Federal Reserve

Will Federal Reserve spoil the stock market party by raising interest rates?

Federal-Reserve-Seal-logo
The prospect of future company earnings are supposed to drive stock markets. But this basic theory has broken down in the aftermath of the financial crisis that started in September 2008.
Western central banks led by the Federal Reserve of the United States have printed an astonishing amount of money over the last six and a half years and some like the Bank of Japan and the European Central Bank, continue to do so. The idea was that money printing would lead to lower interest rates, and at lower interest rates banks would lend more and consumers and businesses would borrow more. This would lead to businesses and in turn, the economy doing well.
But that hasn’t turned out to be the case. As the following table clearly shows, bank loans to small and medium enterprises(SMEs) in the United States have been falling as a proportion of total loans, over the years.

The shrinking importance of SME lending

Nonetheless, lower interest rates in much of the Western world, has allowed investors to borrow money at rock bottom interest rates and invest it in stock markets all over the world.
This is why stock markets including the Indian one have rallied big time over the last few years. For this rally to continue it is important that Western central bank continue to maintain low interest rates.
The economic situation in Europe continues to remain bad, and as of now there is very little chance that central banks of Europe will go around raising interest rates any time soon. In fact, in Switzerland the short term interest rate currently is at  − 0.75%.
Japan also continues to remain in doldrums and the chances of the Bank of Japan, the Japanese central bank, raising interest rates any time soon remain minimal. This leaves the Federal Reserve of the United States, the American central bank. And this is where things get a little tricky.
The Federal Open Market Committee of the Federal Reserve which decides on the interest rate is supposed to meet today and tomorrow (i.e. March 17 and March 18). The rate of unemployment in the United States has come down significantly over the last one year. In fact, the USA Today reports that in 2014, job growth hit a 15 year high.
Typically, a fall in unemployment leads to an increase in wage growth, as employers compete to recurit employees. But that doesn’t seem to have happened in the United States. The Fortune magazine reports that the average hourly pay of an American worker has risen by just $0.03 in the last one year. This basically means that wage growth in the United States has been more or less flat over the last one year.
The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of January 2015, this number was at 1.3% much below the Fed’s target of 2%.
This number falls further once the imputed(i.e. made-up data) is excluded. Before we go any further I need to explain what imputed data is. Take the case of an individual who owns the house he lives in. As the Statistics Bureau of Japan points out: “Buying a house or a piece of land is a form of property acquisition and not consumption expenditure. Such a purchase, therefore, is not counted in the CPI. Still, it is an undeniable fact that a household living in a house it owns receives some service from the house…Also, many households are paying a mortgage. Here, it leads to an issue that, one way or another, the housing expense of an owner-occupied house should be counted in the CPI calculation.”

Hence, such a situation needs to be taken into account. It is done by assuming that the “house-owning household is renting the same house from someone else.” “Then, the household has to pay some rent…An “imputed rent of an owner-occupied house” refers to the rent paid to owner-occupied houses assuming that owned house were rented. Such imputed rents are taken into the CPI calculation,” the Statistics Bureau of Japan points out.
If such data were to be excluded from inflation calculation in the United States, the results would be significantly different from the way they currently are. As Albert Edwards of Societe Generale points out in a recent research note titled Forget the ECB: A key measure of global liquidity is now in freefall, published on March 6, 2015: “We use a variant of this core PCE where the US statisticians exclude imputed (i.e. made-up) data..Five out of the last six months have registered zero inflation with only one 0.1% rise! Headline core PCE is being inflated by made-up data.”
As the fall in price of oil seeps through the system Edwards expects the inflation rate to come down to 0.3%. The other major reason for low inflation in the US is the fact that dollar has rallied majorly against all major currencies. This ensures that imports to the United States become cheaper, and thus drive down inflation.
In this scenario of almost no wage inflation and low overall inflation, will the Federal Reserve start increasing interest rates? If the Fed does not raise interest rates then foreign investors will continue raising money in dollars and investing that money in stock markets all over the world, including India.
But if the Fed does start to raise interest rates then this carry trade may run into some trouble and fresh money from foreign investors may not come into India at the same pace as it has in the past. The way things stand as of now, this remains too close to call. Nevertheless, I will stick my neck out and say, the Fed won’t raise interest rates in June this year, as it is widely expected to.
Having said that, I have my fingers crossed!

