Easy money policies by global central banks are creating major price distortions in the global economy.
In the social sphere, by elevating asset prices and reducing the affordability of many things, they contribute to the widening income divide between rich and poor.
Such policies, benefit the profligate at the expense of the thrifty.
Corporate Zombies
In the marketplace, easy money has kept struggling businesses alive and has contributed to deflation, the very thing central bankers say they are fighting.
These corporate zombies continue to produce redundant stuff, creating a an excess supply of things.
Stocks moving in tandem—to an unprecedented degree—is another consequence.
This means most boats have risen with the tide, giving rise to the popularity of index investing although that strategy still doesn’t guard against oss.
For example, an indexing strategy based on the S&P 500 Index generated no returns whatsoever for the decade ending in 2010, according to my research.
Scarface Treatment
In parts of Europe, where negative interest rates hold sway, bankers treat everyone like the gangster in the movie Scarface: depositors must pay bankers for holding their funds.
Betting that deflation will become entrenched, European Institutional investors are buying bonds guaranteed to lose money, at least in nominal terms. They then hope to make money in real terms.
Money Illusion
It adds up to a grand money illusion. That’s the tendency people have to feel richer, or poorer, without considering the inflation or deflation rate.
Most of us have only experienced inflation. But it is now possible we are in deflationary times. Generally lower prices for everything is not necessarily good, or bad. It is just different.
In the US, stocks have only been more expensive twice before: in 1929 and 1999. Bonds have never been more expensive, at least since good record keeping started in 1694.
Inflated Land Prices
Investment real estate, so sensitive to the level of interest rates, is equally over-valued. The recent collapse in oil prices, predicted by virtually no one, reminds us that commodities are not investments but speculations.
Market chatter today is consumed by talk of potential interest rate hikes. In the US, we may move from ZIRP (Zero Interest Rate Policy), to LIRP (a Low Interest Rate environment).
As an investor, if you spend more than a passing moment worrying about interest rates rising, you are either over-levered or you own things that are too risky.
Case for Stocks
Easy money is probably here to stay and this continues to be a positive for the “only game in town,” the stock market.
Easy money helps stocks in many ways including the following three:
Ø Investors are willing to pay more for earnings.
Ø The income they produce competes favorably with bond rates.
Ø Companies can issue debt and buy back stock because low interest rates make the math work.
Buyback Mania
The corporate demand for stocks is massive. In aggregate, last year Corporate America issued roughly $600 billion of debt to buy back roughly $567 billion of its own shares.
That represents nearly 3% of the value of all publicly traded companies.
How does all this play out over the next couple of years? It’s anyone’s guess, but a bigger bubble in the U.S. followed by a bad ending is not out of the question.
Right now my thoughts are focused on how to protect ourselves in this economy while still trying to make money.
Photo Credit: Gianluca Ramahol Misiti via Flickr Creative Commons
