Forget Supply And Demand, Trade The Central Banks
Does supply and demand even matter any longer? Just think about it for a minute, it is really the central bank's policy that really moves the market. Just look at Alcoa (NYSE:AA) today, the company missed its earnings estimate and the stock is still inflating higher after the Chinese government basically said that they will push investors to buy stocks. This stuff can't be made up. This action by the Chinese government comes as the Shanghai Index was plummeting throughout most of 2011. Last night, the Shanghai Index rallied higher by nearly 3.0 percent, this important stock index has rallied higher by more than 5.0 percent in two trading days. The point is that the central banks can move the markets almost at will.
The central bank that controls the monetary policy of the United States is called The Federal Reserve. In late 2008 this central bank initiated a massive bond purchasing programs called quantitative easing. That has helped to inflate and revive stock and commodity prices over the past three years. It is important to note that the key overnight bank lending rate called the federal funds rate has been held at zero percent since December 2008. That means that the large financial institutions such as J.P. Morgan Chase & Co (NYSE:JPM), Wells Fargo & Co (NYSE:WFC), Bank of America Corp (NYSE:BAC), and Citigroup Inc (NYSE:C) can borrow money at zero percent. Who would not like to have free money available to them? These banks can buy stocks, bonds, commodities, and even operate a high interest rate credit card business. This low rate is the reason why interest rates on a savings account are so low. Once again, the central banks move the markets and supply and demand is having less and less effect.
The European Central Bank (ECB) has now created a new lending facility for the struggling and European banks. The ECB is now lending the banks money at 1.00 percent for three years. This is another way to help keep these banks afloat. Once again, failure has been avoided by throwing more capital (money) at the problem.
On the surface it seems that the central banks could simply just keep artificially inflating the markets. The problem with this method is that it creates inflation. This morning, the price of light sweet crude is around $103.00 a barrel. Food prices soared sharply higher around the world in 2010 after the Federal Reserve implemented its $600 billion quantitative easing program. Simply put, inflation is created by all of this easy money creation. Perhaps this is the trade off that the central banks believe we all need in order to have a functioning economic system.
The one thing we must always remember is that for every action there is an equal but opposite reaction. For the time being, we shall enjoy the inflation rally. In my opinion, these days it seems that it is better to forget supply and demand and actually trade the action by the central banks around the world.