The purpose of this article is to graphically show and describe how the central banks (CB) of most countries have been supporting asset prices with their balance sheets.
The central bank with the most experience in supporting markets is the Central Bank of Japan (BOJ). The chart below shows the long- and near-term efforts of the Japanese Central Bankers.
As can be seen on the chart above, Japan had a financial crisis in the early 1990s, similar to but much larger than the Savings and Loans crisis that occurred in the USA at the same time.
It took the BOJ a long time to step into the market; it let the markets slide for another ten years before reacting.
Making up for lost time, the BOJ has accelerated its efforts since the GFC, as can be seen in the chart below, with a strong correlation between the CB bank balance and the stock market direction.
The BOJ now buys everything: private debt, government debt and also stocks via ETFs, the last taboo. Similarly, when a CB buys a bond from a private bank, the private bank receives cash reserves in return. What it does with the excess cash reserves is up to the bank. Often, it is invested in other assets, such as foreign exchange or stocks. A good portion of this money finds its way the into markets. The origin of the money was the CB. Market support by proxy.
By far the largest supporters of markets are the Americans and the Europeans, as shown in the charts below.
Adding over $4 trillion to its bank balance, the Federal Reserve can be considered the mega-lifter of markets. The bad news for markets is that the support is now being taken away. It is no coincidence that the peak in the stock market this year in January has been followed by flat, choppy markets ever since the Fed's balance sheet began to fall.
The European Central Bank (ECB) has put in a similar performance to the USA, as the chart above shows. As Mario Draghi said, "everything, it takes to support the Euro," except fiscal spending on real benefits such as healthcare, education and infrastructure. More rising markets can be expected from the Europeans, as the stock market tends to follow the CB bank balance and it is still rising, and the markets will follow. Not all Europeans are equal, though.
Germany is by far the best bet. Rising CB bank balances mean rising markets.
This is not the case for other larger European markets such as Spain and Italy, for example. Shown above, the level of CB support is not enough to lift these moribund markets. The level of CB buying is not enough by one order of magnitude.
Given their self-imposed constraints via the fiscal compact (3% deficit and 60% government debt), they cannot marshal the funds to lift markets like the Japanese, Americans and Germans. The level of support is increasing though and has never been higher than now, and these markets could surprise to the upside.
There is a strong correlation between CB bank balances and most major stock markets, as the charts below show.
Canada long and short term. Above and below.
Australia has a very good correlation to CB bank balances.
The UK with and without Brexit, the CB is always there and the UK has one of the best correlations of the series presented here today.
India, long and short term. Above and below. CB support has dropped of late, and the stock market will most likely follow.
Russia below.
In all the above cases, except for Germany, Spain and Italy, the sovereign currency creation powers of the national government have been harnessed by the CB to support asset markets, rescue banks and suppress interest rates. This is a strategy that helps the holders of these assets. One could say that the banker class has rescued itself and those like it at the expense of the rest of the population. The rest have endured fiscal austerity and a loss of real benefits and lifestyle.
Germany, Spain and Italy are not monetarily sovereign in their currency, as they are users of the euro. Germany is fortunate in that it receives an influx of euros into its CB from its large current account surplus. Spain and Italy have the reverse situation. The ECB is the EU currency sovereign and has been doing some big-time asset market support via currency creation for bond purchases. At the same time, job creation programmes in the southern European lands could have solved the 25% general unemployment and 50% youth unemployment problem. What is more important? Inflating paper assets or employing and training the next generation of workers and consumers?
The same sovereign currency creation powers could have been used by the national government for fiscal expenditure on healthcare, education and infrastructure rather than misused by the CB for the inflation of paper assets.
Longer-Term Picture
There is an unfortunate global trend developing, as illustrated in the chart below from Mr. Robert P. Balan and this recent article.
The black dotted line on the chart above is falling in line with central bank balances as assets are sold.
The simple takeaway is that when the monetary base of the big global central banks falls, so do asset markets. The effect is already taking hold in America.
It has never occurred before that the world's central banks have unloaded their balance sheets all at the same time. QE has never occurred before on a global scale. QT has never occurred before. This is new territory. The way politicians and central bankers are mishandling this is a guarantee of a recession and stock market panic "that no one could foresee." They have to be different each time, otherwise they would not occur. It will be glibly termed a "Black Swan" event, an external shock that no model could predict except for Professor Steve Keen's Minsky Model.
There will be three broad effects:
- Paper asset prices will generally fall as global central bank support is withdrawn.
- Bond yields will rise and face values fall. The yield rises only because the face value has fallen.
- The US dollar will soar as liquidity gets soaked up by the bond buying despite the "twin deficits."
CB asset buying is not something that one can stop doing, otherwise the very thing you are trying to save comes down again. At the recent G20 CB and finance minister meeting in Argentina, that would have been the elephant in the room.
For these people, there is no alternative (TINA), and one could expect that one of the less publicised outcomes of the meeting was the need to keep buying. Japan has been doing it for decades, and the others are likely to follow, there being no other choice outside of the taboo realm of national government Keynesian-style fiscal spending on first-class healthcare, education and infrastructure.
