Bernard Hickey: Don't get too comfy

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Investors have been rescued time and again but if inflation takes off, central banks will have to put up interest rates. Photo / AP

By Bernard Hickey

This week's turmoil in global markets has reminded us all that we live in financially turbulent times. They are also morally hazardous times.

"Moral hazard" is the phrase for when investors take a risk knowing they cannot lose and that someone will bail them out.

Time and again since the Global Financial Crisis of 2007-08 a central bank or government has rescued investors from a true collapse.

First, interest rates were slashed to reduce the burden of high debts. Then banks were bailed out. Then, when interest rates were cut to zero, central banks printed money to buy bonds and other assets to push up their prices and drag long-term interest rates down.

The US Federal Reserve cut its Official Cash Rate to almost 0 per cent in 2008 and has left it there. It launched three rounds of so-called quantitative easing and has only just stopped printing money to buy Government bonds.

The Bank of Japan has been printing for years and only recently ramped that up to try to lift its economy out of decades of perma-recession. The European Central Bank has cut its deposit rate to minus 0.2 per cent to try to force savers to invest. That means savers have to pay the bank to mind their money.

All this rate-cutting and money printing has made it attractive to buy stocks, property and bonds that produce a regular income greater than the near-zero interest rates.

Stock and bond markets have rallied to record highs in the past six years, despite the longest recession in the global economy since the 1930s. Bizarrely, it seems, the global economy is misfiring in many areas yet investors can be sure central bank governors and finance ministers will stop collapse.

This time appears no different.

Continued below.

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China has blown $310 billion propping up a stock market that has fallen at least 43 per cent from its peak. It pushed the Chinese yuan lower and spent another US$200b to stop further falls.

This week the People's Bank of China cut its main lending rate to 4.6 per cent and loosened lending rules for banks.

There is now talk the US Federal Reserve will delay until next year the long-feared and hoped-for increase in its version of the Official Cash Rate by the shocking amount of 0.25 per cent from nearly 0 per cent. Some are suggesting the Fed restart money-printing with a fourth iteration of quantitative easing known as "QE 4".

But just how long will governments and central banks be able to use public balance sheets to turn the tides of markets?

There is technically no limit to the amount of money central banks can print. Governments can borrow as much as they want while interest rates are 0 per cent.

The moment of truth will come when, or if, inflation starts to rise. It would unleash the mother of market meltdowns in bond markets and quickly spread to stock markets.

But, curiously, all this money printing and 0 per cent interest rates have yet to unleash the inflation dragon, at least for goods and services. Asset prices are pumped up and juicy, but goods manufactured in factories and in cloud services are firmly in deflationary mode.

Many investors will feel bulletproof while inflation is dead. But they should be careful. All bets are off on this morally hazardous series of trades if inflation takes off. Then central banks would have no choice but to put up interest rates and the leveraged bets would go bad.

The key to this puzzle is inflation. It has the potential to unlock this moral hazard.

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59 Comments

Veritas 2

-
01:03 pm Tuesday 01 September 2015
The banks should never have been bailed out. There would be no collapse. Maybe a hiccup. The money isn't real, it is digital. Anything that can be created at the push of a computer button can be destroyed. Obviously it can be created again. A concept that most completely fail to understand.

Ken Maynard

- New Zealand
01:01 pm Tuesday 01 September 2015
The dragon of inflation was broken by out-sourcing production to the low wage societies of the third world.

Normally rising wage & production costs would present as inflation, so arresting first-world growth; which was happening before out-sourcing killed the inflation dragon.

Outsourcing disconnected western QOL from rising costs thus liberating capital gains from the inflation pressures of a ~closed~ national economy.

Thus there is a clear linkage between the slaying of inflation & the emergence of unrestrained capital gains.

Yet this type of alchemy can only happen once; once you have outsourced production to low wage societies there are no lower wage societies available to repeat the trick.

Further, whereas traditional assembly only required unskilled labour, hi-tech production requires skilled workers with high levels of education. Labour then becomes more expensive no matter where located; so inflation seems back in the game.

The alternate scenario is technology making humans redundant, as much so in the third world as in the first; so rampant capital gains may not default back to rampant inflation but emerge as a new beast called rampant social instability.

Kukuni

- Cameroon
12:02 pm Monday 31 August 2015
We need high demand and shortage of supply for an inflation. But currently there is no demand for goods and services because the majority of the people have no money left after rent or mortgage payments. All the printed money doesn't reach the ordinary people, it goes directly to the lenders. Therefore as we have seen in the best example, Japan, we can look forward to a several decade lasting deflationary period with a number of private bankruptcies to come.

Veritas 2

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11:24 am Monday 31 August 2015
Everything is an investment class these days. Water is the rising star but will be the "bridge too far" that I believe will cause people to finally wake up from their sleep and throw these thieves out of their privileged positions.

