A farewell to easy money
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“The excess credit which the Fed pumped into the economy spilled over into the stockmarket, triggering a fantastic speculative boom,” wrote Alan Greenspan in 1966, doling out blame for the crash of 1929 and the Great Depression. The irony is that many accuse him of making exactly the same mistake during his stint in charge of the Federal Reserve – and say that the unwinding of this policy is at least partly responsible for the jittery state of the markets.
“Abundant liquidity has helped support asset prices from Iceland to India, housing to hedge funds, and commodities to consumer credit,” says The Economist. But “one prominent fear is that central banks are draining liquidity from the financial system”. As central banks, led by the Fed, crank up interest rates, investors will tend to move away from riskier assets, a factor that’s contributed to the rapid sell-offs of recent weeks. This effect balloons when large amounts of the money being invested is borrowed (which has been the case with our recent exceptionally low rates), as investors are forced to sell to cover their debts, meaning that the rush for the exits becomes all the greater, says Philip Coggan in the FT.
Of course, this is not just down to the Fed. Many believe there’s been an even bigger impact from the Bank of Japan abandoning the ultra-easy money policy that it’s pursued for years in its battle against deflation. It has withdrawn ¥20trn of excess funds from its banking system since March and is likely to begin raising interest rates (from zero at present) in the near future. “When the Japanese central bank reduced the excess liquidity, this situation had a global effect on currencies, bonds and stocks,” says George Soros, quoted by Bloomberg.
So far, liquidity has not dried up completely. “In much of the world, money remains cheap, and plenty is still being recycled through global bond markets,” says The Economist. But there are fears over what will happen if banks continue tightening. “Normal [credit] conditions are a lot tougher than what we have been used to,” says Tony Jackson in the FT. If liquidity reverts to normal, markets could “grind along for the next few years going nowhere”. Or worse.
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