'Easy' Money Is No More

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Includes: BNDX, BWX, GIM, IGOV
by: Danielle Park, CFA
Summary

Since the 1978 US Humphrey-Hawkins Full-Employment Act added 'full employment' as a second (and conflicting) mandate to the original goal of price stability, central banks have been relentlessly pushing on a string as globalization, automation and industry consolidation all worked to undermine the bargaining power of workers and keep wage growth tepid.

For this reason, central banks responded to each naturally recurring economic cool-down cycle (regenerative episodes of debt reduction and savings rebuild) by slashing base lending rates to incentivize more debt-fueled spending and lower savings rates.

In truth, the secret to central banks looking powerful in the last three decades was not their brilliance but rather a 35-year unwinding period from abnormally high-inflation, taxation and interest rates starting in 1982.

Our July 31st client letter focused on the history of modern monetary policy and what impacts we should expect next. Last week's NY Times article "Why we should fear easy money" is also on point. Just one key takeaway is this:

"Recessions tend to be longer and deeper when the preceding boom was fueled by borrowing, because after the boom goes bust, flattened debtors struggle for years to dig out from under their loans. And lately, easy money has been enabling debt binges all over the world, particularly in corporate sectors."

Also, see Negative-Yield world lures Central Banks to Canada's Muni Market for some insight on fund flows likely to drive Canadian government bonds higher, and their yields lower as the global slowdown continues.

Since the 1978 US Humphrey-Hawkins Full-Employment Act added 'full employment' as a second (and conflicting) mandate to the original goal of price stability, central banks have been relentlessly pushing on a string as globalization, automation and industry consolidation all worked to undermine the bargaining power of workers and keep wage growth tepid. Debt was the bridge of choice to fuel buying power in the absence of wage growth. For more, watch Why wage growth is slow in a hot job market.

As central banks The U.S. labor market has added jobs for 106 straight months. But wages aren't growing as fast as expected.

For this reason, central banks responded to each naturally recurring economic cool-down cycle (regenerative episodes of debt reduction and savings rebuild) by slashing base lending rates to incentivize more debt-fueled spending and lower savings rates.

In truth, the secret to central banks looking powerful in the last three decades was not their brilliance but rather a 35-year unwinding period from abnormally high-inflation, taxation and interest rates starting in 1982. Now with near-zero and negative interest rates worldwide, that monetary momentum is all used up and deflation has the upper hand once more.

Recovery now requires substantive improvements rather than financial gimmicks. Substantive improvements are those that make life more affordable for the masses both by increasing income and reducing living costs; working down debt, rather than increasing it; encouraging start-ups and competition rather than further conglomeration and consolidation; and encouraging productive investment rather than speculation and gambling. This will be a messy, disruptive period for the status quo, but essential to moving forward.

Disclosure: No positions

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.