"Stocks Post Best Rally of 2009 on Improved Citigroup Outlook" (Bloomberg)
March 10 (Bloomberg) -- Stocks around the world staged the biggest rally of the year after Citigroup Inc. said it was having its best quarter since 2007, spurring speculation the worst of the banking crisis is over. Treasuries and gold fell.
Citigroup jumped 38 percent as Chief Executive Officer Vikram Pandit wrote in an internal memorandum that the bank, which reported five straight quarterly losses, was profitable in the first two months of 2009. JPMorgan Chase & Co. climbed 23 percent and Bank of America Corp. surged 28 percent as Federal Reserve Chairman Ben S. Bernanke urged an overhaul of financial regulations. General Electric Co. rose 20 percent, its steepest advance since at least 1980.
“If we’re not at a bottom, we’re a pretty close,” said Michael Binger, Minneapolis-based fund manager at Thrivent Asset Management, which oversees about $60 billion. “It’s time to start putting money into stocks. Stocks are cheap and worldwide stimulus will eventually help lift earnings.”
The Standard & Poor’s 500 Index rebounded from a 12-year low, increasing 6.4 percent to 719.6 as all 10 industry groups rose more than 2.3 percent. The Dow Jones Industrial Average added 379.44 points, or 5.8 percent, to 6,926.49.
Wow. That's great. A stockmarket rebound encourages investment, by making capital more valuable, and investment is the key driver of the business cycle in normal times, though this one is very different in many ways. That said, I suspect stock prices would have to rise quite a bit before firms would see a point in growing the capital stock. Even with stocks pushing 14,000 investment was sluggish. Meanwhile, here's a warning: "Ease Up on the Gas Pedal, Bernanke!"
Inflation is reigniting. The U.S. Bureau of Labor Statistics announced last week that consumer prices, which had declined from November and December, rose 0.4% between December and January, an inflation rate of 4.9% on an annualized basis. The bureau announced earlier that producer prices rose 0.8% in the same period, a 10% annual rate of inflation.
Why is this happening? The answer is painfully clear. From the end of January 2008 to the end of January 2009, the Federal Reserve's monetary liabilities, the sum of currency and bank reserves known as the "monetary base," more than doubled. This is a year-over-year expansion unprecedented in the Fed's history. During the last three months of that period alone, the base grew an incredible 50%. (At that pace, it would have quintupled in a year's time.) The base has thankfully receded a bit in February.
Broader measures of the money stock reflect the rapid growth in the base. The M1 measure (the sum of the public's currency and checking deposits) has grown at an annualized rate of 23% over the last six months, while the broader M2 measure has grown at 15%. As standard theory predicts, this rapid money growth has pushed short-term interest rates to historic lows. For the last 10 weeks 12-month Treasury bills have been trading at yields below 0.6%.
For perspective, flash back to the early years of the Great Depression. Between 1929 and 1932, runs on the banking system led to a sharp decline in the money stock, leading in turn to a general deflation. The best-known historians of the event, Milton Friedman and Anna J. Schwartz, faulted the Federal Reserve system for not using its money-creation powers to stop the decline.
In a 2002 speech at a conference honoring Milton Friedman on his 90th birthday, Ben Bernanke promised that the Fed would never again commit that error. Today, as chairman of the Fed, Bernanke is so eager to fulfill his promise that he is erring strongly on the side of monetary overexpansion.
Chairman Bernanke is quite right to want to avoid a collapse of the money stock, because when that happens, economic activity contracts needlessly. Certainly the Fed should not sit idly by while the money stock shrinks.
But today's money stock is not collapsing--not by a long shot. Moreover, while asset prices have fallen over the past year due to the bursting of real estate and stock market bubbles inflated by years of excessive money growth, the prices of consumer goods and services have not. The decline of asset prices thus does not represent a general deflation. Instead, it represents the correction of a relative price distortion. The reduction in asset prices is actually the beginning of recovery; thus, an effort to prop up asset prices delays recovery.
It's true that the decline of asset prices represents the correction of a price distortion. But that correction could occur either by asset prices falling or by consumer prices rising. If you have a $200,000 home that should be worth $100,000, the correction could occur through asset prices falling by half, or consumer prices doubling. The latter is better. Home-price deflation is disastrous because it creates a lot of deadbeat debtors, gives people an incentive to walk away from mortgages, and kills the banks. Consumer price inflation is also bad, but probably less so. A big inflation would be, in effect, a generalized partial debt amnesty, which is just what the country needs. An inflationary five to ten years thereafter is a price worth paying.
If there is a recovery in the near term, the next question is whether Obama's stimulus worked, or whether it was a result of monetary policy by the Fed. I'd bet on the latter. I think-- very tentatively-- that Bernanke has been a bit too experimental in bailing out banks and buying private assets, but I've always thought his uber-easy money was the big bright spot in the US government's policy response to the crisis.
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