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 Richmans' Trade and Taxes Blog

Is the U.S. stock market going up because of Central Bank Purchases?
Howard Richman, 6/16/2014

On June 17, the Official Monetary and Financial Institutions Forum is going to launch its Global Public Investor Report in London. If you check out their website today (June 16), you will find the following headline for that forthcoming report:

Central banks are switching into equities to offset risks, outlined in OMFIF's Global Public Investor report, launched in London on 17 June.

Financial Times has already published an article based upon that report, and Zero Hedge has already put up a blog posting about it which includes a graph that shows that as predictions of future world economic growth go down world stock markets go up. The mechanism could be the following: 

  1. First, the mercantilist central bank of a country sees that predictions for growth in its economy are going down. 
  2. Second, the central bank engages in a beggar-thy-neighbor policy, designed to boost its economy by lowering its exchange rate, thus increasing its exports and reducing its imports. So it creates money which it gives to its Sovereign Wealth Fund to buy foreign currencies and then use those foreign currencies to buy foreign equities.
  3. Result, as economic growth in the mercantilist countries deteriorates, stock markets in the beggared countries (including the United States), go into bubbles.

The Central Bank of Japan may be the chief culprit here. As part of Abenomics, its central bank purposely lowered the exchange rate for the yen as compared to the dollar, but the dollars purchased never appeared on its balance sheet as increased foreign reserves. The likely reason was that those dollars were almost all given to Japan's sovereign wealth fund for use purchasing U.S. equities. (In general, central banks do not report the equities held by their sovereign wealth funds as reserves.) 

These purchases do not help the U.S. economy. They increase the U.S. trade deficit which, in turn, is driving down the U.S. growth rate. What they do is create bubbles, which end up being extremely destructive in the long-run.

The U.S. stock market is now in a bubble, as shown by the ratio of market capitalization to GDP on this website. With every new bad economic report, the U.S. stock market goes further up in value. The wealth disparity between rich and poor in the United States has been growing. But that is temporary.

As the holders of shares, real estate and commodities during past bubbles know: all bubbles eventually burst. The way to make money is to buy and sell before the bubble bursts. The way to lose your money is to be caught holding the shares, real estate, commodities or tulip bulbs when the bubble bursts. When a bubble pops, it pops fast.

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Comment by Jesse, 6/17/2014:

The Treasury Department estimates the amount of foreign investment in U.S. financial instruments including equities every year.  Their 2013 survey is now almost a year out of date.  It shows that about 37 percent of long term investment was in equities, which is a high since 2006 at least (earlier data is less available).  China's investment in US equities has grown tremendously over the last few years.  In 2006, China and Chinese citizens were listed as holding four billion in equities.  In 2013 that number had grown to 261 billion.  Of course this is still dwarfed by the tax shelters.  Cayman Islands is listed with 628 billion, Luxembourg with 378 billion... etc.  It's a bit hard to know who really owns the trillions in the tax shelters.

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]