After the disastrous beginning of the 2008 global financial recession, stock prices dropped to the bottom finally in 2009, when stock-exchanges all around the world recorded the lowest prices and highest volatility of the last decade. But in the first week of February of the present year, stock-exchanges all around Europe and North America recorded unbelievable volatility results never seen before, followed by unconditional shrinks in the price of shares. To display some data, we can make reference to the Dow Jones Industrial Average, which fell more than 8.5% last week, which resulted in a contraction of 2,200 points in the overall value of the index. In consonance with these results, the S&P 500 tumbled 7.9% in contrast with the last week of January. But this contractions in the prices of shares should overall not be very worrying, as they have just returned to last year's stable levels, following a more than expected market movement for those of us who thought that based on P/E ratios results, the majority of tradeable companies were being overvalued by an excess of liquidity and demand in financial markets. But, the most surprising result of all has been the VIX cyphers, which have sky-rocketed back to numbers normal of 2009. Nearly all financial analysts have commented about this market movements, and have concluded several statements which seem not to be false, but to be just partly true, as the underlaying causes are not correctly described.
Some of the assertions made have been that the tax reforms has caused some sudden higher levels of uncertainty in relation to future business models, or even new inflation has been claimed to have the possibility of emerging, as wages increased nearly 2.9% across the US, which some people think could be used by the Fed as data to back them up when rising interest rates; something which is more than necessary, not just for financial America, but for global industries overall. The increase in bond prices with the consequent contraction of their correspondent yields has altered many financial firms, making them think that this could lead to future overwhelming price inflation, hindering the set-up of new businesses or even the development of present ones. Couldn't it be that we have been living in a bubble constantly inflated by the Fed which has prevented us from seeing the real cost and conditions of doing business?
We should let aside all this "fantasy novel" type of arguments, and centre our analysis in what really matters, which are fundamentals and historical causes, taking us back to how central banks, and not just the Fed, dealt with the period just after the beginning of the 2008 financial recession. During the economic collapse of the time, many of us were astonished by how central banks responded to the crisis, causing Krugman to applaud each of their policies, as we saw the biggest credit expansions in history at the same time interest rates reached bare minimum levels, and even turned negative in some cases as that of the ECB, converting us in the clowns of global financial markets. At the same time, we shouldn't blame everything to the Fed, as the Bank of Japan owned more than 75% of ETFs that were trading at the moment in that nation, or we could also take a brief look at Greek bonds, which until a few months had a lower intrinsic risk that American ones! It can be admitted based on empirical evidence that this type of expansionary policies helped to boost growth and took us back to stable GDP variations of positive 2-3% per year, but at the same time, global debt jumped over 325%/GDP... so, did we condemn the future trying to save the present?
If we look at any of the post-2008 Fed balance sheets, we will be able to observe how while rates dropped to the bottom causing loans and credit to explode the markets and create millions of unprofitable business models, the same central bank continued directing trillions of homemade dollars into financial markets and banks, generating cheaper credit and boosting spending to unprecedent levels. Which was the results (clearly expected)? Well, debt, debt and even more debt, preceded by the lowest saving rates in deposits of the last years. This is not the customers' fault, as if prices of stocks and yields of bonds just kept up rising, this shifted their investments towards these securities and kept money out of deposits. This trend finally caused the main central banks in the world to keep on with their QE policy, as they knew that sudden tapering would cause tremendous contractions in the price of securities, and the public will (correctly) blame them for having increased an unnecessary bubble. Well, the public except for Paul Krugman, who will always defend intervention in financial markets independently of its causes and effects.
We could say, according to the Austrian School economic cycle theory, that central banks prevented financial markets from going into the necessary correction at the time and condemned them to a greater and memorable slump afterwards. Because bubbles can't be inflated forever, and the loudness of their burst tends to be proportional to their diameter. It's not me the only one thinking that facing a short market correction is healthier for the economy and industry than making us addict to low interest rates. It was Ludwig Von Mises the first to display how central banks help, not just to create, but also to accelerate and accentuate booms and busts through the cycle. This can be simply explained by saying that consumers and producers are prevented from making the wisest decisions possible if they are presented false information about costs and demand levels, as near-zero interest rates and an incredible liquidity which tends not to be at all realistic.
Market interest rates are necessary to balance supply and demand between the various interacting economic agents in financial markets, permitting them finally to reach a stable equilibrium. In a real market system, without state or central bank intervention (a complete utopia) low interest rates will generate an excess of demand which will finally consist in greater inflation, dropping demand back to normal levels and causing rates to rise consistently to reach an equilibrium where the majority of consumers and suppliers will be satisfied. This shows that interest rates are not just an indicator in a balancing act, but also a reference in financial markets for entrepreneurs and borrowers to judge which production and consumption levels they can reach while being able to pay all their liabilities in a determined and fixed future. This is the reason why when central banks generate outstanding levels of credit artificially through monetary expansions, it pushes interest rates down, and makes market look like having a greater number of saved resources and capital than they really have, shifting funds into new businesses and industries that will be inefficient at realistic market rates.
Some will argue that these measures are justified, as employment goes up, inflation goes back to stable levels, business' stocks increase, and stocks fly up to the sky and present unprecedent prices, generating profits for everybody, and making financial businesses accessible and profitable for all kind of investors. These trends tend to shift a greater amount of money to indexed funds and passive management, as finding value in a hyper-inflated market tends to be much more difficult, while sticking to an index is the easiest thing of all; as if it doesn't work... you can always blame the market (notice sarcasm).
The final bust always starts when the non-stoppable printing press of central banks slows down its pace and allows people to see how inefficiently they have allocated their capital based on false approaches to interest rates and liquidity, expecting future profitability that will never come due to a return to realistic levels of demand and supply. In this case, markets shouldn't be blamed for greater costs, but central banks should for falsifying market information as prices and interest rates. A realistic and perfectly timed bust is necessary for the market to correct itself, even if it generates some unemployment or inflation, market corrections will show the real availability of capital and its efficient employment and necessary allocation for productive uses.
In conclusion, we should prevent central banks from reflating markets and creating new bubbles, as this will just generate greater busts than the one experienced recently throughout global stock-exchanges, but this can just be done in one way, which is turning off central banks' printing press, which is usually employed to create false credit and liquidity and introduce them into financial markets. Central banks just incentivize the law of gravity applied to financial assets.