Tuesday, 27 October 2015

Here Comes Another Round of Easy Money

Guest post by the Casey Daily Dispatch 

China’s central bank is cutting interest rates again.

On Friday, the People’s Bank of China (PBOC), China’s central bank, cut its key one-year lending rate from 4.6% to 4.35%. The PBOC also cut its one-year deposit rate from 1.75% to a record low of 1.50%.

As you can see in the chart below, China’s central bank has now cut rates six times since last November.

The People’s Bank of China hopes low rates will boost China’s economy [how? somehow], which grew at its slowest annual pace in twenty-five years last year.

To make matters worse, the Chinese stock market is also coming off its worst quarter in seven years. The Shanghai Stock Exchange fell 28% in the third quarter.

Friday’s rate cut happened just days after the National Bureau of Statistics said China’s economy had only grown 6.9% during the third quarter. This was China’s slowest quarterly growth since 2009.

•  Major central banks like the PBOC have been cutting rates since the last financial crisis...

This summer, Forbes reported that “nearly 90% of the industrialised world economy is presently anchored by zero rates.”

The Federal Reserve has held its key rate at effectively zero since December 2008. The European Central Bank (ECB) dropped its key rate to effectively zero last September.

Easy money has allowed people to borrow trillions of dollars to buy things like houses…cars…college degrees…and stocks. It’s also helped businesses borrow billions of dollars to buy up competitors. Record low rates have pumped up the prices of everything, from govt bonds in Europe to houses in Auckland.

•  Record low rates have also created a powerful bull market in U.S. stocks…

The S&P 500 has gained 211% since bottoming in March 2009 during the financial crisis. U.S. stocks are now 49% more expensive than their historical average.

Today, cheap money has made almost everything expensive.

Yet, low rates have done little to help the “real” economy. The real median annual income in the United States has dropped from $57,795 in 2008 to $55,218 today.

•  Like the PBOC, the European Central Bank has also been using easy money policies to fight a slowing economy…

On Thursday, ECB president Mario Draghi said:

We are ready to act if needed, we are open to a whole menu of monetary policy instruments...
The degree of monetary policy accommodation will need to be re-examined at our December policy meeting when the new…projections will be available.

That’s central-bank-speak for “we’re prepared to print as much money as necessary.”

Last March, the ECB launched its first quantitative easing (QE) program. QE is when a central bank creates money from nothing and injects it into the financial system. It’s basically another word for money printing.

The ECB’s current QE program already injects €60 billion ($67 billion) into the eurozone’s financial system every month. It’s supposed to run “at least until September 2016.”

By that point, it will have injected at least €1.14 trillion into Europe’s financial system. And possibly much more, if the ECB decides to increase QE at its December meeting, as Draghi hinted it would.

•  European stocks rallied the day after Draghi’s announcement…

The STOXX Europe 600 Index, which tracks 600 of Europe’s largest stocks, closed Friday up 2.2%.

Chinese stocks also rallied after China’s central bank announced its surprise rate cut. The Shanghai Composite Index closed Friday up 1.3%.

Even U.S. stocks rallied. The S&P 500 closed Friday up 1.1%...

•  QE and other easy money policies often give stocks a boost…

But easy money is like a drug for the financial system. And like any drug, it loses its potency over time. The markets end up needing bigger injections just to keep from falling apart.

At some point, easy money won’t work at all. That’s when investors will realize they’ve been living in an “Alice in Wonderland” economy. Years of bad investments will unravel, taking down the price of everything from stocks to bonds to real estate.

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