Ben Bernanke was very reassuring. In his post-Fed meeting press conference on June 19, the Fed Chairman spoke of an exit from ‘quantitative easing’ in 2014, but laid down a number of riders: unemployment dropping to 7 per cent, core inflation heading gently upward to close to 2 per cent and GDP growth rising above 3 per cent.

In fact, Bernanke was pretty clear that ‘tapering QE’ was conditional on a distinctly stronger economic recovery.

But we live in a very different era. Financial markets rule. What’s good for the economy is, it seems, not so good for them. So even the limited prospect of better days was enough for a stock market rout, a bond market rout, an emerging market rout, et al .

What’s the story?

The fact is that financial markets live in a world of their own. And on steroids, since the financial sector overtook the profile of the real economy especially in the US in the last two decades and more, with hyperactivity in mergers, acquisitions, private equity, securitisation, commodity financialisation, and derivatives.

The steroids are supplied by central banks. Not wantonly. They had no choice. To stimulate economic activity, interest rates were cut to near zero levels. Simple, naïve faith in the ‘transmission mechanism’.

Falling inflation emboldened central bank aggression. The more they cut, the better behaved was inflation, Japan being the classic case of a country with both zero interest rates and zero inflation.

Who was best positioned to take advantage of the Fed promise of prolonged zero rates? Not industry and business, as it intended, but financial market players. The former depend on demand for their products and services but the latter can manufacture the products and demand themselves using the services of their kindly central bank which gave them all the money needed free of cost.

This juices up returns from financial assets no end. The biggest beneficiaries were banks, hedge funds and the wealthy, who leveraged their portfolios by borrowing directly or indirectly from central banks at no cost and made spectacular profits in whatever asset classes they were engaged in.

It’s these players who are now quickly heading for the exits, even as there are mentions of QE exits. The wave of selling engulfing markets is understandable. Unwittingly, central banks have ended up subsidising carry trades instead of job creating businesses. ‘A fool is born every minute’ has much to commend for itself when applied to them.

The funny thing is Bernanke knows he’s being taken for a ride, but is helpless. The price of the modest improvement in the US economy is vast profits for financial market players.

Those who object to the stimulus of government spending might chew on this.

(The author is a Chennai-based financial consultant.)

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