Sensex hits record high: Now Japan takes over the easy money party from the US

japanVivek Kaul

Two days after the Federal Reserve of the United States brought to an end its money printing programme, the Bank of Japan decided to do exactly the opposite. In a surprise move the Japanese central bank on Friday (October 30, 2014) decided to increase the amount of money it has been printing to get the Japanese economy up and running again.
The Bank of Japan will now print 80 trillion yen (or around $727 billion) per year. The central bank has been printing money since April 2013 and was earlier targeting around 60-70 trillion per year. It pumped this money into the financial market by buying Japanese bonds.
In fact, the Bank of Japan entered the money printing party rather late. The money printing efforts of the Japanese central bank in the aftermath of the financial crisis were rather subdued and it had expanded its balance sheet (by printing yen and buying bonds) by only 30% up to December 2012. And then things changed.
This was after Shinzo Abe took over as the Prime Minister of the country on December 26, 2012. He promised to end Japan’s more than two decades old recession through some old-fashioned economics, which has since been termed as Abenomics.
Abenomics is nothing but money printing in the hope of creating some inflation. Abe’s plan was to get the Bank of Japan to go in for money printing and use the newly created “yen” to buy Japanese bonds.
By buying bonds, the central bank ended up pumping the printed money into the Japanese financial system. The hope was that all this extra money in the financial system would lead to lower interest rates. At lower interest rates people would borrow and spend more, and in the process the government would manage to create some inflation, as more money would chase the same amount of goods and services.
The Bank of Japan, the Japanese central bank, went with the government on this and is targeting an inflation of 2 percent. It wants to reach the goal at the earliest possible date, by printing as much money as maybe required.
And how will that help? In December 2012, Japan had an inflation rate of –0.1 percent. For 2012, on the whole, inflation was at 0 percent, which meant that prices did not rise at all. In fact, for each of the years in the period 2009–2011, prices had fallen in Japan.
When prices are flat, or are falling, or are expected to fall, consumers generally tend to postpone consumption (i.e., buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses, as their earnings either remain flat or fall. This slows down economic growth.
On the other hand, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So, by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decades old recession.
In fact, when it started to print money, the Bank of Japan had planned to inject $1.4 trillion into the Japanese financial system by April 2015. This was pretty big, given that the size of the Japanese economy is around $5 trillion. Now it will end up printing even more yen. The size of the balance sheet of the Bank of Japan has gone up rapidly since March 2013, a month before it actually started to print money.
Back then the size of the balance sheet of the Bank of Japan had stood at 164.8 trillion yen. Since then it has jumped
to 276.2 trillion yen as of September 2014. This has happened because the Bank of Japan has printed money and pumped it into the financial system by buying bonds.
The question is why has the Bank of Japan decided to increase the quantum of money printing now. The answer lies in the fact that even with all the money printing it hasn’t managed to create the desired 2% inflation even though the inflation in Japan is at 3.4%. But how is that possible? As investment letter writer
John Mauldin explains in a recent column “What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voilà, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1%.”
Given this, the real inflation is at 1%. The Bank of Japan wants to increase it to 2% and hence, has decided to print more money than it did before.
The irony is that Bank of Japan like other central banks in the developed-world before it have, is trying more of a policy which hasn’t worked for it. James Rickards explains this dilemma beautifully in
The Death of Money: “the great dilemma for the Federal Reserve and all central banks that seek to direct their economies out of the new depression [is that] … the more these institutions intervene in markets, the less they know about real economic conditions, and the greater the need to intervene.”
This move by the Bank of Japan also means that the era of “easy money” will continue. More money will now be borrowed in yen and make its way into financial markets all over the world. In fact, the Indian stock market has already started partying with the Sensex rallying by 519.5 points or 1.9% and closing at 27,865.83 points on Friday.
And this is the irony of our times. The stock markets treat bad economic news as good news because the investors know that this will lead to central banks printing more money as they try and get economic growth going again.
As Gary Dorsch, Editor, Global Money Trends newsletter, wrote in a recent column “Bad economic news is treated as Bullish news for the stock market, because it lead to expectation of more “quantitative easing.” Quantitative easing is the term economists use for central banks printing money and pumping it into the financial system by buying bonds. This is precisely what is happening in Japan.
As Dorsch further points out “And the easy money flows that are injected by central banks go right past goods and services (ie; the real economy) and are whisked into the financial markets, where it pushes up the prices of stocks and bonds. In simple terms, what matters most to the stock markets are the easy money injections from the central banks, and to a lesser extent, the profits of the companies whose stocks they are buying and selling.”
To conclude, this is not the last that we have seen of a developed-world central bank deciding to print more money to create some inflation. There is more to come.
Stay tuned.

