Interest rates and inflation peaked in the UK and US in 1980. Over the following 29 years interest rates declined in the US and UK from 20% to 1% generating a long uplift in the value of equities and other assets.
Japan became a global source of very cheap investment capital in the mid 90s as a consequence of ultra low-interest rates, the declining value of the Yen and the emergence of hedge funds meant that it became risk free to borrow Yen and invest in investment assets with much higher yields.
The Dow closed at under 1,000 in 1980; twenty-seven years later it reached nearly 14,000. The FTSE rose from 500 in 1980 to nearly 7,000 in 2007.
By 2000, monetary policy was being used to avert possible recessions, rather than as had been the practice, to stimulate the way out of one. This policy created additional credit, at a time when credit was already cheap and plentiful The super liquid conditions stimulated the securitization of loans by banks and the creation of many new financial derivatives outside of the control of central banks .
Inflationary consequences of the asset boom on consumer prices were absent probably because of the unprecedented productivity enhancement effects of computerization and the internet reinforced by the availability of ultra-cheap manufactured goods from China.
The point was reached where no more financial air could be blown into the bubble and it began to contract. Interest rates have now been declining for nearly thirty years, In the case of the UK and US they cannot go any lower.
The last upward cycle in interest rates began in 1950 and lasted thirty years and coincided with an era of great prosperity and growth, although the Dow ‘only’ increased 275% in those thirty years.
Here’s to the next thirty years…..
I wrote that in February 2010. What happened next?
January 2013, the credit bubble is inflating again. Worldwide, bank shares have typically doubled over the past few months. An unexceptional example is Lloyds Group whose shares were 35p in June 2012 and are now 50p i.e. Lloyds market cap has doubled to £35 billion for no discernible reason other than credit easing (mainly quantitive easing).
Junk bond yields are at an all time low, most stock markets are have risen sharply seemingly both because of credit easing – fundamental prospects haven’t changed, junk is junk, austerity is austerity, flat or declining gdp is the story in most places.
The financial establishment appear to have won enough to fight another day. Newspapers report any signs of rising property prices as ‘good’ news. Similarly more easily available consumer credit is reported as a ‘good’ story.
Let’s keep it simple. Much of the fund management ‘industry’ earns income as a percentage of assets under management – AUM. In the past six months the majority of investment assets have risen in price. The reason they have risen in unison is because of cheap and easy credit (the lowest interest rates for 300 years, mind-boggling central bank money printing via QE).
The effect of this is to sharply boost the income of financial services, a windfall which will no doubt be portrayed as the consequences of cleverness and skill (a simple lie) The resultant recovery in profits and bonuses becoming a’ good’ financial recovery story in 2014.
So its game on.