Tuesday, January 12, 2016

Hoisington & Hunt: "...central bank operations boost financial asset returns relative to real asset returns and induce a shift away from real investment."

"Quantitative easing and zero interest rates shifted capital from the real domestic economy to financial assets at home and abroad due to four considerations:

1) First, financial assets can be short-lived, in the sense that share buybacks and other financial transactions can be curtailed easily and at any time. CEOs cannot be certain about the consequences of unwinding QE on the real economy. The resulting risk aversion translates to a preference for shorter-term commitments, such as financial assets.

2) Second, financial assets are more liquid. In a financial crisis, capital equipment and other real assets are extremely illiquid. Financial assets can be sold if survivability is at stake, and as is often said, “illiquidity can be fatal.”

3) Third, QE “in effect if not by design” reduces volatility of financial markets but not the volatility of real asset prices. Like 2007, actual macro risk may be the highest when market measures of volatility are the lowest. “Thus financial assets tend to outperform real assets because market volatility is lower than real economic volatility.”

4) Fourth, QE works by a “signaling effect” rather than by any actual policy operations. Event studies show QE is viewed positively, while the removal of QE is viewed negatively. Thus, market participants believe QE puts a floor under financial asset prices. Central bankers might not intend to
be providing downside insurance to the securities markets, but that is the widely held judgment of
market participants. But, “No such protection is offered for real assets, never mind the real economy.” Thus, the central bank operations boost financial asset returns relative to real asset returns
and induce the shift away from real investment."

This creates a false mask of financial asset growth and stability, making way for a larger shock/adjustment of financial asset prices when investor's faith in fiat support ultimately fails and the economy returns to normal long-term capital investment in productive assets based on real returns rather than the current environment of financial asset speculative frenzies (seeking "yield") across nearly all financial asset classes present today.

Below is the entire, OUTSTANDING, macroeconomic analysis by Van Hoisington and Lacy Hunt--2 of the brightest luminaries in finance today:

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