Wednesday, February 7, 2018

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.


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.


Redacted said...

Personally, I expect a correction in leisure travel stocks and brewers/distillers/luxury goods if the Republican student loan legislation is enacted into law.

David Kelly, JP Morgan's chief global strategist, sees a more hawkish Fed with Powell's ascendance to the Chair and replacements on the Board of Governors. I see no reason to doubt that assessment. 'Bout time to end the helicopter loads of Obamabucks, IMO. Besides, tbe Iranians were paid in cash so we're square.

Ares Olympus said...

It seems even the economists are novices in the "dismal science", and more wicked a problem than climate change, but this predicament has been known since they started QE and low borrowing rates to stimulate economic activity.

And even Donald Trump was in on the scam when he accused the Federal Reserve of keeping interest rates low to help the Democrats win the presidency.
Of course when he was elected under promises of lower regulations, lower taxes, and higher debts, he happily took responsibility for the ever growing "Net household wealth"

Stuart: ...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?

That's my understanding. Trump tried promoting the default approach, being an experts on negotiating with creditors when his businesses went bad.

But overall I think the strategy is "race to the bottom" and "last economy standing." And in this game the U.S. has a huge advantage as the world's currency of trade. And that's why we NEED to keep a high trade deficit, because the world has a huge appetite for dollars, at least as long as global trade keeps increasing.

To me this means Trump is a LOSER when he suggests other countries are taking advantage of the U.S. in their trade deals with us. How do you take advantage of someone who pays for things with IOUs? They're the ones taking the risk that we won't be good for it.

I don't know if the "Era of Easy Money" is ending, except in the sense that this round had to end, while we can't afford to stop it. David Stockman can't go wrong by calling it all a failure, if we can unwind.

OTOH, the Republicans claimed inflation would explode if the government borrowed more money back in 2009, but Krugman is right so far, inflation is only happening in assets - real estate and stocks, but thanks to imports, consumables (imported from China and elsewhere) keep the cost of living sort of inflation low.

A falling dollar index is a sort of "slow default" against foreign creditors and it has fallen 15% since Trump took office, while its been strong since mid-2014. A weaker dollar is another way that we can screw foreigners who hold our dollars, but the cost is out imports will go up, which will raise regular inflation.

I also recall Martin Armstrong says the "Elites" use war to create inflation, but I don't get the logic, and he seemed wrong on his Oct 2015 "Sovereign debt big bang" date.

Oh, and there was talk of "negative interest rates" in the next crisis which makes sense in some mathematical universe I don't understand, where your bank would start charging you for holding your money. But first they have to get rid of the paper cash I guess!?

Bizzy Brain said...

I favor default. It will piss off a lot of people, but we will not be saddled with a punishing debt. Then maybe investors will think twice about buying our bonds and financing our wild spending sprees. It will necessitate a much needed frugality in the area of government spending. OTH, many times after a person declares bankruptcy, creditors are there to offer new credit because the bankrupt individual is not saddled with debt and can afford to incur new debt.

Illuninati said...

There is a serious problem with the article. In this environment cash is king. Investing in bonds when interest rates are rising is much more risky than investing in stocks. Long term government bonds could lose 30% or more of their value in the next year or two. This risk shows up more in bond funds than for those who own individual bonds since the bond funds are prices every day so that the investors can see real time what is happening to the investment.

Ares Olympus said...

Jim Rickards is a consistent doomer and gold bug, but he just covered the predicaments of unwinding QE, now 8 years too late apparently.

He say the expansion of the money supply (via QE and government debt) hasn't gone into core inflation but asset inflation. And so as the central banks try to start selling financial assets, rather than an increasing money supply, the money supply will be decreasing, and with that the "asset bubble" must deflate, as big investors reduce their own debt as well, due to increasing costs for borrowing.

This will not be a soft landing. The central banks — especially the U.S. Fed, first under Ben Bernanke and later under Janet Yellen — repeated Alan Greenspan’s blunder from 2005–06. Greenspan left rates too low for too long and got a monstrous bubble in residential real estate that led the financial world to the brink of total collapse in 2008.

Bernanke and Yellen also left rates too low for too long. They should have started rate and balance sheet normalization in 2010 at the early stages of the current expansion when the economy could have borne it. They didn’t. Bernanke and Yellen ... got an “everything bubble.” In the fullness of time, this will be viewed as the greatest blunder in the history of central banking.

This conundrum of how central banks unwind easy money without causing a recession (or worse) is just one small part of a risky mosaic. For now, think of 2018 as the year of living dangerously. Smart investors should prepare now with reduced exposure to stocks.

It makes sense that this is the time for individuals, especially if you're approaching retirement is to divest (buy low, sell high), and pay off debt. But if you still have "winnings" there's still no way to know where when will be the bottom of a bear market, or what the Fed can or will do about it.

But others say we can still have Dow 30,000 (when the Fed chickens out again?), so why not keep gambling while we've given Wall street all the keys to the government? It's not like insiders know how to time their exit better than the rest of us, right?

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