The column originally appeared on The Daily Reckoning on Mar 17, 2015

A 400 year old economic theory that the world has forgotten about

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee (FOMC), which decides on the monetary policy of the United States, had its last meeting for this year scheduled on December 16-17th, 2014. After this meeting, Janet Yellen, the Chairperson of the Federal Reserve spoke to the media.
Everything Yellen spoke about during the course of the press conference was closely analysed by the financial media all over the world. The gist of what Yellen said at the press conference was that she expects that the Federal Reserve will start raising the federal funds rate sometime next year.
The federal funds rate or the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis, acts as a benchmark for the short-term interest rates in the United States. The last time the Federal Reserve increased the federal funds rate was in 2006.
In the aftermath of the financial crisis, the Federal Reserve decided to print money and pump it into the financial system by buying government bonds and mortgage backed securities. The Federal Reserve referred to this as the asset purchase programme. The economists called it quantitative easing. And for those who did not want to bother with jargons, this was plain and simple money printing.
This was done to ensure that there was enough money going around in the financial system and interest rates remained low. At low interest rates the hope was that people would buy homes, cars and consumer durables. This would drive business growth, which in turn would drive economic growth, which would create both jobs and some inflation.
While this has happened to some extent, what has also happened is that a lot of money has been borrowed by financial institutions at very low interest rates and has found its way into stock markets and other financial markets all over the world. This has led to bubbles.
The economic theory explaining this phenomenon was put forward by Richard Cantillon, an Irish-French economist who lived during the early eighteenth century. He basically stated that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, that is, the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines. These individuals would end up with a greater amount of gold and silver, that is, money. They would spend this money and thus, drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would impact even people not associated with the mining industry, even though they hadn’t seen a rise in their incomes, like the people associated with the mining industry had. This was referred to as the Cantillon effect.
Interestingly, Cantillon was also an associate of John Law. In 1705, John Law published a text titled Money and Trade Considered, with a Proposal for Supplying the Nation with Money. Law was of the opinion that money was only a means of exchange and that a nation could achieve prosperity by increasing the amount of money in circulation.
The problem of course was that when it came to gold and silver coins, only so much currency could be produced. But this disadvantage was not there with paper money. Law firmly believed that by circulating a greater amount of paper currency in the economy, commerce and wealth of a nation could be increased.
His theory was in place. But, like a physicist or a chemist, it could not be tested in a laboratory. Law needed a nation that was willing to let him test his theory. And France proved to be that nation. In 1715, France was the richest and the most powerful country in the world. But at the same time it was also almost bankrupt.
This was primarily because the country did not have a central bank of its own like the Dutch and the British had. Law’s idea was to create a central bank which would have the right to issue paper money which would be a legal tender. He also wanted to create a company which would have a monopoly of trade. This would create a monopoly of both finance as well as trade for France and the profits thus generated would help pay off the French debt.
Law went around establishing a bank called the Banque Royale and formed a company called the Mississippi Company, which was given a 25-year-long lease to develop the French territory along the Mississippi River and its tributaries in the United States. The Banque Royale was allowed to issue paper notes guaranteed by the French Crown.
Cantillon was an associate of John Law and observed the entire thing very closely. As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “Cantillon noticed that Law’s new paper money backed by the shares of the Mississippi Company—didn’t reach everyone at the same rate. The insiders—the rich and the well connected—got the paper first. They competed for goods and services with it as though it were as good as the old money. But by the time it reached the labouring classes, this new money had been greatly discounted—to the point, eventually, where it was worthless.”
This was the Cantillon effect. As analyst Dylan Grice told me during the course of an interview: “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printed by the Federal Reserve in the aftermath of the financial crisis has been unable to meet its goal of trying to create consumer-price inflation and getting consumer spending up and running again. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit. They were the ones standing under the helicopter when the money was printed and dropped.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
It has also left these investors wondering what will happen once the Federal Reserve decides to end the era of “easy money” and start raising interest rates. In October 2014, the Federal Reserve brought its asset purchase programme to an end. This did not lead to a panic in the financial markets simply because the Fed made it clear that even though it would stop printing money, it would not start immediately withdrawing the money it had already printed and pumped into the financial system over the years.
But that is going to happen one day. Yellen is trying to get the financial markets ready for interest rate hikes starting next year. At least, that is the impression I got yesterday after watching her press conference.
Once the Fed decides to start withdrawing the money that it has printed and pumped into the financial system, and which in turn has found its way into financial markets all over the world, interest rates will start to go up. That will happen sooner rather than later. Maybe 2015. Maybe 2016. Who knows.
And once interest rates start to rise, the arbitrage of borrowing at low interest rates and investing money in financial markets all over the world, won’t be viable any more. It is difficult to predict precisely how exactly the situation will play out.
Nevertheless, Bonner summarizes the situation well when he says: “What exactly will happen, and when it will happen, we will have wait and find out. But it will be bad, that much is certain. We will hit rock bottom.”
All I can say to conclude is—Watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on December 19, 2014

