“I’d never heard this song before,” he told his economist girlfriend.
“Well, there’s always love at first,” she told her out-of-work boyfriend who used to work for a unicorn.
“But now that we’re talking about easy money, tell me something… why are stock prices on fire?”
“You want to start Monday morning talking about stocks… and here I am, thinking we’ll spend a little bit of time on this… maybe even look at last season of Better Call Saul.”
“So, why did the Sensex cross the 60,000 mark again before falling on Friday?” He asked, completely ignoring what he had just said.
“Men will be men!” He thought.
“Tell me no,” he continued.
Therefore, on October 18 last year, the Sensex closed at an all-time high of 61,766 points.
“I know that.”
“By June 17, it had fallen almost 17% to around 51,360 mark. This happened primarily because rich-world central banks, led by the US Federal Reserve, decided to raise short-term interest rates to control decadal-high inflation. They decided to slowly pull out the money they had printed and pumped into the financial system over the years to reduce long-term interest rates.”
“This is what the experts said when they said the era of easy money was over?” He asked.
“Yes,” she replied.
“So, what happened after June 17th?”
“We first need to understand what happened before that.”
“Well.”
“No market waits for things to happen. It discounts possibilities. And the same was happening with stocks, especially when it came to foreign institutional investors (FIIs) who invest in Indian stocks.”
“for example?”
“While the rich-world central banks decided to reverse their easing currency policy this year itself, FIIs have been playing down that possibility since late last year. He did this by selling a portion of his stake in Indian stocks. FIIs sold shares between October and June 2.56 trillion.”
“very nice!
“During the same period, domestic institutional investors (DIIs) …”
“Domestic Institutional What?” He interrupted.
“Domestic institutional investors,” she said. “They are basically firms like mutual funds, insurance companies, pension and provident funds, banks etc. The money they invest is money entrusted to them by retail investors.”
“Ah, the money that you and I invest indirectly in the stock market.”
“Yeah, exactly the same.”
“What did DII do?” He asked.
“Between October and June, he bought shares worth 2.98 trillion and it ensured that the market fell only as much as it dropped and not more.”
“Now, what has changed since June?”
“The FIIs are back.”
“Well.”
“Hence, FIIs became buyers in early July and have bought the stock overall since then. In July, he bought shares worth 4,989 crore (net), which was not much. But he actually came to the party this month. By August 19, he . value shares were bought 44,481 crore (net) during the month.
“Why this change?”
“To answer this question, we have to understand a little bit of economic history.”
backstory
“Turn it on,” he replied, all excited. This left her wondering – when did their relationship become so intellectual?
“So, do you know about the Great Depression of 1929?”
“Not that you could possibly know about it.”
“Ah, mascara polish!”
“Well!”
“The year was 1929 and by October, stock prices in the US had risen significantly. On September 3, 1929, the major US stock market index, the Dow Jones Industrial Average, reached a little over 381 points.”
“and then what happened?” He asked.
“As of October 17, the stock market had fallen more than 10% from its peak on September 3. At the time, Irving Fisher, possibly the greatest American economist of that era, remarked, ‘Stock prices have reached a level that looks like a permanently high plateau … I expect the stock market to be within a few months’ I’ll have a good deal.'”
“Ah, experts are experts.”
“The week of October 21 determines the shape of things to come. By the end of the week, the Dow had fallen 6.9% to nearly 299 points. In the first two days of the next week (October 28 and October 29), the Dow fell to 230 points. By November 13, the stock market had settled at around 199 points, down 48% from its high of 381 points in early September. Fischer lost his fortune in the accident.”
“Oh my, stock prices fell in half in two months.”
“Yes they did.”
“It must have been disastrous for the economy.”
“It was. But not just because of the stock market crash,” she explained.
“Meaning?” He asked.
“One of the first things that happened after the accident was that New York bankers tried to stop the falling stock market. By doing so, they reduced loans to commodity dealers. Commodity dealers were unable to borrow, so they could not buy the commodity.”
“What happened with this?”
“With no credit available to commodity dealers, the prices of commodities such as coffee, rubber, hides, silk and tin, which depended on credit available in New York, began to fall.”
“And thus the economic crisis broke out.”
“Yes. Indeed, as the economic historian Charles Kindelberger put it, ‘this caused a financial crisis in the commodity markets … to make waves around the world … if the price of a commodity fell, it would fall everywhere. is,’ he explained.
“It’s very interesting to know how things eventually add up,” he remarked philosophically.
“The fall in the stock market may not have hurt a large portion of the American population, but the fall in commodity prices did begin to hurt the population at large, given that nearly one in four Americans were on agriculture at the time. It eventually caused the economy to contract and cause massive unemployment.”
