Many investors will often say that the stock market leads the economy. While in the past this has appeared to be the case on many different occasions, is it really true? That question is open for debate. The current situation for the economy looks to be slightly different. Throughout the past 97 years every time the Federal Reserve Bank(which is the central bank to the United States) has lowered interest rates to extremely low levels the stock market has inflated higher and recovered. Currently, the Federal Reserve has the benchmark fed funds rate at zero to a quarter percent since December 2008. The central bank has also purchased over $1 trillion in U.S. Treasury bonds. At this time the Federal Reserve is in the middle of it's $600 billion quantitative easing part two program which is meant to help inflate asset prices. This is an unprecedented amount of money being thrown at these markets in order to create inflation and higher stock prices.
To the Federal Reserve Bank's credit it has worked as everything has inflated higher. The people that are employed and have jobs are also feeling better because their retirement accounts have bounced back up. When people feel better they will spend money. It is important to note that consumer spending accounts for 70.0 percent of the gross domestic product in the United States. Can quantitative easing actually work if people start feel better?
There are a few problems with inflating the markets higher by creating cash reserves. The first problem is the high inflation that it creates around the world. Every emerging market is now facing high inflation. People in the United States can see how much higher they are paying for food and energy. The other problem is that unemployment is still near 10.0 percent according to government standards. There are also a lot of people on food stamps or as we now say government assistance. It is estimated that over 43 million people are on food stamps. Food riots have also broken out around the world in various nations. Rice, wheat, cotton, coffee, and many other commodities are soaring higher on a daily basis. The iPath Dow Jones-UBS Commodity Index Total Return ETN(NYSE:DJP) is trading at a new two year high. The iPath Dow Jones-UBS Cotton Subindex Total Return ETN(NYSE:BAL) is trading at a new all time high. Can these high prices be beneficial for the economies in the United States and around the world?
This morning the U.S. Dollar Index has declined lower again by 0.34 cents to $77.38. The purchasing power of those that use dollars have diminished again. Well, just about every commodity in the world is traded in U.S. Dollars. Every person that lives in America has just about every asset that they own denominated in U.S. Dollars. How can a rising stock market and a falling dollar be viewed as a positive? Wouldn't one think that a strong currency and a strong stock market should be be viewed as real wealth creation? However, our political leaders and our banking leaders tell the public differently. It is important to note that President Obama never onced mentioned the condition of the U.S. Dollar last week in his State of the Union speech. We can only wonder why?
The stock market will continue to inflate until it realizes that it cannot inflate anymore. People should remember that very similar trading action took place throughout 2003 into 2007. Unfortunately, we all saw what happened when that rally came to an end. Right now the United States has over $14 trillion in debt and the market does not seem to care yet. We shall see how far this inflation rally can last.