References:
M. Thornton, “Cantillon on the Cause of the Business Cycle,” The Quarterly Journal of Austrian Economics 9, 3(Fall 2006): 45–60 

J.E. Sandrock, “John Law’s Banque Royale and the Mississippi Bubble.” Avail­able online at http://www.thecurrencycollector.com/pdfs/John_Laws_Banque_Royale.pdf

C. Mackay, Extraordinary Popular Delusions and the Madness of Crowds (Project Gutenberg, 1841). Available online under Project Gutenberg.

The Western growth model is broken and it ain’t getting fixed any time soon

3D chrome Dollar symbol

Everyone has a plan until they get hit in the mouth – Mike Tyson

In the aftermath of the financial crisis that started in September 2008, the central banks of Western countries started printing money and pumping it into their financial systems. The hope was that by flooding the financial system interest rates could be maintained at low levels.
At low interest rates people would borrow and spend more and economic growth would return. The Federal Reserve of United States led the money printing race. But money printing hasn’t led to people borrowing and spending as was expected, as can be seen from the accompanying chart.

Source: http://www.pimco.com/EN/Insights/Pages/For-Wonks-Only.aspx

The total loans in the United States currently amount to around $58 million. The loans have been growing at 2% per year in the last five years and 3.5% over the last 12 months. As can be seen from the accompanying graph this rate of loan growth is much slower than the growth in pre-financial crisis years, when the loan growth was at around 10% per year. It even touched 20% in 2007, a year before the crisis broke out.
Hence, economic growth in the United States was a clear function of the loan growth in the pre-financial crisis years. Now that the loan growth has slowed down so has economic growth. So what will it take to bring this growth back?
As Bill Gross who formerly worked for PIMCO, one of the largest mutual funds in the world, put it in a September 2014 column “Over the long term, however, economic growth depends on investment and a rejuvenation of capitalistic animal spirits – a condition which currently does not exist…The U.S. and global economy ultimately cannot be safely delivered with artificially low interest rates, unless they lead to higher levels of productive investment.”
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right people need to be encouraged to borrow and spend. The trouble is that it was “excessive” borrowing and spending that had led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales suggest this in a new afterword to Saving Capitalism from the Capitalists: “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
Interestingly, from 1900 to 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level that it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases that they used to in the past. This led to Western governments following an easy money policy, where they encouraged citizens to borrow and spend, and this ensured that economic growth remained strong.
But in the aftermath of the financial crisis this growth model has broken down with people not borrowing as much as they did in the past. So what is the way out? The way out is to create sustainable growth that is not financed through debt-fuelled consumption all the time. As Rajan and Zingales put it “The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts they will be saddled with. The best short-term policy response is to focus on long-term sustainable growth.”
Nevertheless that is easier said than done. A March 2011 working paper by Michael Spence and Sandile Hlatshwayo provides the reason for the same. As the economists point out “Between 1990 and 2008, jobs have seen a net increase of 27.3 million on a base of 121.9 million in 1990..Almost all of those incremental jobs (26.7 of 27.3 million) were created in the nontradable sector. In the aggregate, tradable sector employment growth was essentially flat.”
So what does this mean? Jordan Ellenberg defines the term nontradable sector in his book How Not To Be Wrong—The Hidden Maths of Everyday Life. Nontradable sector is “the part of the economy including things like government, health care, retail, and food service, which can’t be outsourced and which don’t produce goods to be shipped overseas.”
Hence, basically whatever could be outsourced outside the United States has already been outsourced. This is simply because it is cheaper to produce stuff outside the United States. And this is likely to continue in the years to come. Over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a further downward pressure on costs and prices. Hence, Americans will not really be in a position to demand pay increases as they could have in the past.
What is true about the United States is also true about other developing countries as well. Given this, the Western growth model is well and truly broken. And as of now, the way things stand, it doesn’t look like if it will be fixed any time soon.

