Despite Emperor Trump’s endless proclamations regarding the renewed health of the US economy, I fear we are on the edge of a great big cliff. Believe me. We may have already begun to slip.
When we fall off the edge, stock markets will crash, companies will default on their debt (especially in Southern Europe). Company pensions will go unpaid, the housing market will take a bath, swathes of people will be laid off, and to top it all off, prices of everything - from food to electricity - will skyrocket. Worse yet, governments won’t be able to do much about it as they’ll be going bust at the same time.
And the most amazing thing of all? Trump might have called it back in 2016 during the election campaign, before completely reversing his tune and becoming a cheerleader to financial markets soaring to evermore ridiculous heights.
Got your attention? Good. Then let me explain.
Since 2008, central banks all over the world have been printing money like billy-ho, as part of a policy they call quantitative easing, or ‘QE’. As any central banker can tell you, the danger of doing this is inflation - i.e. prices for everything going up. This is because, when you print more money without making more goods, the amount of money you need to swap for a good (i.e. the price) goes up.
Why are they doing this, you ask? The short over-simplified answer is ‘cos some dead economist once believed doing this would ‘stimulate’ the economy, which is what politicians wanted back in 2008. The issue is that once they started, they realised that there’d be hell to pay if they stopped… so they kept going. They kept drinking to delay the hangover.
Anyway, central bankers have been doing this - and yet, we haven’t seen any inflation! Weird, right? It’s certainly something that’s been puzzling lots of central bankers!
But here’s the thing. Because of the way the QE policy worked - rather than printing money to give it to regular people, they printed money and used it to buy government bonds from banks and insurance companies, many of whom are legally obliged to buy these bonds from the government in the first place. As a result, all of that money hasn’t ended up in the market for goods. Instead, it stuck around in the market for assets. And we have been seeing inflation there. Massive inflation! I won’t bore you with the details, but CAPE, which is a common metric used by investors to assess the price of the stock market, is currently higher than it was before the 1929 Wall Street crash, which caused the Great Depression.
I mean, think - what is the market for assets? It’s the market for houses, for stocks, for government debt, for corporate debt, for nice bottles of vintage wine, or for paintings. And all of these markets have been booming since 2008. Assets have in fact gotten so expensive that investment professionals are struggling to find anything that does not seem overvalued.
Now, there’s a lot of debate about why investment markets have been getting so expensive. The answer is QE. When central banks start using new money to buy government debt, they add that new money on top of all the pre-existing money that people were willing to lend to governments. And when the number of people willing to lend to a government by buying its bonds goes up, the interest rate the government has to pay on that debt goes down.
Now, other than being great news for governments, this also meant that people who wanted to get a particular interest rate on their investments started to have to look for other people to lend money to - they just couldn’t get the interest rate they needed from lending to governments any more. What people are these? Well, banks who have promised people interest rates on their current accounts, for example, or pension funds who have promised workers a set pension after retirement.
So these people started lending their money elsewhere, to companies. Only, as the banks kept printing, more and more people started lending money to companies by buying their bonds, until the interest rate there also became too low. And so then they had to go further afield. Everytime reaching for riskier investments. They bought houses, they bought stakes in companies, they set up venture capital firms. They put their money anywhere they could find that looked like it would make them enough money to pay off their pensioners.
And then what happened? Well, when lots of people start investing in companies or buying bonds, the prices of the stakes in those companies (the shares) and the prices of those bonds start to rise. People start to think “well, I can’t get a good interest rate lending to this business, but hey, the central bank is going to keep printing money, and so next year someone else will want this crap interest rate even more, and so I’ll just make my money selling it on to them”. At that point, people stop buying shares and bonds because they like what they’re buying - that is, because they think the interest rate (or ‘yield’) they’re getting is good - and start buying because they think it doesn’t matter, as someone else will turn up and give them a better price for it tomorrow. Also, as mentioned above, many large institutional buyers don’t even have this luxury. They have to buy this crap, no matter the price and no matter the yield.
And the thing is, as long as the central bank keeps printing money and no-one falls off the roundabout, they’re right. It’s like a Ponzi Scheme - as long as it keeps growing and no-one sounds the alarm, it just gets better and better. I think the technical term for this is a ‘bubble’.
But if history tells us one thing, and if our very own Julien Delacroix III agrees with anything in said history, it’s that bubbles pop. As the economic situation of countries around the world seems to improve, central bankers are increasing interest rates and slowing down (in Europe) or stopping (in the US) further purchase of assets, meaning that suddenly investors can no longer hope to shove their worthless piece of paper to the next dummy willing to buy it at an even more ridiculous price. At that point, people start falling off the speeding roundabout. At that point, if you can’t sell your bonds for more than you paid for them, you have to live with its yield, or interest rate. This is something that investors could ignore so long as the bubble was growing, but no longer.
When people realise how little money they can make from their investment going forward, many will sell, as is happening currently in the market that was most affected by QE in the first place: government debt. Eventually, as it happened on the way up, this sell-off will extend to corporate debt, stocks, housing, and yes bottles of wine (which I guess is the silver lining here). The result will be a widespread collapse in the value of financial markets, which I look forward to Trump blaming on the Chinese.
The hurt does not stop there. As investors cash out, all that money will leave the market for assets and come into the market for goods. In other words, if people are no longer investing their money, they will use at least some of it to buy stuff. If you massively increase the amount of money that people want to spend on goods, but there aren’t any more goods to buy, then clearly, prices will have to go up. In other words, inflation. Lots of inflation.
Ironically, central banks have a responsibility to control inflation - it’s written into their constitutions. So when the inflation they have created in the market for assets is unleashed upon the market for stuff, they will have to stop printing money and start raising interest rates. The alternative, which is even more palatable in the long run but attractive in the short run, would be to start printing money like crazy again. That would bring us right back to what caused this whole mess in the first place and keep a lid on things for a few more years. But that is not what seems to be happening as central banks, especially in the US, are planning to further increase interest rates. And that is when the real nastiness starts.
As interest rates rise, many businesses, especially in Southern Europe, that have borrowed money when times were good and loans were really cheap, and many people with shaky finances who have borrowed to buy an overpriced house will struggle to pay back their debt, leading to bankruptcies. These companies will go out of business and these individuals will have their home taken away from them, just as the price of everything explodes.
Clearly, I can’t tell you how bad this will be. Another 2008? Worse than 1929? Who knows. Nor does anybody know when this will happen. What we know is that central bankers have caused massive inflation in the market for assets and that as they stop printing money, people will realise how crap these investments are, thus selling their paperwealth to buy more stuff, causing inflation and eventually bankruptcies.
And remember, Trump called it. Before he forgot.
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