With central banks owning $25 trillion of financial assets and sovereign wealth funds owning countless trillions more, it is time to ask whether capitalism as we know it is a thing of the past.
These non-economic actors have different motivations than traditional investors who buy assets in order to earn a profit over a reasonable period of time.
Central banks are buying stocks and bonds in order to monetize government debt and keep afloat the endless Ponzi schemes required to finance massive entitlement promises to their constituents.
Sovereign wealth funds are looking for places to park their cash for extremely long periods of time and often focus on assets with trophy or strategic value.
But the most important thing these two types of buyers have in common is that they don't have to sell, which means that their ownership can inflate the value of what they own for prolonged periods of time.
This destroys the price discovery mechanism that markets are supposed to provide. And without price discovery, markets cease to function properly.
Then the destruction starts in earnest…
Here's Where We See This Effect in Action
Bond markets are ground zero for this phenomenon. Somewhere in the vicinity of $13 trillion dollars of global bonds carry negative interest rates, which produces the absurd and dangerous prospect of lenders paying borrowers for the dubious privilege of lending them money.
While some try to rationalize this monstrous arrangement as a sensible way to provide for the return of their money if not a return on their money, it is nothing more than government confiscation of capital.
It is a catastrophic undertaking destroying savings and eroding the capital bases of banks, insurance companies and pension funds. It speaks to a broken global financial system guided by corrupt and incompetent central bankers and politicians.
Quite a few of them were clustered together this week.
What We Heard from Jackson Hole
Last week, the Federal Reserve met in Jackson Hole, Wyoming for its annual confab and naturally investors were hanging on every word uttered by the former tenured economics professors comprising the committee to destroy the global economy.
There were strong hints from Fed Chair Janet Yellen and Vice Chair Stanley Fischer that rates will soon rise, but we have heard such promises before only to see nothing happen.
Before the meeting, an economically illiterate activist group called "Fed Up" met with the Fed and demanded that interest rate hikes be further delayed lest they harm minority communities. But the worst thing the Fed could do for anyone is keep interest rates low; instead, it should announce that it will start raising rates by 25 basis points each quarter until the Fed Funds rate reaches 2% and then urge Congress to act on meaningful tax reform and fiscal stimulus that are the only policies that will help minorities and the rest of the economy.
And then this nation should embark on meaningful civic and economic education for all of our children to insure that they understand how economies work – which is not by increasing entitlements and reducing the cost of money to the point where it has no value.
Markets Dipped Like Clockwork After the Meeting
The market didn't much like what it heard from Jackson Hole last week because it lives in fear of another rate hike.
The Dow Jones Industrial Average lost 157 points or nearly 1% to close at 18,395.40 while the S&P 500 declined 15 points or 0.7% to 2169.04. The Nasdaq Composite Index fell 0.4% to 5218.92.
The last time the Fed hiked rates by 25 basis points in December, the market fell sharply before recovering after the Fed backtracked and promised it wouldn't do it again for a very long time.
This pathetic appeasement of the stock market is another sign of just how far the Fed has wandered from its role as lender of last resort.
While August has become a volatile month since the financial crisis, this August has seen the lowest market volatility in 20 years.
That's an upsetting development.
Why Too Little Volatility Is a Bad Thing
Central banks are not only suppressing interest rates and price discovery – they are suppressing volatility, too, which is extremely dangerous.
With the CBOE Volatility Index (VIX) trading at new lows, volatility could break out to the upside and seriously hurt those economic investors who actually care about their returns (which excludes, of course, investors like the Japanese Government Pension Fund that reportedly lost $130 billion in the past year on its financial assets).
One of the things investors should be asking themselves is why they are paying advisers to manage assets that generate zero returns. This is particularly relevant with respect to their bond investments, an area I know a great deal about.
If you are paying someone to manage investment grade, municipal or Treasury bonds, you are throwing money out the window. In addition to the fact that managing such assets requires no special skill, these assets are generating negative real (i.e. inflation-adjusted) returns – and are likely to either keep doing so or generate large losses when interest rates rise.
You would be much better off exiting such investments entirely or moving your assets into a low-cost exchange-traded funds (ETFs) or mutual funds.
Of course your manager will tell you that you are making a big mistake in doing so, but that advice is as conflicted as Hillary Clinton's relationship with the Clinton Foundation.
You are paying for nothing and getting nothing from these managers.
But that's not to say there's nothing to be learned, at least, from these Wall Street types.
Carl Icahn Just Made a (Bigger) Fool of Bill Ackman
Finally, last week saw a classic beat down of activist investor Bill Ackman by the more experienced and hardened activist Carl Icahn.
After a bogus press report on Friday morning that Icahn was shopping his $1 billion block of stock in Herbalife, Ltd, (NYSE: HLF) and that Mr. Ackman, who is famously (and wrongly) short the stock was a potential buyer, Mr. Ackman quickly ran on television to crow that Mr. Icahn was selling because he knows that the company "is toast."
Several hours later, Icahn announced that he has bought another 2.3 million shares of HLF and then delivered a long statement on social media describing Mr. Ackman as "obsessed' with Hebalife, leading him to exercise poor judgment that has resulted in massive losses on his short position.
Ackman, never one to walk pass a microphone, spent part of the week explaining his even more egregiously poor judgment in riding down Valeant Pharmaceuticals International Inc. (NYSE: VRX) stock from $265 per share to its current $30.80 per share, the biggest factor in his second consecutive year of double-digit losses and his inability to make money for his investors since 2012 despite a spectacular 38% return in 2014.
This type of "hedge fund porn" is bad for the industry but remains instructive for those of us who try to learn from the mistakes of others.
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About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.