The article originally appeared in www.FirstBiz.com on Nov 12, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

 

Why the US Fed will not be sucking out all the printed money any time soon

 

Vivek Kaul

The Federal Open Market Committee(FOMC) is scheduled to meet on October 28-29. This is one of the eight regularly scheduled meetings during the year. It is widely expected that the Janet Yellen led Federal Reserve will more or less bring quantitative easing to an end.
Economists like to refer to the good old money printing as “quantitative easing”. The Federal Reserve till date has printed around $4 trillion and pumped it into the financial system. It currently prints around $15 billion per month and pumps this money into the financial system by buying government bonds and mortgage backed securities.
The writer John Lanchester perhaps describes quantitative easing(QE) in the simplest possible way and what it really stands for by cutting out all the jargon in his new book How to Speak Money. As he writes “QE involves a government buying its own BONDS using money which doesn’t actually exist. It’s like borrowing money from somebody and then paying them back with a piece of paper on which you’ve written the word ‘Money’ – and then, magically, it turns out that the piece of paper with ‘Money’ [written] on it is actually real money.”
Lanchester describes QE in another way as well. He compares it to a situation where an individual while looking at his “bank balance online” also has “the additional ability to add to it just by typing numbers on [his] keyboard.” “Ordinary punters can’t do this, obviously, but governments can; then they use this newly created magic money to buy back their own debt. That’s what quantitative easing is,” writes Lanchester.
This has been done in the hope that with all the newly money created being pumped into the financial system, there would be enough money going around and interest rates would continue to remain low. At lower interest rates the hope was people would borrow and spend more, and this in turn would lead to economic growth.
This did not turn out to be the case. What happened instead was that financial institutions borrowed money at very low interest rates and invested that money in financial markets all over the world. This explains to a large extent why stock markets have rallied all over the world in the recent past.
Lanchester believes that instead of going through the QE route the Western governments should have simply handed over this money directly to the people. He makes this comment in the context of the United Kingdom. As he writes “In the UK, the government has spent magic money on QE to the tune of £ 375 billion, an amount equal to 23.8% of…GDP…If they’d just had given the money direct to the public, perhaps in the form of time-limited. UK-only spending vouchers, it would have amounted to just under £ 6,000 for every man, woman and child in the country. Can anyone doubt that the stimulus effect that would have been much bigger?”
A similar argument can be made for the American economy as well. Nevertheless, this is just a counterfactual and something that did not happen.
Now the US Federal Reserve is likely to stop printing money after its meeting over two days. Does that mean there will be trouble ahead? As Lanchester writes “Nobody quite knows what’s going to happen once QE stops. In fact, the ‘unwinding’ of the QE is on many people’s list as the possible trigger for the next global meltdown.”
Once the US Fed stops printing money, new money will stop coming into the market every month. Hence, perpetually increasing liquidity will come to an end, at least in the American context.
So, does that mean interest rates will start to go up? The answer is no. As Mohammed A. El-Erian wrote in a recent column for Bloomberg “They will reiterate their willingness to keep interest rates low, should economic conditions warrant it. In doing all this, Fed officials will again try to buy time — both for the economy to heal and for politicians to step up to their responsibilities — hoping for better times ahead.”
