Learning by Doing

Actions lead to consequences and, whether intended or unintended, results are real. When the then UK Prime Minister Gordon Brown called a meeting of the G20 on November 15th 2008 in London, the world was the closest it had been at any time in history to a collapse in the financial system. European banks had run out of US Dollars, the lubricant of the global trading system.

Like the British economy and Sterling in the 18th century, no economy can be dominant without also having the world’s reserve currency. Sixty-one per cent of global transactions are currently in the US Dollar.

The response of governments in 2008 was to authorise their central banks to embark on aggressive monetary policy, flooding billions of USDs into the capital markets. Central banks rode out as the 7th cavalry but, unlike bankers who were blamed for the crisis, central bank leaders became cult figures with celebrity status.

When the Chair of the European Central Bank (ECB) said he would do whatever it takes to keep the Euro from failing, Mario Draghi was hailed as a hero. As he finishes his term as Chairman, he is courted by a fawning media for saving the planet in 2008, along with Ben Bernanke Chairman of the NY Federal Reserve. Ten years on and the central bank’s genius has given us negative interest rates, penalising savers, the very catalyst required to produce investment into an economy while destroying the motivation of young to save.

When interest rates are negative in either real or nominal terms (not adjusted for inflation), cash is no longer helpful to savers, forcing many to invest in risky assets which they should not own. At the time of Draghi leaving the ECB, savers in Euro receive a negative nominal return of minus half of one per cent. With inflation in the eurozone at one per cent, savers are guaranteed to lose money by saving. If this is the work of a hero, I would hate to see what a ‘villain’ would do?

But he is not alone. In August a quarter of G20 central banks lowered their interest rates. And they can go lower. Rates are still positive outside Japan and the eurozone. To receive less than the nominal sum that you deposit with a bank or to guarantee that you will lose capital if giving it to the government just feels wrong – even unnatural. Central bankers, far from being seen as heroes, are increasingly seen by the public as ‘alchemists’, experimenting in their financial laboratory.

The huge build-up of public and private debt is one of the most serious causes of the experiment with monetary policy. In this highly leveraged sub-zero interest rate environment with central banks ‘learning by doing’, savers and investors need to be very careful if chasing yield and need to examine carefully at a company’s balance sheet before buying into high-yield debt no matter where the recommendation comes from.

Jeremy Blatch TEP
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