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Home / Business

Don't get too comfy

Bernard Hickey
By Bernard Hickey
Columnist·Herald on Sunday·
29 Aug, 2015 05:00 PM3 mins to read

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Investors have been rescued time and again but if inflation takes off, central banks will have to put up interest rates. Photo / AP

Investors have been rescued time and again but if inflation takes off, central banks will have to put up interest rates. Photo / AP

Bernard Hickey
Opinion by Bernard Hickey
Bernard is an economics columnist for the NZ Herald
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This week's turmoil in global markets has reminded us all that we live in financially turbulent times. They are also morally hazardous times.

"Moral hazard" is the phrase for when investors take a risk knowing they cannot lose and that someone will bail them out.

Time and again since the Global Financial Crisis of 2007-08 a central bank or government has rescued investors from a true collapse.

First, interest rates were slashed to reduce the burden of high debts. Then banks were bailed out. Then, when interest rates were cut to zero, central banks printed money to buy bonds and other assets to push up their prices and drag long-term interest rates down.

The US Federal Reserve cut its Official Cash Rate to almost 0 per cent in 2008 and has left it there. It launched three rounds of so-called quantitative easing and has only just stopped printing money to buy Government bonds.

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The Bank of Japan has been printing for years and only recently ramped that up to try to lift its economy out of decades of perma-recession. The European Central Bank has cut its deposit rate to minus 0.2 per cent to try to force savers to invest. That means savers have to pay the bank to mind their money.

All this rate-cutting and money printing has made it attractive to buy stocks, property and bonds that produce a regular income greater than the near-zero interest rates.

Stock and bond markets have rallied to record highs in the past six years, despite the longest recession in the global economy since the 1930s. Bizarrely, it seems, the global economy is misfiring in many areas yet investors can be sure central bank governors and finance ministers will stop collapse.

This time appears no different.

China has blown $310 billion propping up a stock market that has fallen at least 43 per cent from its peak. It pushed the Chinese yuan lower and spent another US$200b to stop further falls.

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This week the People's Bank of China cut its main lending rate to 4.6 per cent and loosened lending rules for banks.

There is now talk the US Federal Reserve will delay until next year the long-feared and hoped-for increase in its version of the Official Cash Rate by the shocking amount of 0.25 per cent from nearly 0 per cent. Some are suggesting the Fed restart money-printing with a fourth iteration of quantitative easing known as "QE 4".

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But just how long will governments and central banks be able to use public balance sheets to turn the tides of markets?

There is technically no limit to the amount of money central banks can print. Governments can borrow as much as they want while interest rates are 0 per cent.

The moment of truth will come when, or if, inflation starts to rise. It would unleash the mother of market meltdowns in bond markets and quickly spread to stock markets.

But, curiously, all this money printing and 0 per cent interest rates have yet to unleash the inflation dragon, at least for goods and services. Asset prices are pumped up and juicy, but goods manufactured in factories and in cloud services are firmly in deflationary mode.

Many investors will feel bulletproof while inflation is dead. But they should be careful. All bets are off on this morally hazardous series of trades if inflation takes off. Then central banks would have no choice but to put up interest rates and the leveraged bets would go bad.

The key to this puzzle is inflation. It has the potential to unlock this moral hazard.

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