What this means in simple English is that the Federal Reserve will not start sucking out all the money it has printed and pumped into the financial any time soon. And this means that the era of “easy money” will continue for the time being.
The reason for this is fairly straightforward. Even though the American economy is doing much better than it was in the past, the recovery at best has been fragile. The US economy grew by 4.6% during the period between July and September 2014, after having contracted by 2.1% during April to June, earlier this year.
The rate of unemployment in the US has been coming down for quite a while now. In September 2014, it stood at 5.9% against 6.1% in August. This rate of unemployment is around the average rate of unemployment of 5.83% between 1948 and 2014. It is also below the 6.5% rate of unemployment that the Federal Reserve is comfortable with.
Nevertheless, even with these reasons, the Federal Reserve is unlikely to start sucking out money and raising interest rates any time soon. This is because the US has become what Lanchester calls a “two-speed economy”. Lanchester defines this as “an economy in which different sectors are performing differently at the same time”. In the American context, it is a matter of Texas and the rest of the country.
The state of Texas has been creating more jobs than any other state in the United States. As Sam Rhines an economist at Chilton Capital Management points out in a recent article in The National Interest “From its peak in January 2008 through today, the United States has created only 750,000 jobs. Texas created over a million jobs during that same period—meaning that the rest of the country (RotC) is still short 300,000 jobs. During the recovery, job creation has been all Texas or—at the very least—disproportionately Texas.”
This has meant that the contribution that Texas has been making to the US economy has increased over the last few years, from 7.7% in 2006, it now stands at 9%. So, if one takes Texas out of the equation, the United States still hasn’t recovered all the jobs it lost since the start of the financial crisis in September 2008. Further, if one takes out the Texas growth out of the equation, the GDP growth also falls considerably. As Rhines writes “From 2007 through the end of 2013, the U.S. economy grew by $702 billion, and Texas grew by $220.5 billion.”
Other than this the broad unemployment numbers hide the fact that the labour force participation rate has been falling over the years. Labour force participation rate is essentially the proportion of population older than 15 years that is economically active. The number for September 2014 stood at 62.7%. This is the lowest number since 1978. The number had stood at more than 65% before the start of the financial crisis. Hence, more and more people are now not looking for jobs and they are no longer counted as unemployed.
Further, a lot of jobs being created are part-time jobs. Also, with jobs being difficult to come by many people looking for full-time jobs have had to take on part time jobs. In August 2014, nearly 7.3 million Americans were involuntarily working part time, compared to 4.6 million in December 2007, before the financial crisis had started. In September 2014, this number dropped to 7.1 million. Even after this fall, the number remains disproportionately high. This underemployment is not reflected in the rate of unemployment number.
Janet Yellen obviously understands this. As she had said in a press conference in September 2014 “There are still too many people who want jobs but cannot find them, too many who are working part-time but would prefer full-time work.”
Taking all these factors into account the Federal Reserve is unlikely to start sucking out all the money it has printed and pumped into the financial system any time soon. Nevertheless, whenever it gets around to doing that there will be trouble ahead.
Lanchester perhaps summarises the situation well when he says: “If a medicine is guaranteed to make you very sick when you stop taking it, and you know that one day you’ll have to stop taking it, then maybe you shouldn’t start taking it in the first place.”
But that at best is a benefit of hindsight. The horse, as they say, has already bolted by now.

