The era of easy money is over. That’s no bad thing
Since the crash ten years ago, stock markets the world over have been steadily recovering. The Dow Jones, a bellwether index, has enjoyed double-digit growth in five of the past ten years and soared by 25 per cent last year — credit for which, inevitably, has been claimed by Donald Trump. ‘The reason our stock market is so successful is because of me,’ he said on board Air Force One a few weeks ago. ‘I’ve always been great with money.’
We should not expect him to repeat this point any time soon. Earlier this week, the Dow suffered its worst fall in six years, losing 4.6 per cent in a single day and triggering a sell-off around the world. It went on to recover, but the loss — it was down by 1,175 points at one point, the largest drop in its history — was a lesson for everyone. Something fairly important has changed: the days of surefire gains are probably over. The benign financial environment of recent years has gone. The VIX index, a measure of market volatility, on Monday registered its biggest daily spike on record. There have been periods during this sell-off when shares, government bonds and gold have dropped simultaneously, signifying indiscriminate, across-the-board liquidation.
But this was not really a crash: markets worldwide are still far higher than they were two months ago. The dip on Tuesday was as nothing compared with Black Monday in 1987, when the Dow lost a quarter of its value in a few days. And the market is not a barometer of the economy. There was no banking collapse, no terrorist-driven panic, no geopolitical disaster. This was a good old-fashioned market–driven change in valuations, after a bull run. In fact, it may well be that the world economy is finally moving on from the 2008 crisis, escaping the doldrums of its long aftermath.
Crucially, last week’s sell-off was sparked by good economic news. It emerged that wages for the average American worker had grown by 2.9 per cent during the year to January — the fastest rate since the recession. It seemed to fit a trend: American unemployment rates were even lower than those of Britain, and when workers are harder to find, they have bargaining power. Strikingly, the strongest wage growth was enjoyed by less-educated workers. As the Cleveland Federal Bank put it, companies are having to do more to attract such workers, ‘raising wages and creating career paths’.
This is a reversal of the trend in recent years. It was a sign — no more than that — of blue-collar workers asserting themselves. And a hope that after a 17-year low, the benefits of rising labour demand were making their way into workers’ pockets.
The American economy matters here because markets around the world take their lead from the US. Global stock prices have long relied on a core assumption: that US inflation will remain low. That, in turn, allows the Federal Reserve to keep interest rates low. The challenge now is for central bankers to tiptoe back to normality, raising interest rates without spooking markets. Janet Yellen, the outgoing Fed boss, has handled this deftly, raising rates in five baby steps from 0.25 per cent to 1.5 per cent — without sparking a crash. Handing over to Trump-appointee Jay Powell, Yellen left the markets expecting another rise next month.
But now, if average workers are finally being paid more, there’s the prospect of inflation rising, and higher interest rates to counter it. That pushes up bond yields, which makes equities less attractive while raising general borrowing costs. After a decade of ultra-cheap money, this comes as a shock. The reality is, though, that ultra-loose monetary policy has long been counterproductive, and should have been done away with years ago. What is a shock for the markets is overdue good news for the rest of the economy.
After the Lehman crisis, low rates and quantitative easing were needed. Had the world’s leading central banks not provided emergency liquidity back in 2008, the global economy would have faced meltdown. Payment systems would have failed, sparking panic, economic torpor and civil unrest. But what started as a short-term emergency painkiller then morphed into a prolonged monetary coma.
When the US Federal Reserve began QE in November 2008, it was billed as a $600 billion programme. The Bank of England, five months later, announced £50 billion of QE. Eurozone policy bosses, meanwhile, dismissing the sub-prime crisis as ‘an Anglo-Saxon problem’, declared the European Central Bank (ECB) wouldn’t use expansionary monetary policy in response to ‘America’s credit crunch’. Then, restraint vanished and the western world’s virtual printing presses have been on overdrive. The Fed implemented six times more QE than envisaged; in the UK it was nine times. The ECB, having shrouded its early QE in technicalities to avoid worrying German voters, has caught up fast. A temporary medicine became, for powerful politicians and financiers, a lifestyle choice.
