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How cheap can money get?

10 November 2014  |  Economics

cashJust how cheap can money get? The AFR reports that global sharemarkets have been rallying in the wake of the Bank of Japan’s shock decision to ramp up monetary stimulus a week ago. Some expect the European Central Bank to follow suit. So even though the US Federal Reserve has finally brought quantitative easing to an end, the era of world wide easy money has not ended:


"The BoJ’s move, which came in the same week as the US Federal Reserve decided to end its bond-buying program, dispelled any fears that liquidity in global financial markets could be on the wane. The BoJ increased its target goal for the expansion of its monetary base to ¥80 trillion ($810 billion) from ¥60 trillion to ¥70 trillion. It has raised the amount of Japanese government bonds it buys monthly to a range of ¥8 trillion to ¥12 trillion.

On Wednesday, BoJ governor Haruhiko Kuroda said the move demonstrated the central bank’s “unwavering commitment” to achieving its 2 per cent inflation target, adding it would not hesitate to act again if needed. “To completely overcome the chronic disease of deflation, medicine should be taken until the end,” he said.

Meanwhile, the European Central Bank appears to be preparing to administer its own dose of monetary medicine to revive flagging growth and falling inflation in the euro zone.

ECB president Mario Draghi told a press conference on Thursday that the bank’s policymakers are unanimous in their readiness to support more stimulus if needed, and that they all expected the central bank’s balance would expand to early 2012 levels. Investors took this as a sign that the ECB is preparing to spend up to €1 trillion ($1.4 trillion) buying private sector debt, and perhaps even government bonds, if the region’s economic and inflation outlook continues to deteriorate.

Completing the trifecta for investors were the US mid-term elections, which saw the Republicans increase their power in the final two years of Barack Obama’s presidency by recapturing majority control of the Senate. The Republicans also boosted their majority in the House of Representatives and now control both chambers of Congress for the first time since 2006.

Investors believe Washington is likely to provide a positive backdrop for markets, particularly when the US budget deficit is shrinking. They believe both parties will be keen to avoid any measures that will jeopardise the US economic recovery, and that this will allow the Fed to keep running an accommodative monetary policy."



The worry is that the world's financial system is becoming a giant "carry trade". In this scenario, money is borrowed at near zero and used to buy higher yielding assets -- 'carried' from one to the other. The problem with this is that it creates the habit of investing in money to make money to make money, rather than investing in the underlying productive capacity of the asset being bought. Instead of capital being used to facilitate production, money just serves itself.

Carry traders might borrow at near zero, then invest in a risky business and simply bail out as soon as the target return is generated. There is no need to worry about the true value of the underlying asset:


"They don’t look too closely at whether they are paying too much, as they are only concerned with earning the “spread” (the difference between the yield on the risky asset and the cost of borrowing). And they assume they will be able to sell their risky assets to other investors when they choose without risking their capital.

So asset prices are pushed higher as investors take on more risk in the “reach for yield”. Eventually prices are pushed to such a dizzying height that some investors take fright. As soon as investors start worrying they may have overpaid for assets – and risk capital losses when they sell – a wave of selling begins. And as investors rush to sell their risky assets, prices collapse, triggering more panic selling."


This is not a new problem. It went on in the years to the lead up to the Global Financial Crisis. It was called the "Greenspan put". It is part of the character of late stage capitalism. Net investment is no longer needed to fund productive output. So the surplus capital is instead invested in money making schemes, such as the massive derivatives market. In effect, the markets are being run by a financial sector gambling at a casino of their own making.


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