And The Winner Is... The Financial Industry!

by: John M. Mason


This past week the stock market flirted with new highs, the commodity markets were said to be in bull territory and the bond markets closed with historically low yields.

As the financial circuit thrives, the industrial circuit with slow economic growth, low capacity utilization, slow business investment and lagging productivity growth seems to be severely lagging.

The financial engineering in the economy seems to have overcome the physical engineering needed to produce a strong economy and there seems to be only little effort to change.

The economist Irving Fisher wrote in the 1920s and 1930s about the movement of money in an economy and distinguished between money moving through the economy to produce real goods and services, creating jobs and employment… the industrial circuit… and the money moving through the banking system and financial markets, just spinning around and around... the financial circuit.

Over the past fifty-five years or so, we have seen the financial circuit in the United States growing relative to the industrial circuit as the federal government and its agencies, including the Federal Reserve, create more and more credit into the economy, as risk taking increased, the use of financial leverage increased, and financial innovation came to dominate the world.

This past week we've seen the stock market approach historical highs, the commodity markets move into bull-market territory, and bond prices reach highs that have resulted in yields not seen in centuries (according to some).

Friday, the bond markets closed with the yield on the 10-year US Treasury note at 1.64 percent; the 10-year German bund closed to yield three basis points; and the 10-year Japanese bond closed to yield a negative 15 basis points.

Bill Gross of Janus Capital has been yelling for weeks that bond yields have to rise and just this last week shouted out that negative bond yields are going to result in a "super nova" implosion in the bond market.

And, the underwriter of it all, the Federal Reserve system, has apparently backed off from making any move on interest rates at this time because of soft labor market data… news from the industrial circuit.

What about the news from the industrial circuit?

Well, the economic recovery from the Great Recession will reach seven years in the US at the end of this month.

The economy has grown at a compound annual rate of just over 2.0 percent during this time, the slowest economic recovery in post-World War II history.

Figures are now being released showing that the growth of labor market productivity has been abysmal during this recovery and even moved into negative territory during the first quarter of this year.

Furthermore, the labor force participation rate, now at 62.6 percent, is at lows not seen since the latter part of the 1970s.

Real business investment in the economy is horrible. It seems as if corporations only want to borrow at the historically low interest rates to pay higher dividends, buy back their stock, and, particularly in the case of large corporations, buy other corporations so as to get bigger.

Whoops, we are back into the financial circuit again… back into financial engineering.

And, what was one of the most common complaints of the corporate world this week? It was that the Republicans in Congress needed to scale back the Dodd-Frank Wall Street Reform and Consumer Protection Act. The next loudest cry coming from the commercial banks and others, was about the absence of CDS, Credit Default Swaps, because investors did not feel that they had a full portfolio of hedges to protect themselves from bad loans or other downward movements in debt instruments and exposures.

All of this is disconcerting information. As Bill Gross argues, there are asset bubbles popping up all over the place, supported by the Federal Reserve system, with little or no spill-over into the production of goods and services.

The financial circuit dominates the news and the Greenspan "put," which was promoted by Alan Greenspan when he was the chairman of the Board of Governors of the Federal Reserve system to protect stock market prices from declining, has now become the asset market "put" as Janet Yellen and the Fed pursue a 2.0 percent inflation target and attempt to keep all asset prices from falling.

The financial circuit has won!

And, as long as the US government continues to focus on creating more and more credit, labor productivity and the growth of the US economy are going to continue to be mediocre.

Unfortunately, it will probably not be an easy path to get the industrial circuit up and going once again, regardless of what Paul Krugman and other modern Keynesians believe to be the case.

Furthermore, solutions will not be quickly achieved.

The real question has to do with how long the stock market, the commodity markets, and the bond market can sustain their high prices?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.