Markets are on alert in a week that could see more great insights from the gods of central banking on high. Investors seem a little spooked with the MSCI emerging markets index off 4% in the last eight trading days, while currency volatility has picked up as the US dollar has strengthened. And yet despite these minor ructions, there remains a deeper sense of calm. It is the sort of quiescence born of insiders’ knowledge that the nature of financial markets has changed, and in a way that favors them.
In the past, money sat at the center of the economic system. When money was created, it moved slowly through the real economy toward the fringes where assets were located. Too much money caused a bull market; too little and we got the reverse. Now asset prices sit at the center of the system and money is relegated to the periphery. Every right-minded person knows the main role of a central bank is to create sufficient money to stop asset prices going down, because if this can be achieved then a little of that elixir may just flow into the real economy and create growth.
Indeed, talk to a central banker, preferably a retired one, and they will admit that they have one long term goal which is to stop asset prices from going down the following week. This is because so much debt is linked to these assets that should prices start to fall then the mother of all margin calls would materialize. Most central bankers have read Irving Fisher’s great 1934 tome The Debt Deflation Theory of Great Depressions and they don’t want something similar starting on their watch.
This post was published at Zero Hedge on 09/17/2014.