Home Economy Loose monetary policy is the biggest market risk today

Loose monetary policy is the biggest market risk today


Jeremy Grantham argues that there are no two ways to solve this problem: “The long-term bull market since 2009 has finally matured into a complete epic bubble.”

“With overvaluation, explosive price increases, insane issuance and hysterical investor speculation, I believe,” said the co-founder of the Boston-based fund management company GMO. this will be noted as one of the major bubbles in financial history, is it not with the South Sea Bubble, 1929 and 2000. “

Coming from a famous man who predicted the bubble burst in 2000 and 2008, this Red alert about investment risks, released in January, is noteworthy.

Others still have to be persuaded. In a recent strategy article, Economists at Goldman Sachs argues that, while stocks are overvalued, “the lack of substantial leverage (outside of the government sector) and the early stages of the cycle indicate investment bubble risk with systemic risk. for the financial system and the economy is relatively low. “

Giddy height

There is no doubt that there is a lot of turmoil on the market today.

Inexperienced retail investors are flocking to popular stocks. The share prices of unprofitable companies have skyrocketed. Special-purpose acquisitions (Spacs), circumventing protections in the conventional initial public offering and pockets of investment bankers, have raised more than 70 Billion dollars in new money in the US by 2020. That record streak appears to have been exceeded the first three months of 2021.

Companies like Uber and Deliveroo, whose competitive advantage comes mainly from regulated labor market arbitrage rather than magic technology, but still dictate magic pricing, even after Deliveroo floatation.

Moving to the big picture, global stock market capitalization has hit a record high compared to global gross domestic product.

In terms of systemic risk, there are some reassuring signs. Unlike the period before the 2007-08 crisis, the real estate market, with the exception of China, is not overvalued. Banks are also not overly stressed, having been forced to rebuild capital since the crisis – though the fall of the shadow bank Greensill suggests an increased risk outside the banking system. usually, common, normal.

And, unlike the peak of the dotcom bubble, the big tech corporations leading the bull market were cash-rich and high-income earners.

At the same time, efforts by central banks and governments to combat the coronavirus decline have prevented widespread corporate bankruptcy. This, along with the acceleration of vaccinations, is contributing to a global recovery: the IMF is forecasting global growth of 6 percent This year. Meanwhile, Jay Powell, chairman of the Federal Reserve, is a super-dove, pointing to markets that any shift to tighter policy is far from future.

Into the debt trap

But there is friction. The biggest risk to all current markets lies in the looser monetary policy that has introduced extremely low policy rates and contributed to low nominal yields, still in historical territory. not even after let it up.

Elroy Dimson, Paul Marsh and Mike Staunton, in Credit Suisse Global Return on Investment, point out that, over the past 40 years, their world sovereign bond index provided an annual real return of 6.2%, only slightly lower than 6.8% compared to equity stocks. gender.

They say extrapolating those returns into the future would be foolish because this is the golden age for bonds. The average annual real yield of a government bond since 1900 has been just 1%.

Global debt increased to a record high

The big problem here is that high bond prices and incredibly low yields create dangerous dynamics. Investors look for higher returns regardless of the risk and everyone – household, company and government – borrows excessively while the cost of debt repayment is minimal.

The result is an explosive increase in debt. The Institute of International Financea trade body for global banks estimates that global debt hit a new record of $ 281 billion by 2020, with the government’s response to the pandemic contributing $ 24 billion to the figure. there.

The non-bank business sector in particular has seen strong growth since the financial crisis, with debt currently at 100% of GDP.

That is hardly consistent with Goldman’s view that there is no significant leverage in the private sector.

In fact, the world is in a debt trap. It is not possible for the large central banks to tighten policy without posing a threat to financial stability and thus the broader economy. Such action will also result in retaliation from politicians, whose central bank independence is good as long as it offers low interest rates.

There is no easy escape from overly loose monetary policy, with the risk of a financial crisis or higher inflation or both. Indeed, inflation will be part of the solution to excessive debt.

The lower the interest rate mantra, the better it is impossible to have a happy ending. But predicting when that end could come would require the skill of a Nostradamus.

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