The End of the Era of Easy Money

Writing in the New York Times Peter Goodman offers a cogent analysis of what is going on with the stock markets. He explains that it’s about how central banks have been juicing the world’s economies by keeping interest rates low. And about how these same bankers are changing their policies.

This tells us that the banks were the agents of the economic recovery that the world enjoyed over the last ten years. Artificially low interest rates flooded the world with cheap money and the world threw a big party.

Now the party is over, or it looks as though it is over. This has made the markets more volatile and more risky.

I will allow Goodman to explain it:

A decade-long era of easy access to money engineered by central banks in Asia, Europe and the United States was ending, opening a new chapter in which corporations would have to pay more to borrow and ordinary people would have to pay more to finance homes, cars and other purchases.

To digest the wild swings in stocks and bonds from New York to London to Tokyo is to absorb this uncomfortable realization taking hold.

Investors concluded that interest rates would rise faster than they had anticipated, almost certainly in the United States, and perhaps eventually in Europe and Asia, too. They yanked their treasure out of stocks and entrusted it to safer repositories of wealth like bonds and cash.

As it happened, the problem was created by the strength of the American economy and the increase in hourly wages. Dare I say, it is not self-evident, but it seems plausible. A strong economy increases the demand for labor. This causes wages to increase. Higher wages means a greater inflation risk.

Ergo:

The fear that seized the United States was the spawn of good times. As the feeling sank in that stock trading was governed by a surplus of exuberance, the odds increased that the Federal Reserve would dampen the festivities by lifting interest rates faster than policymakers had previously telegraphed.

Not for nothing, central banks are seen by investors as crucial yet fun-averse grown-ups charged with solemnly watching for trouble. When crises emerge, they make money available to spur commerce while keeping terror at bay. The global economic expansion underway now is in large part a product of the Fed’s swiftly unleashing an overwhelming surge of credit after the start of the financial crisis in 2008, combined with the slower yet, eventually, effective torrent of cash delivered by the European Central Bank.

But when the party gets raging — when economies accelerate and stock prices ascend to levels out of whack with fundamentals — central bankers play killjoy, lifting interest rates to snuff out attendant dangers.

Higher rates diminish speculation that can end badly by making credit more expensive. They slow economic growth while making stocks less appealing, because corporations must pay more to keep up with their debts. Investors can make more just by keeping their holdings in cash or bonds, rather than by accepting the higher risk of stocks.

But the increase in wages for American workers meant something else. It was a flashing warning to investors about potential inflation, or rising prices, which have crippled many economies. The Fed, always vigilant, wields a standard tool for snuffing out inflation if necessary: higher interest rates.

This is how a positive jobs report, presumably a sign of a strengthening American economy, wound up as the impetus for the dumping of stocks from Taipei to Toronto. It enhanced the likelihood that the Fed would raise rates faster. It prompted investors to wonder how long the European Central Bank could maintain its own ultralow rates.

The interesting part of this, for those of who are not well-enough informed to grasp these issues, is that our nation now has twice as much debt as it had in 2008. Double the debt does not necessarily mean double the fun. At least, not for very long.

Of course, there are two obvious ways to deal with that much debt. We can inflate the currency or we can default on our obligations. If inflation is the more politically viable option, why are we assuming that the central bankers are trying to fight inflation?

In such subjects, I am a mere novice. Better informed voices are welcome.