing Peter to pay Paul), occurs only in the extreme situation of a heady bull run. A greater fool theory where underlying fundamentals get thrown out of the windows.

In normal times, stock valuations are determined by weak market efficiency. No single party is big enough to resist market forces of supply and demand.

 

[Timmy]

Great stuff thanks lakemac, and a question for you also.

You say in your post re central banks:

Ok first up - central banks are neither benign nor neutral. They were created by bankers for bankers under the guise of stabilising the markets. They are not, repeat not, part of the government.

Can you comment on the differences between the Reserve Bank of Australia and the Federal Reserve Board in the US?

 

[fimmwolf]

As well as being a policy-making body, the Reserve Bank of Australia (RBA) provides selected banking and registry services to a range of Federal Government agencies and to a number of overseas central banks and official institutions. Its assets, which include Australia's holdings of gold and foreign exchange, amounted to around A$132 billion at 30 June 2007. The Bank is wholly owned by the Australian Government, to which its profits accrue.

http://www.rba.gov.au/AboutTheRBA/overview_functions_and_operations.html

 

[lakemac]

Thanks for the feedback guys. Much appreciated.

for troy81 - have a look at the RBA D02 data series - Lending and Credit Agregates. They have it on their website - updated monthly. You will need to import it (it is already a spreadsheet) then do a moving average on the data then do a month to month difference for each month (let me know if you don't know how to do this on a data series).
For the US the series is G.19 (also check out H.8).
http://www.federalreserve.gov/releases/

for jeflin - the stock market is a Ponzi scheme. If you don't supply new buyers and only have sellers (ie. retiring baby boomers) then the scheme collapses as it is doing now - no buyers only sellers. To value a company by issued shares x last price is ludicrious. The 15x multiple often quoted as an average is based on future earnings. Either way if new buyers don't enter a market you will get a falling market. Maybe not exactly a Ponzi scheme but pretty close.

For fimmwolf - if you believe that kind of advertising then I have a block of flats and half of tasmania to sell you Seriously though trace back to the Act of parliment that created the RBA or rather stripped the assets out of the original Commonwealth Bank and left just a retail shell. Someone else posted the exact reference for this (thanks Gotib):
https://www.aussiestockforums.com/forums/showpost.php?p=175620&postcount=50

I would suggest to anyone reading this thread to go an read thru the whole of that other thread from which that post is from:
https://www.aussiestockforums.com/forums/showthread.php?t=7108

Bottom line about the original Commonwealth Bank (the precursor to the RBA) - same kind of origins as the Fed in the US. Certainly not clear cut - and that is the way they like it.

fimmwolf - if you go to the Fed website you will get the same kind of line. I still have those block of flats and half of Tasmania waiting...

One final bit of research for you guys after fimmwolf's post - if the profits go to the Australian Government, show me where those "profits" show up in the statement of accounts for the Aus. gov.

 

[fimmwolf]

One final bit of research for you guys after fimmwolf's post - if the profits go to the Australian Government, show me where those "profits" show up in the statement of accounts for the Aus. gov.

http://www.rba.gov.au/Statistics/Bulletin/A01Whist.xls

 

[lakemac]

http://www.rba.gov.au/Statistics/Bulletin/A01Whist.xls

Ok lets look at this.
First thing is this is a BALANCE SHEET or what is currently known as a "STATEMENT OF FINANCIAL POSITION".

It does not show cash flow.

Even so it is an interesting document to analyse.
I will use a Pareto approach (look for the biggest numbers - the rest are of less importance and can be ignored for the big picture) (btw I do the same thing when I analyse a company's fundamentals - although funnily enough I am a technical trader and investor - go figure )

So starting from the right we have total assets: $97B
Of which the largest two factors are "gold and foreign reserves" (oh no don't tell me the RBA has $US in its bank...) and $A securities ie. government bonds (remember every Australian tax payer is footing the interest bill on these thru taxation - so you are up for the interest on approx $50B of bonds at say 5% - a cool $2.5B a year give or take - this is why a government borrowing is never a good idea) (remember this figure by the way) (also go back 10 years to Sep 1998 - we only had to pay interest on $18B... ah the house of cards we live in). So $50B in bonds, $47B in foreign reserves (I don't think we have that $45B in gold by the way... Acutally I know we don't - the RBA splits this down in another publication).

Liabilities: $97B
Notes on issue: $43B
Deposits: $28B
Other: $16B (what a euphemism)...

(sorry guys got to go - wife needs me - will have to finish this at a later time)
In the meantime find out where the $2.5B of interest goes...

 

[fimmwolf]

RBA weekly turnover

http://www.rba.gov.au/Statistics/turnover.html

 

[lakemac]

Thanks for finding the links fimmwolf.

Any analysis on your side?

Must finish my previous post...

 

[BentRod]

of the most enlightening and informative posts I have read

I agree.

Keep up the good work Lakemac, some great posts there(aswell as your others).