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Tuesday, September 28, 2010

The Economy versus the Stock Market

The economy is still in the doldrums. Unemployment remains high. With all the political hostility to prosperity, why hasn't the stock market collapsed again? Why are the indexes moving higher?

Investors and analysts have a growing belief that the Federal Reserve Board (the Fed) will move forward with a second round of Quantitative Easing of interest rates (QE2).

The fact that the Fed is willing to act again shows we have worse economic problems than we thought. Also it is evidence that Federal spending and massive deficits have been ineffective against the economic problems.

The Fed is planning this because the of the rising possibility of deflation. Deflation would damage any recovery because holding onto money would become preferred to spending or investing it.

The Fed's main weapons are adjustment of interest rates and new money creation. "New money" is a misleading term. "New liquidity" would be simultaneously more accurate and more arcane.

Consider this for a moment: Gold is rising against the dollar because gold has a long history as money. Gold has few "real" uses other than as replacement teeth and in some electronics, so it is not really a commodity like copper. Also gold is never liquid in the same sense a dollar is; the dollar has a specific value. Gold must carefully weighed to find its specific value. On the other hand, a dollar has no real value other than the paper it is printed on. In this sense, gold is money; a dollar is liquidity. But I digress....

The QE2 game plan would be for the Fed to buy long dated Treasury bonds. This should lower Treasury rates and provide a little spark to the economy.

The side effect of QE2 is that the dollar will drop against other currencies making our exports more attractive in world markets and imports less interesting to us. That sounds like that should spur domestic production. Its attractive on the surface.

But a weak dollar is a sign of the government pissing away its people's wealth. A strong currency is a sign of a healthy economy and responsible government.

In the short run this is good news for the stock market thus it is rising. When rates on Treasuries go lower, then stocks look more attractive in comparison.

The political result is the stock market performance makes it look like Mr Obama knows what he is doing. Presto -- Rasmussen Reports shows approval of the Prez is rising.

But take note Mr Obama did nothing and is not involved. Only when the Prez is not doing anything does he have a chance of doing what is right.

You see, nothing will keep this president and this Congress from more economic abuses. They have already laid the economic poison of enormous tax increases on us, scheduled to start after 2010 election. They will also let the Bush tax cuts expire.

The new taxes will slow the economy, the expiring cuts will dull investor interest. But don't worry, its all part of Mr Obama's plan to make the rich pay. Too bad that's every one of us.

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