The article originally appeared on www.FirstBiz.com on Nov 1, 2014

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

Federal Reserve ends money printing, but the easy money party will continue

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee(FOMC) which decides on the monetary policy of the United States in a statement released yesterday said “the Committee [has] decided to conclude its asset purchase program this month.”
What the Federal Reserve calls “asset purchase program” is referred to as “quantitative easing” by the economists. In simple English this is just the good old money printing with a twist. Since the start of the financial crisis, the Federal Reserve has printed around $3.6 trillion of new money.
This month the Federal Reserve has printed around around $15 billion. It has pumped this money into the financial system by buying government bonds and mortgage backed securities. From November 2014, the Federal Reserve will no longer print money to buy government and private bonds.
So why is the Federal Reserve bringing money printing to an end? The simple reason is that with so much money being printed and pumped into the financial system, there is always the threat of too much money chasing too few goods, and leading to a massive price rise in the process. Even though something like that has not happened the threat remains.
As John Lanchester writes in
How to Speak Money “More generally QE[quantitative easing] taps into the fear that governments printing money always leads to dangerous levels of inflation, and that inflation, like a peat-bog fire, is all the more dangerous when it’s cooking up underground.”
There have been too many instances of money printing by the government leading to massive inflation in the past. And the Federal Reserve couldn’t have kept ignoring it.
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 despite slow economic growth in large parts of the world.
So with the Federal Reserve deciding to stop money printing, will the era of easy money come to an end as well? The answer is no. For “easy money” junkies the party will continue. The Federal Reserve stated yesterday that “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial condition.”
What does this mean in simple English? The Federal Reserve has printed and pumped money into the financial system by buying bonds. It currently holds around more than $4 trillion worth of bonds.
Bloomberg points out that this makes up for around 20% of all the bonds issued by the American government as well as mortgage backed securities outstanding. The Federal Reserve holds around $2.46 trillion of US government bonds.
In the days to come as these bonds mature, the Federal Reserve plans to use the money that comes back to it to buy more bonds. In this way it plans to ensure that the money that it has printed and pumped into the financial system, stays in the financial system.
Hence, 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 Federal Reserve also stated that fit plans keep interest rates low “for a considerable time following the end of its asset purchase program this month.”
By doing this, the Federal Reserve is essentially buying time. Currently, it is very difficult to predict how exactly the financial markets will react if the Fed decides to start sucking out all the money that it has printed and pumped into the financial system.
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.” Further, 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. Alan Greenspan, the former Chairman of the Federal Reserve, recently said that the next phase of Fed’s retreat would not be so smooth and the Fed would not able to avoid turmoil. “I don’t think it’s possible,” Greenspan said.

The column is an updated version of a column that appeared on October 29, 2014. You can read it here.