The article originally appeared on www.FirstBiz.com on Oct 29, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Fed may be reducing easy money, but here’s why Sensex will keep soaring

yellen_janet_040512_8x10Vivek Kaul

In theory there is no difference between theory and practice. In practice there is.

– Yogi Berra

A question I am often asked is why are the stock markets around the world still rallying despite the Federal Reserve of United States going slow on printing money. In a statement released yesterday the Fed decided to cut down further on money printing.
It will now print $15 billion per month instead of the earlier $25 billion. This was the seventh consecutive cut of $10 billion. Since December 2012, the Federal Reserve had been printing $85 billion per month. This money was pumped into the financial system by buying mortgage backed securities and government bonds. The idea was that by increasing the amount of money in the financial system, long term interest rates could be driven lower. The hope was that at lower interest rates, people would borrow and spend more.
From January 2014, the Federal Reserve decided to buy bonds worth $75 billion a month, instead of the earlier $85 billion. This meant that the Fed would be printing $75 billion a month instead of the earlier $85 billion. This cut in money printing came to be referred to as “tapering”, which means getting progressively smaller. Since then the amount of money being printed by the Federal Reserve has been tapered to $15 billion per month. At this pace the Federal Reserve should be done at dusted with its money printing by next month i.e. October 2014.
A lot of this printed money instead of being lent out to consumers has found its way around into stock markets and other financial markets around the world. The Dow Jones Industrial Average, America’s premier stock market index, has rallied more than 30% since October, 2012. This when the American economy hasn’t been in the best of shape.
The FTSE 100, the premier stock market index in the United Kindgom, has given a return of 15% during the same period. The Nikkei 225, the premier stock market index of Japan has rallied by 53% during the same period. Closer to home, the BSE Sensex has rallied by around 43% during the same period.
Stock markets around the world have given fabulous returns, despite the global economy being down in the dumps. The era of easy money unleashed by the Federal Reserve has obviously helped.
Nevertheless, the question is with the Fed clearly signalling that the easy money era is now coming to an end, why are stock markets still holding strong? One reason is the fact that even though the Fed might be winding down its money market operations, other central banks are still continuing with it.
The Bank of Japan, the Japanese central bank is printing around ¥5-trillion per month and is expected to do so till March 2015. The European Central Bank is also preparing to print €500-billion to €1-trillion over the next few years. What this means is that interest rates in large parts of the Western world will continue to remain low. Hence, big institutional investors can borrow from these financial markets and invest the money in stock markets around the world.
The second and more important reason is that the Federal Reserve does not plan to shrink its balance sheet any time soon. Before the financial crisis started in September 2008, the size of the Federal Reserve balance sheet stood at $925.7 billion. Since then it has ballooned and as on August 27, 2014, it stood at $4.42 trillion.
The size of the Fed balance sheet has exploded by close to 378% over the last six years. This has happened primarily because the Fed has printed money and pumped it into the financial system by buying bonds, in the hope of keeping interest rates low and getting people to borrow and spend.
Janet Yellen, the current Chairperson of the Federal Reserve made it very clear yesterday that the Fed was in no hurry to withdraw this money from the financial system. It could take to the “end of the decade” to shrink the Fed’s huge balance sheet “to the lowest levels consistent with the efficient and effective implementation of policy.”
What this essentially means is that the money that the Fed has printed and pumped into the financial system by buying bonds, will not be suddenly withdrawn from the financial system. When a bond matures, the institution which has issued the bond, repays the money invested to the institution that has invested in it.
If the investor happens to be the Federal Reserve, the maturing proceeds are paid to it. This leads to the amount of money in the financial system going down, and could lead to interest rates going up, as money becomes dearer.
This is something that the Fed does not want, in order to ensure that individuals continue borrow and spend money, and this, in turn, leads to economic growth. Hence, the Fed will use the money that comes back to on maturity, to buy more bonds and in that way ensure that total amount of money floating in the financial system does not go down.
This means that long term interest rates will continue to remain low. Hence, investors can continue to borrow money at low interest rates and invest that money in different parts of the world.
Yellen also clarified that short-term interest rates are also not going to go up any time soon. As she said “economic conditions may for some time warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”The federal funds rate is the interest rate that banks charge each other to borrow funds overnight, in order to maintain their reserve requirement at the Federal Reserve. This interest rate acts as a benchmark for short-term loans.
Given these reasons, the stock markets around the world will continue to rally, at least in the near term, as the era of easy money will continue. These rallies will happen, despite global growth being down in the dumps and the fact that the global economy is still to recover from the financial crisis that started just about six years and three days back, when the investment bank Lehman Brothers went bust on September 15, 2008.
To conclude, Ben Hunt who writes the Epsilon Theory newsletter put it best in a recent newsletter dated September 8, 2014, and titled The Ministry of Markets: “No one doubts the omnipotence of central banks. No one doubts that market outcomes are fully determined by central bank policy. No one doubts that central banks are large and in charge. No one doubts that central banks can and will inflate financial asset prices. And everyone hates it.”
The article appeared originally on www.FirstBiz.com on Sep 18, 2014

 (Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)