Wall Street 'Love' of QE Is An Obnoxious Myth

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It's accepted wisdom within the commentariat - both right and left - that Wall Street loves ‘easy money.' To believe what one reads is to accept the view that financial institutions thrive when interest rates are artificially low and money is being corrupted through the creation of it for the sake of creating it.

What's funny about this broadly held view is that it's the equivalent of saying those in the market to rent apartments love rent control. In reality, rent control is bad for those who seek shelter given the simple truth that the very notion of artificially cheap rents speaks to apartment scarcity.  It's possible renters do love the idea of rent control despite it being inimical to good rent outcomes, and just the same it should be said that even if it's true that ‘Wall Street' loves easy money, this purported love is surely inimical to its health.

If this is doubted we need only consider what most animates Wall Street. Specifically, Wall Street is healthiest when stock markets are booming. To deny this is willful blindness, at which point it must be remembered that stock markets were in the best shape when short rates for credit wrongly set by the Fed were at the very least less artificially low during the ‘80s and ‘90s. From 1983 to the late ‘90s rates were far more normal, the dollar's value in terms of gold was far more stable, and stocks soared alongside the economy as logic dictates.

Much as conspiracy theorists and class warriors want it to be otherwise, Wall Street is healthiest when the dollar is stable, interest rates as much as possible under the fatal conceit that is the Fed are normal, and investment bankers, traders and money managers are as rationally as possible allocating capital. To be clear, the interests of Wall Street and Main Street are very much aligned.

They are because profits and hiring in finance are greatest when investment bankers are finding capital for companies seeking to float their shares, and merging companies that would do best for combining their operations with others. Traders are at their very best when they're providing liquidity to shareholders and institutions who can only be exposed to companies insofar as traders exist to provide an exit out of or ‘in' to shares, and then money managers do best when they're investing client capital in companies bolstered by rising investor optimism. The scenario just described was most prevalent in the ‘80s and ‘90s when the dollar was strong and mostly stable, and the Fed less interventionist than normal in terms of targeting a short rate for credit.

Conversely, Wall Street was very unhealthy in the ‘70s when U.S. commitment to a strong and stable dollar was near non-existent. The S&P during the ‘70s was so flat that by the early ‘80s there was talk (remember the famous Business Week cover?) of an ‘end' to equities. Much the same, commitment to a strong dollar was similarly dismissed in 2001 with predictable results. Though markets have revealed better health over the past year, stocks remain for the most part at levels reached 13 years ago. To put it plainly, markets do best when the dollar is strong and the Fed less interventionist as the ‘80s and ‘90s attest, and then markets are at their worst - and Wall Street least well - when the dollar is cheapened alongside excessive central bank involvement in the economy as the ‘70s and the ‘00s reveal.

None of this should surprise anyone. It's a constant theme in this column, but it can't be stressed enough that when investors commit capital to equities and debt, they are tautologically buying future dollar income streams. Given the latter truth, it's only natural that Wall Street would be most profitable under a stable dollar that lures investors into the marketplace; the latter driving enormous amounts of work for investment bankers, traders and money managers.

Notable here is that there is empirical evidence backing that which makes intuitive sense. Nicole Gelinas of the Manhattan Institute observed back in April that Wall Street staffing levels are at 1997 levels. More recently Wall Street bellweather Goldman Sachs reported quarterly earnings that were down 70%. Just yesterday USA Today reported that "Financial firms are cutting tens of thousands of jobs because of a slowdown in the mortgage business, the sluggish economy, the growth of online banking and new regulations."

The story only gets worse. As is well known, the vast majority of Wall Street pay comes in year-end bonuses. But as John Aidan Byrne reported in Sunday's New York Post, bonuses for "shell-shocked traders, bankers and investment staff" are expected to decline as much as 20% compared to one year ago. It's popular in the commentariat to suggest that Wall Street firms have thrived based on a ‘carry trade' that allows them to borrow cheaply only to buy Treasuries that yield nominally more than the cost of credit, but even if true, such a trade is hardly the stuff of large bonuses. Better it would be for financial firms if rates were normal and the economy booming such that prosaic uses of capital were in the rear-view mirror in favor of the IPOs, mergers, block trades and investment fees that truly drive profits, bonuses, and hiring.

Looking ahead, and markets always look ahead, Ben Bernanke's departure from the Fed is a positive dollar event. And while Janet Yellen is said to be even more of a QE fanatic than is Bernanke, the happy truth is that the infantilization of money that is QE is even losing stalwarts inside the Fed. What this foretells is that Yellen will not have the power to wreck the economy that her predecessor did, this is already reflected in the dollar, so it's no surprise that IPOs and other useful economic activity from finance are on the uptick. Good.

Needless to say, ‘easy' credit and dollar devaluation are hardly good for Wall Street just as a weak dollar was hardly good for the U.S. automakers despite clamoring from those same automakers (their collapse amid the weak dollar was not coincidental) for devaluation. Even if Wall Street's leading lights beg for low rates and devaluation, the fact that Wall Street is in terrible shape as its leading companies toil under the thumb of government signals the greater truth about what makes it healthy.

To make simple what is, the U.S. economy does best when the dollar has a stable definition and interest rates are set by actual markets. This is also what's best for Wall Street as evidenced by its much greater health during the ‘80s and ‘90s when this potent brew for amazing growth most prevailed. In short, the conspiracy theorists and class warriors are wrong. Wall Street and Main Street do best when both are thriving.

 

John Tamny is editor of RealClearMarkets, Political Economy editor at Forbes, a Senior Fellow in Economics at Reason Foundation, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He's the author of Who Needs the Fed?: What Taylor Swift, Uber and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank (Encounter Books, 2016), along with Popular Economics: What the Rolling Stones, Downton Abbey, and LeBron James Can Teach You About Economics (Regnery, 2015). 

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