(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)

The Wrong Causality

george cooper photo (2)

Vivek Kaul

Raghuram Rajan, the governor of the Reserve Bank of India (RBI), gave a spate of interviews to international publications in early August 2014. In these interviews he talked about the financial markets bubbles that have sprouted up all over the world, due to Western central banks printing a lot of money over the last six years.
In an interview to the Time magazine Rajan said that central bankers had constantly “infused liquidity into the markets” (basically printed money and pumped it into the financial system) in order to ensure that interest rates continue to remain low. The idea was that at low interest rates people would borrow and spend more money and this would lead to economic growth.
But that doesn’t seem to have happened. Instead a lot of this money has been borrowed at low interest rates and has found its way into financial markets all over the world. As Rajan told the Central Banking Journal “The problems arising are not so much from credit growth, which is relatively tepid in the industrial markets and has been much stronger in emerging markets, but from asset prices due to financial risk-taking and so on.”
With so much “easy money” floating in the financial system, investors have borrowed money at very low interest rates and invested them in financial markets all over the world. This has led to prices of financial assets (shares, bonds etc) being pushed way beyond their fundamentals justify.
Or to put in simple English financial markets through large parts of the world are now in a “bubble” (a word that central bankers do not like to use) phase.
This is something that economists who run central banks have refused to see. As Rajan put it “ Unfortunately, a number of macroeconomists have not fully learned the lessons of the great financial crisis. They still do not pay enough attention – en passant – to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you.”
The trouble is that no one really can predict when exactly will these bubbles burst. Rajan admitted to as much in an interview to the Financial Times when he said “the truth is, nobody really knows where the next one will come.” Nevertheless, when these bubbles start to burst, there will be trouble of the kind that the world experienced in 2008, all over again. As Rajan put it “We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”
The question is why has been there so much faith among economists when it comes to printing money. George Cooper explains this very well in his book Money, Blood and Revolution. As he writes “[The] monetarists economists believed the money supply controlled economic activity and therefore monitored it to measure and forecast economic activity. When they found that their forecasts were verified they naturally assumed that their thesis – money controls economic activity – was proven.” Hence, when the economy was not doing well, it made sense to crank up the printing presses, print more money, increase the money supply and get the economy going again all over again. QED.
This was the formula followed in the aftermath of the financial crisis that broke out in September 2008, with the investment bank Lehman Brothers going bust. Trillions of dollars, pounds, yen and renminbi, have been printed and pumped into the financial systems all over the world. This policy in central banking terminology has been referred to as quantitative easing.
The question is how effective has quantitative easing really been? As Cooper puts it “These policies have had, at best, mixed results so far. It is sobering to contemplate that all of this money may have been spent based on a basic misunderstanding of cause and effect.”
And what is this misunderstanding? Cooper explains this through an example of an economist who starts to study the number of trucks travelling on a motorway system. After having studied this for a while, it becomes obvious to the economist that there is a relationship between “the number of trucks travelling in a given period and the subsequent reported level of economic activity”. Hence, the economist draws the conclusion that road freight activity is a key driver of economic activity. So far so good.
This economist then goes on to found the freightist school of economics. The school then lobbies the government and policies that encourage the movement of trucks moving goods on the roads, are put in place.
Taxes are cut and schemes to subsidise the purchase and running of trucks are introduced. The first results of this experiment are positive as the economy grows. This leads to the government directly subsidising freight journeys. And this is where the problem starts. As Cooper puts it “Eventually truckers start driving freight up and down the country just to harvest subsidies. The economy stops growing but the freight statistics shoot through the roof. The relationship between economic activity and road freight breaks down.”
A basic mistake has been made here. “The freightist school has mistaken the direction of the causality between road freight and economic activity. Stronger economic activity causes more road freight but more road freight does not necessarily cause more economic activity,” writes Cooper.
A mistake along similar lines has been made by central banks all over the world, during the last few years. When economic activity picks up, money supply picks up as well. But that does not mean that the level of money supply can be manipulated to increase economic activity. As Cooper summarises it “Money is a measure of credit, and credit, like truck journeys, is created and destroyed according to the prevailing economic activity. Money supply, in its various forms, is an excellent measure of economic activity when left alone. But it cannot be used as an instrument to control the economy.”
In Cooper’s example we saw truck drivers driving freight up and down the country simply to harvest subsidies. Over the last six years, investors have worked along similar lines. They have borrowed money at very low interest rates and invested them in financial markets all over the world. And this has led to huge bubbles, which will burst in the years to come.

The column originally appeared in the Wealth Insight magazine for Sep 2014 

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected])

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)