When the Japanese stock market lost more than six percent of its value on Wednesday in a massive sell-off, pundits jumped on the move to try to explain what happened, and what it all means. Evan Lucas, a market strategist at IG Markets, wrote:
The storm clouds are building: the Dow has just suffered its first three-day losing streak for the year, the Chicago VIX [fear] index has climbed further; Europe is sliding off its highs; China is slowing down faster than expected, and the BOJ [Bank of Japan] is holding [off] on additional stimulus action.
Hans Goetti, chief investment officer at Finaport, explained why:
We've been living in an environment where economically speaking, bad news was good news because bad news meant more monetary stimulus. The rally that we have had over the past one-and-a-half years has been mainly driven by central banks and now the punch bowl is about to be taken away.
Two analogies are often used to describe the actions of the Federal Reserve in the United States as well as other central banks around the world: the punch bowl, and the drug addict. Each is helpful in explaining the addictive nature of easy money (or alcohol or drugs) and the inevitable withdrawal that takes place when the stimulus is removed.
According to Austrian school business cycle theory these declines in markets are the inevitable consequences of an expanding money supply, sold as the answer to fighting a recession. Low interest rates, Keynesians believe, help to stimulate borrowing and investment which works to reverse the economic downtrend and get things moving again. There are numerous flaws in this theory, including not knowing just how much new money needs to be printed, or when to stop. The problem is simple: Central bankers don’t know the answer to either question and as a result are unprepared for the consequences, or even to recognize them while they are occurring.
Click here to read the entire article.