As Central Bankers Lose The Plot, Smart Money Should Be On A Market Crash

The stage is being set for a possible global stock market decline, if not a crash, in the next 6-18 months. This is because the penny is dropping for central bankers, who have since 2008 been following a bankrupt policy of near-zero interest rates, and even negative interest rates, with nothing to show for it barring the absence of a Great Depression.

Monetary policy in the West has hit rock-bottom in terms of options, and the only thing left to try is “helicopter money” – putting cash directly in the hands of ordinary individuals and companies in order to get them to spend and invest and spark a revival. Mark Mobius, Executive Chairman of Templeton Emerging Markets Group, believes that Japan could try this out fairly early and cautiously at first.

The main impact of “helicopter money” will be fiscal, with deficit bloating out of shape once again. It may have worked if the West had tried this in 2008-10, but governments chose to use monetary policy instead of fiscal stimuli to revive their economies after the crisis. Now, “helicopter money” may be like an antibiotic to which the body has developed resistance.

The idea behind “helicopter money” is to manufacture inflation in some form, and then hope that it will force people to save less and spend more. Corporations are not investing because demand is weak, and it makes no financial sense to invest in new plant and machinery; in fact, a Financial Times article points out that corporations in the major economies (US, Germany, UK, Italy and Japan) have been adding to savings instead of drawing them down, with Japanese corporations alone showing a savings surplus (own savings minus investment) of a massive eight percent of GDP.

The main beneficiaries of the near-zero interest rates have not been ordinary borrowers or corporations but speculators on Wall Street. This should have been obvious to any central banker worth their salt, as interest rates and stock markets have an inverse relationship; if you keep rates near zero, it means that money can be borrowed at almost no cost and invested in stocks, creating an asset price boom. Zero-cost money is a goad to speculators on Wall Street, and they have made full use of free money to make real money for themselves.

Between September 2008, which marked the start of the global financial crisis, and today, the Dow has risen by a smart 68 percent; if one looks at where the Dow is now, compared to the level to which it had crashed in March 2009, the index has nearly tripled in value. This means only investors and speculators have benefited enormously from zero rates, at the cost of the real economy. Even companies with cash surpluses would have been tempted to try their hand at stock investment rather than plant and machinery.

The other major side-effect of free and negative money is the destruction of bank profitability. It is ironic that central bankers dropped rates and capitalised their banks with public funds in order to prevent a collapse of the financial system; now, with their prolonged zero-rate policies, they are again pushing banks towards bankruptcy.

In a recent commentary, Deutsche Bank CEO John Cryan warned that “monetary policy is now running counter to the aims of strengthening the economy and making the European banking system safer.” He also warned that current monetary policies of the European Central Bank (ECB) would have “fatal consequences” for savers and pension funds, even as companies refuse to invest in the face of lack of demand.

Some central banks are probably getting the message. Last week, the US Fed Chair Janet Yellen talked of a rate hike. She said: “In light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.” Rates could be raised after the next Fed meeting, and there could be room for at least one more rate hike before the end of the year.

This is the right move, and the US Fed should speed up the return to normal interest rates, even if it means a short-term stock market crash. The easy money made by the wolves of Wall Street cannot be doing the real economy any good. Worse, it will be causing social angst and anger due to the redistribution of wealth from the poor and middle classes to the super-rich.

Once the Fed starts moving boldly (assuming it does), even the ECB and the Bank of Japan would not continue with their ruinous rate policies.

Here’s the prognosis: as central banks start realising that monetary policy has nowhere to go but in the direction of sanity and positive interest rates, stocks everywhere ought to correct.

Two questions arise: will the resultant wealth destruction cause another recession worldwide? And how will India be affected?

Obviously, we are not going to be immune to global contagion from stock crashes. If Wall Street crashes, Dalal Street too will. When wealth is decimated on Wall Street, investors will pull out funds from where they are being destroyed less aggressively (as in India).

But it is possible for us to cushion the impact of this upcoming crisis if we do something right.

First, we need to consciously move more domestic money to stocks, especially from organisations like the Employees’ Provident Fund Organisation. This will counter any immediate adverse effect of a foreign institutional investor pullout.

Second, we have to hold interest rates at their current levels, if not raise them, as the immediate impact of the rich countries raising rates will be to pressure the rupee and trigger a fall in our debt market. FII interest in debt, which is another important factor for rupee values, will need to be maintained.

The world cannot indefinitely put off a recession or slowdown or a market crash by keeping rates at a level where it only benefits the speculators. Central bankers would do the world a favour by bringing it on early so that we can slide into a normal recession instead of being pushed into a global depression.

There is a limit to how far we can grow with artificial stimuli and money printing. Something has to give.