Veritas 2

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11:24 am Monday 31 August 2015
Unbelieveable irony isn't it? The "free" market and the legendary "invisible hand" need more state assistance than the worst communist government department you can imagine!

Vested interests are in charge and while that continues to be the case don't expect much to change. They are like the little Dutch boy plugging holes in the dyke, the problem is they are running out of fingers and toes. I know it will be incredibly turbulent and potentially ugly, but the sooner the "free" market implodes the better.

We might be able to get control of it back from the lunatics currently in charge and get back to fundamentals instead of this neo liberal, crony capitalism. Madness.

Kiwi Rambled

- England
10:48 am Monday 31 August 2015
Irony right?

Mary Lamb

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10:48 am Monday 31 August 2015
Hardly an 'Undecided Voter'! - more like a love-fest for the National Party! ....The migrants leaving the middle east are a direct result of good old George Bush and his idiot puppy Tony Blair's campaign to rid the world of WMD's - only thing is there weren't any.

Still aren't. So who was telling porkies so the USA would go to war? Who made the money? Now we have millions of displaced people in the middle of a war zone of our making.

It is our responsibility to take them in. It's our mess, we did it. George and the mad Republicans (the gun & munitions lobby) did. Most of us under 60 know that.

Belgarion

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10:48 am Monday 31 August 2015
As other have suggested, Inflation is not sleeping. The way it is being measured isn't working properly and governments love it because it keeps their costs in check, i.e. directly through inflation adjusted increases and indirectly through wage increase adjusted increases.

Belgarion

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10:48 am Monday 31 August 2015
Such predictions were completely right based upon the expected behaviour, i.e. that interests would return to long term averages. They didn't. Why? The article is about the why.

It is also about what will happen if they do. And that, is a very scary thought indeed. The thought becomes less scary however if we rethink our fixations of "growth" and how it is measured.

John W

- New Zealand
10:48 am Monday 31 August 2015
To all those glass half full types out there. NZ has debt per head of population the same as Greece.

103 billion and rising fast.

The big crash is coming to you soon. Wake up!

John W

- New Zealand
10:48 am Monday 31 August 2015
This crash will make the 2008 crash look like chicken feed.

Alex More

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10:47 am Monday 31 August 2015
We are headed for serious turmoil some years down the track.
All this mad printing of money by many sovereign states takes my mind back to the days of the Gold Standard.

Then, all currencies were pegged to the price of gold. For each dollar, pound, yen, yuan or sheckle that a country printed it had to have a quantity of gold in the central vaults. That prevented any rogue Central Bank from printing money like it was confetti. As is happening today.

However, that was too restrictive for the 'bright young people', that every generation produces by the cart load, and so eventually the Gold Standard was dropped and the era of 'shadow accounting, shadow finance and shadow boxing' is upon us.

The last 30 years, the period of my serious interest in financial stability ( I recently retired), provide ample examples of this. Some might prefer the use of 'smoke and mirrors' to describe the actions of the World's Central Bankers over this period.

I am just hoping that my children and grand children will not suffer too much from this turmoil.

Crow of the Underworld.

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10:47 am Monday 31 August 2015
Yet Brazil & Russia are in recession. NZ is on the edge of negative GDP growth (0.2%) & deflation (0.1%). Canada is on the verge of a recession.

NZ is population growth is now almost entirely dependent on migration as the NZ birth rate continues to decline as the general White (Pakeha) population now have a lower birth rate than Asians,Maori & Pacific Islanders in NZ.

Future US population growth is mostly coming from Hispanics.

Future NZ population growth is mostly coming from Asians,Maoris & Pacific Islanders.

Crow of the Underworld.

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10:47 am Monday 31 August 2015
You can do that by just nationalizing the entire economy to have total dependence on the state. Australia doesn't do that with NZ-owned companies such as Fonterra,A2 Milk,Kathmandu etc.

Yet NZ companies make profits from Overseas yet those countries don't demand those NZ companies to have a local shareholder.

Of course he is going to borrow that much money since New Zealand had to rebuild an entire city (Christchurch) that was destroyed by a devastating earthquake, before the 2008 election New Zealand went into recession just before Helen Clark left office & was over $10 billion in Public Debt.

NZ farmers owe over $50 billion in debt. NZ created a lot of private debt over the decades. NZ household debt is over (160%) of GDP. land prices in NZ are way overvalued. All types of debt in NZ besides that of Government debt was very high.

New Zealand's total debt is $515 Billion.

Luc Hansen

- Beach Haven
10:47 am Monday 31 August 2015
In general, you are confused about the notion of inflation - asset price increases is not inflation - but you are correct about a correlation between the slaying of the inflation dragon and the increase in asset prices. That is simply money seeking the highest return.

The lesson is, always beware unintended consequences of policy actions.
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