“The Great Depression is that.”
“Yes.”
freedman and easy money
“But how is all this connected with the Sensex crossing the 60,000 level again?”
“Catch!”
“Well.”
“The Great Depression inspired many Americans to study economics. Milton Friedman was one such person. In 1963, Milton Friedman wrote A Monetary History of the United States, 1867–1960 with Anna J. Schwartz. This book also shows a revisionist history of the Great Depression in the U.S.. Friedman and Schwartz argued that the Federal Reserve System ensured that only a stock market crash became the Great Depression.”
“And what was their reasoning?” He asked.
“Between 1929 and 1933, more than 7,500 banks with deposits of about $5.7 billion were closed. This, according to Friedman and Schwartz, dropped by a third the total amount of currency in circulation and demand deposits in banks.”
“So?”
“Had the Federal Reserve poured more money into the banking system, there would have been enough confidence among depositors who had lost their money and the Great Depression could have been avoided. Bankruptcies left depositors’ money either stuck or permanent. In this situation, they cut spending further to try and increase their savings. This affected economic activity, given that one man’s expenditure is another man’s income.”
“But I still don’t understand what this has to do with the Sensex again bullish.”
“You know, the British economist John Maynard Keynes once remarked: ‘Practical men who consider themselves quite free from any intellectual influence are usually the slaves of some passive economist.’ Most economists are also pragmatic men. Friedman’s views on the Great Depression have dominated the American economic establishment since he first coined them six decades ago.”
“You’re confusing me even more now!” He said with both his hands in the air.
“American central bankers have been hugely influenced by Friedman’s thinking over the years. This includes Ben Bernanke, who was chairman of the Federal Reserve at the time of the financial crisis in 2008,” she explained, ignoring her barb.
“Well.”
“In fact, at Friedman’s 90th birthday celebration in 2002, Bernanke, who was then governor of the Federal Reserve, said: ‘I’d like to say to Milton and Anna: About the Great Depression. You’re right, we did. We’re very sorry. But thanks to you, we won’t do it again.'”
“Hmm.”
“As Bernanke wrote in Essays on the Great Depression: ‘There is overwhelming evidence that the main factor depressing aggregate demand was a worldwide contraction in the world money supply.’ Or as he put it in a 2002 speech: ‘The correct interpretation … is not popular – that the stock market overvalued, crashed, and caused a Great Recession. The true story is that monetary policy made extreme efforts to contain the rise in stock prices.'”
“How does it all add up?”
“So, for American central bankers, the Great Depression was the biggest economic event of the last century. And in their heads, when deciding on monetary policy, they are trying to avoid the next major recession, if not a depression. Like 2008 They flooded the system with money when the financial crisis started in 2000. Earlier, interest rates were cut sharply when the dotcom bubble burst in 2000. In 2020, once the Covid pandemic broke out, The Fed printed the money and filled the financial system with it.”
“Why do they do this?” He asked.
“The idea is to lower interest rates, both long-term and short-term, and get people and firms to borrow and spend money to revive economic activity and prevent a recession.”
“Well.”
market bet
“Now, the US economy contracted 1.6% during the January to March period and 0.9% during the April to June period. So, technically, it is already bearish.”
“And?”
“The stock market is betting that sooner or later the Fed will have to reverse its current policy and go back to easy currency policy. Because with the current policy of raising interest rates, the Fed is engineering an end to a huge recession. And looking at past evidence, that’s something the Fed doesn’t do,” she explained.
“Ah, now it makes sense,” he remarked.
“In addition to raising short-term interest rates, the Fed has said that by June 2023, it will take out nearly a trillion dollars of money it had printed and pumped into the financial system. This will raise long-term interest rates, boosting demand. will control and in the process control inflation.”
“Well.”
“The trouble is, the data suggests this is happening at snail’s pace, leaving stock market investors betting against what the Fed is actually saying. In fact, in July, retail inflation in the US was 8.5%. But it was much higher than the level Americans are accustomed to and the Fed prefers.”
“then what will happen?” He asked.
“I wish I could give you a straight answer.”
“Then give me a complex.”
“The Fed has clearly stated in its public communication that it will continue to raise interest rates until it is able to control inflation. But the market is betting on the Fed going back to the easy money policy. FII money has been replenished in the U.S. and the market is again touching the level of 60,000. The question is, will it last?”
Billy Joel’s song began streaming as soon as he finished saying it: “I want easy easy money easy money”.
While Springsteen’s song is clearly better, Joel’s song still captures the spirit of the times we live in.
And she kept wondering if romance really exists outside of books and movies.
(example is imaginary)
Vivek Kaul is an economic commentator and author.
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