Midterm elections: bull market friend or foe?
Early voting has already started, but the majority of the US go to the polls tomorrow for the...
You know something is not quite right when Japan, one of the most indebted countries in the world, and one which some argue is in danger of going bust, is able to borrow money for 30 years with an annual coupon of 0.15%. It’s strange times in the world of investing and things are only getting stranger.
Rather than returning to ‘normal’, after eight years of ’emergency’ low levels, interest rates all over the developed world are instead turning negative. You now have to pay the German government for the privilege of lending them your money for the next ten years!
Is this right? Is it rational? No. Bond markets, like stock markets, have been artificially distorted by central banks, which have engaged in quantitative easing (QE). Fundamental analysis has become irrelevant.
The trouble is that, whilst QE has arguably stopped the world economy from coming to a grinding halt, it hasn’t exactly been successful in generating growth and inflation – at least in any meaningful amount. The plan of QE was to flood the market with liquidity and drive down borrowing costs to encourage borrowing, thereby boosting investment and growth. It simply hasn’t happened.
In terms of QE, Japan is ahead of the rest of the developed world. They first attempted it 15 years ago and have really upped the ante in the past three years, throwing everything they can at the problem. To put it into context, roughly 10 times the amount of money has been pumped into the system as in the US, and the economy is a third of the size. They have now imposed negative interest rates. Yet growth is flat, because the banks have no one left to lend to.
Having gone so far down the path of QE, they (and for that matter other central banks) have little option but to take this experiment one step further. Debt to GDP is 229%. With Japan’s low growth economy, ageing demographics and minimal immigration levels, there is little to no hope of paying this off.
It’s a similar situation with eurozone countries like Italy, which also has huge levels of debt. Deflationary forces, which are coming out of China, and the new digital economy are pushing prices down, which is only making this debt more onerous.
Something has to give. The debt can’t be paid off, so there’s only one way to get rid of it and that’s through inflation. QE was supposed to help with this but it hasn’t because banks have been either unable or unwilling to lend. It now seems inevitable that central banks will have to try ‘helicopter money’ in some form to generate inflation to deal with the debt. We don’t know exactly what form helicopter money will take. It might be used to invest in infrastructure, or it could be used to give everyone a tax break.
Helicopter money has two very important differences to QE. Firstly, it will bypass the high street banks and direct money straight into the economy. Secondly, it is permanent and irreversible. This is a crucial point. With QE, a central bank creates money but they then buy an asset, usually a government bond. If the central bank wants to reduce the money supply again, all it has to do is sell the government bond back and then destroy the money it had previously created. So QE is reversible and controllable. If you give everyone a tax break with helicopter money, that is not reversible, it is permanent.
It’s also quite possible helicopter money could get out of control and create hyper inflation. This is the reason it was dismissed as a strategy for many years. But now it looks like the last resort, as everything else has failed.