- Central banks have intentionally inflated asset prices that benefit those who own assets, while wages and real prices have remained equal.
- There’s no case for being a saver. The risks are too high for miserable returns.
- I’ll discuss three options to protect yourself and take advantage of the next quantitative easing rounds.
In the last 10 years, the financial environment has changed significantly. You might not see it in your everyday life, but the 2007 environment and the environment today are hugely different. The wealth effect hasn’t really worked as Central Banks had planned and has significantly skewed asset values compared to fundamentals.
In today’s article, I’ll describe what happened, compare it to what the previous situation was, show who benefited from the significant monetary policy market intrusions, and who will keep benefiting in the future to find ways to take advantage of the situation.
What We Have Created
We all know that global Central Banks have been on a spending spree in the last 8 years. Their balance sheets have more than tripled.
Figure 1: European Central Bank, Bank of Japan, and the FED’s balance sheets. Source: Bloomberg.
The best explanation for the goal behind such monetary easing was given by former FED chair Ben Bernanke:
“Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
So it was clear that Central Banks had the goal to push stocks and bonds higher on the hope that doing so would have a positive effect on consumption, the economy, and inflation.
Well, after 8 years of quantitative easing, and zero and negative interest rates, developed economies are doing ok, but not great, while stocks and bonds have done extremely well. However, inflation is still below target. The FED that has reached a relatively satisfying level of inflation, but the ECB and the BOJ continue with their easing policies.
Einstein used to define insanity as doing the same thing over and over again and expecting different results. We can ask ourselves how much longer central banks will continue with what they’re doing to reach targets that seem elusive.
Nevertheless, monetary policies have created some kind of inflation, but not where those whom Central Banks are supposed to serve can benefit. Thanks to the high levels of liquidity, bonds and stock prices have surged in the last 8 years while real economy prices, like wages, consumer products and commodities, have languished.
As the rich own stocks and bonds, it’s clear who has benefited the most from the loose monetary policies.
Figure 2: Comparison of asset price bubbles and real wage increases. Source: Goldman Sachs.
This clearly has increased inequality amongst those who live in developed countries, and I must say that the manufactured asset bubbles do temporarily make things look better. Eventually, those asset bubbles that have no connection to fundamentals will revert to the actual economic growth trend, which has been terrible in Japan, just turned positive in the EU, and has been acceptable in the U.S. This will lead to even worse consequences than those we experienced in 2009, but what is certain is that at the first sign of trouble, Central Banks are going to put more liquidity into the system. This allows us to look for ways to take advantage of what’s going on and will probably continue to go on as the real economy hasn’t really seen many benefits from inflated asset prices.
What Will Happen In The Future & How To Take Advantage
All Central Banks and politicians know to do is to put more money into the system. Therefore, we can expect that at the first sign of economic trouble, there will be more quantitative easing.
There are two scenarios we have to look at. The first scenario is similar to the last 8 years with low interest rates, quantitative easing, and low inflation. The second scenario is one where there is higher inflation alongside quantitative easing. Whatever happens, there are assets that will do well in both circumstances.
The first investment that takes advantage of monetary policies is a fixed 30-year mortgage as the fixed payments become smaller in real terms due to inflation while the real estate provides you inflationary protection. In the case of a scenario with low inflation, interest rates will remain extremely low and thus it pays to be in debt.
The second investment option is to invest in strong currencies where there is no quantitative easing eroding the value of money. Look especially in to economies that are going to grow no matter what happens in the stagnating developed markets.
The third investment option is commodity stocks. Stocks will benefit in general from easing policies while the commodities inherent to their businesses will give protection against eventual inflation.
The worst thing to do now is to save because savers have been the losers in the last decade and could continue to be for the next few decades.
Now, I have to note that what I have described above is what will probably be going on in the long term as the economic growth developed countries currently enjoy is all based on credit. High credit levels allow for economic growth and shy Central Banks tightening attempts. So for the short term, we could see higher interest rates alongside higher inflation. Therefore, for the short term, the assets that offer protection against inflation should be the way to go.