Ordinary savers have been hammered. With interest rates below inflation, real returns have been negative, with those putting money aside seriously losing out. Rock-bottom annuity rates resulting from the impact of QE have similarly condemned countless retirees to lower pension incomes for the rest of their lives. The resulting asset boom, however, saw stock and property owners becoming much richer. Most voters have had to watch the financiers, having wrecked the economy, get rich all over again — courtesy of the world’s leading central banks. This has been the trademark of western economies now for a decade.
In Britain, the market distortions have been eye-watering. The average house now costs eight times average earnings. Home ownership, especially among the crucial family-forming 25- to 39-year-old age group, has consequently plunged. The Conservatives are now beginning to find out that there is a political price for all of this — a high correlation between those with no property and those who in the election backed Jeremy Corbyn in droves. When Labour took the seat of Kensington and Chelsea, it seemed a mystery. But a look at its home ownership rates offered a clue.
An economy that seems rigged against workers helped fuel unrest everywhere from the right-wing Tea Party in the US to populism in Europe. Former finance minister Wolfgang Schäuble blames ‘ECB money-printing’ for the electoral success of the right-wing nationalist party Alternative für Deutschland. Germany’s historic experience has given particular reason for sensitivity about the wider consequences of government rigging money markets. The German stock market roared in the 1930s.
What seemed like a quick fix, rewarded by high share prices, can have other implications. Ultra-low rates have also kept thousands of ‘zombie’ companies alive, so we have firms able only to pay debt-interest rather than clear actual debts. Around a quarter of a million struggling UK firms are in this situation, kept on life support by unnaturally low rates. Unable to invest and expand, they tie up resources that should be channelled into healthier firms. This helps to explain the low productivity and wages that have cursed the UK economy in the past ten years.
If bond yields are kept artificially low, pension funds will be forced to divert their cash into far riskier financial assets. This risks stoking another boom/bust cycle, driving financial markets too high and making a Lehman-style collapse more likely. And should it happen, what would governments do? The easy money era has seen them all borrow staggering amounts: global debt as a share of economic output is now 40 per cent higher than it was on the eve of the last crash, according to the Bank for International Settlements. The world has tried to borrow its way out of a debt crisis. The result is, as the BIS described, a ‘risky trinity of unusually low productivity growth, unusually high debt levels and unusually limited room for policy manoeuvre.’
The Fed and the Bank of England are beginning to take heed and are no longer using QE. Having raised rates once, the Bank is also gingerly following the Fed’s lead, with markets beginning to price in another increase in May or June. The ECB and Bank of Japan, though, are still boosting their balance sheets, creating the equivalent of tens of billions of dollars of virtual money each month. So QE hasn’t ended, not by a long chalk. And no one knows what will happen when it finally does.
The Dow Jones closed at an all-time high more than 70 times last year — more record closes than during any years in history. It may be that the timing of his recent tax cuts, coming at a time when the US economy was already buoyant, pushed valuations too far. But if overvalued stock and bond markets are to return to earth without a deeply damaging collapse, then a series of smaller corrections will be needed.
A fully blown stock-market crash would have major political implications, of course. The emerging narrative about failing global capitalism in crisis would go into overdrive. With the big emerging giants like China boasting massive financial reserves, and likely to ride out any storm, more power would shift from west to east. And with continental Europe still harbouring a slew of bad bank debt, certainly compared with the US and UK, the eurozone is likely to suffer disproportionately — as it did after 2008. And, like last time, the UK economy would certainly be hit.
The likelihood, though, is that this is not the start of a big crash but instead a soft landing, a necessary downturn in stock prices, part of a process that will mean savers might finally start to be given a return on their bank deposits. Serious market slumps also generally follow a US recession and, for now, Trump’s America looks strong — perhaps a little too strong for the market’s liking. And across the world, there’s a lot of cash waiting on the sidelines, ready to enter the market.
The market upswing of recent years reflects, in part, optimism about the world economy: partly based on technological advances and post-Lehman ‘bounce back’. But much of the rise was due to cronyism, the emergence of cartels, unjustified share buybacks, dividend payments from borrowed money and, above all, QE and absurdly low interest rates. That’s why a falling market — for all the pain of adjustment — shows financial logic, and genuine capitalism is fighting back. And about time too.
10 Feb 2018 )