Curious Capitalist

Foroohar: The Government Is Down, So Why Aren’t Stocks?

Why Wall Street isn't panicking—yet

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Spencer Platt / Getty Images

Apparently, markets have nothing to fear but fear itself. Yesterday, they were down in anticipation of the looming government shutdown. But so far today, US stocks are slightly up, and international markets have been mostly holding their own. Japan opened up, with business confidence at its highest level in years. Germany is up a bit too, and London and Paris are holding steady. Part of this is investor disbelief that the shutdown will last very long.

Why? Wall Street exists in a very different world than Washington.  For the last three years, every time the country has weathered a patch of political turmoil, there’s been a “come on, guys, really?” response from the Street as investors hope against hope that the trouble gets sorted out soon.

Even if the current stalemate is resolved quickly, markets are actually telling us something important and surprising—that the foundations of our recovery are weak. Equities have remained relatively strong because the Federal Reserve is artificially keeping them up by continuing its $85 billion a month program of asset buying. Their reasons for doing so are understandable — the Fed has kept the money spigots on, risking market bubbles, in large part because it’s afraid of “fiscal headwinds,” i.e. growth-destroying Beltway ridiculousness. Ben Bernanke may not have any influence on whether Congress can agree to fund the government or raise the debt ceiling, but at least he figures he can help keep stock and home prices higher than they might otherwise be. Other countries, like Japan, have followed suit, with their own massive quantitative easing program, one of the reasons that business confidence is up.

(MORE: Federal Government Begins First Shutdown in 17 Years)

The problem is that the cycle of easing and rising stock prices is slowly breaking down. People simply aren’t buying into the sugar high of this kind of monetary policy anymore, or at least not to the extent that they used to. For proof, look at the gap between stock prices and Gallup poll economic confidence numbers. Then there’s the Fed’s decision not to “taper” off its massive spending spree a couple of weeks ago which only buoyed stocks for a day—it used to keep them up for weeks or even months on end. But each new round of “quantitative easing” does less to goose the market than the round before. “It all shows what a weak and narrow recovery we are in,” says behavioral economist Peter Atwater.

It also shows the schizophrenic nature of our economy. As long as Congress remains dysfunctional, the Fed has to play the role of economic stimulator of last resort, and banks, hedge funds and big money managers have to play along. As Atwater points out, they are now using record levels of debt and leverage to buy up stocks, since the Fed’s money dump keeps interest rates so low. (I’m reminded of former Citigroup CEO Chuck Prince’s infamous line that “as long as the music is playing, you’ve got to get up and dance.”)

But a recovery that’s felt mainly in the financial markets, and is built on the shaky foundations of debt, rather than real job and income growth, is not the sort that you want.