Markets suffer too much central bank attention … That restatement of Goodhart's Law is almost perfectly appropriate to today's financial markets. Bonds, stocks, currencies and commodities have all become treacherous terrain for investors. Charles Goodhart, a British economist, developed his law in 1975. He was worried about the central bank orthodoxy of the day, the belief that monetary policy should aim only at controlling money supply. Growth in M2 and inflation rates had long been closely correlated, but as soon as the monetary authorities started to work on M2 the correlation broke down. Inflationary momentum stopped passing through this measure of the money supply. – Reuters
Dominant Social Theme: Central banks are at the center of finance and deservedly so.
Free-Market Analysis: In an article yessterday, we pointed out that central banks are the unacknowledged aggregate sun of the financial solar system. In this article from Reuters we find further proof of this perspective.
The editorial is stating just what we explained: That too much of the financial marketplace is influenced by bank policy and nothing more. According to this commentary, it used to be that a number of different items could influence Western stock and bond markets, not just banking policy.
Ever since the advent of the Federal Reserve some 100 years ago, we would tend to believe the markets have been the playthings of top moneymen. At least this article provides us with a resonant statement that no matter the past, the present reality is what we perceive. It's nice not to be lied to, once in a while. Here's more:
The current generation of central bankers has put its trust in another historically strong correlation: between asset prices and economic activity. They believe that high asset prices lead to GDP growth because they inspire confident consumers to spend and companies to borrow. As an added benefit, the cheap and free money which pumps up asset prices also pushes down currencies, a boon to exporters.
The post-crisis loose monetary policy did push asset prices up and many currencies down, but economic growth remains pretty sluggish. It seems that markets do not move the economy in the same way when they are heavily drugged by the monetary authorities as when their enthusiasm is more natural. Now, instead of central banks learning about the economy from markets, investors study the economy largely in order to anticipate what central banks will do. And investors study each other, trying to guess their peers' response to changes in policy expectations. Meanwhile, central bankers monitor investors, trying to keep them confident.
All of this mutual attention makes markets behave like a group of narcissistic teenagers. Both respond emotionally to every little development – in ways that are unpredictable and difficult to analyse. Markets gyrate when the Fed or the Bank of Japan sounds a tiny bit less dovish, or when the unemployment rate is a tiny bit higher or lower than expected. Monetary authorities think strong asset markets and weak currencies will help growth, but their financially orientated policies are now more confusing than helpful.
Almost everything we've pointed out is surprisingly restated in this Reuters article, from the disconnect between asset prices and economic growth to "emotional" investor response based on "every little" central banking development.
If a Reuters commentator can see it, you can bet many others in the mainstream financial reporting community can see it as well. But that doesn't stop the endless flood of investment inanities that clog the financial airways. Thousands of company updates, financial snapshots, public disclosures, etc., all being reported on with great seriousness and painstaking accuracy.
Take a step back. Take a deep breath. Don't just strive to see the whole picture; try as well to see what factors really have influence and why.
When you see things more clearly, it helps with investing … and generally with understanding the Way the World Works.