There are equally important questions in today’s economy and financial markets, so I thought
I’d condense a few of them to hopefully explain our current situation, perhaps a little more
honestly than my “kittens in a pet store” ruse or what “Victoria’s Secret” really was. They are
as follows:
1) When does our credit-based financial system sputter/break down?
When investable assets pose too much risk for too little return. Not immediately, but at the
margin, low/negative yielding credit is exchanged for figurative and sometimes literal gold or
cash in a mattress. When it does, the system delevers as cash at the core, or real assets like
gold at the risk exterior, become the more desirable assets. Central banks can create bank
reserves, but banks are not necessarily obliged to lend it if there is too much risk for too little
return. The secular fertilization of credit creation may cease to work its wonders at the zero
bound, if such conditions persist.
2) Can capitalism function efficiently at the zero bound?
No. Low interest rates may raise asset prices, but they destroy savings and liability based
business models in the process. Banks, insurance companies, pension funds and Mom and
Pop on Main Street are stripped of their ability to pay for future debts and retirement benefits.
Central banks seem oblivious to this dark side of low interest rates. If maintained for too long,
the real economy itself is affected as expected income fails to materialize and investment
spending stagnates.
3) Can $180 billion of monthly quantitative easing by the ECB, BOJ, and the BOE keep on
going? How might it end?
Yes, it can, although the supply of high quality assets eventually shrinks and causes
significant technical problems involving repo, and of course negative interest rates.
Remarkably, central banks rebate almost all interest payments to their respective treasuries,
creating a situation of money for nothing – issuing debt for free. Central bank “promises” of
eventually selling the debt back into the private market are just that – promises/promises that
can never be kept. The ultimate end for QE is a maturity extension or perpetual rolling of debt.
The Fed is doing that now but the BOJ will be the petri dish example for others to follow, if/
when they extend maturities to perhaps 50 years.
4) When will investors know if current global monetary policies will succeed? Almost all assets are a bet on growth and inflation (hopefully real growth) but in its absence at least nominal growth with some inflation. The reason nominal growth is critical is that it allows a country, company or individual to service their debts with increasing income, allocating a portion to interest expense and another portion to theoretical or practical principal repayment via a sinking fund. Without the latter, a credit-based economy ultimately devolves into Ponzi finance, and at some point implodes. Watch nominal GDP growth. In the U.S. 4-5% is necessary, in Euroland 3-4%, in Japan 2-3%. 5) What should an investor do? In this high risk/low return world, the obvious answer is to reduce risk and accept lower than historical returns. But don’t you have to put your money somewhere? Yes, of course, except markets offer little in the way of double digit returns. Negative returns and principal losses in many asset categories are increasingly possible unless nominal growth rates reach acceptable levels. I don’t like bonds; I don’t like most stocks; I don’t like private equity. Real assets such as land, gold, and tangible plant and equipment at a discount are favored asset categories. But those are hard for an individual to buy because wealth has been “financialized”. How about Janus Global Unconstrained strategies? Much of my money is there