Another nice piece today from Chris Joye on the bizarro world of ZIRP in which we find ourselves:
By fiddling with risk-free rates, governments can manipulate all asset prices, which is tempting when politicians are searching for short-term wins. So in addition to lowering overnight cash rates to levels never seen before – they are near zero or negative in America and Europe – central banks have printed more than $10 trillion of fresh money to buy government bonds of all maturities.
Beyond artificially inflating bond prices, lowering risk-free rates and boosting asset prices, this also conveniently cuts sovereign debt servicing costs, which perversely only encourages governments to leverage up more.
Two of the most important questions for portfolio construction today are how savage the adjustment will be when governments withdraw from wholesale market manipulation and what could trigger this event
…The trigger will probably be the return of wage inflation in the US and China feeding into global prices. I suspect central banks will get behind the curve and allow history to repeat itself with our own 21st-century Volcker moment.
One day, sure. But not this cycle, and perhaps not the next, either. The lesson to bear in mind is that of Japan. The world has a vast dearth of demand, or a an oversupply of production, depending upon your perspective. Capital circulates much more easily than labour, arbitraging the entire planet to keep costs down, most of the Western world and China are sinking into a demographic mire, we’ve just installed several decades worth of global commodity capacity and then there is the huge global debt overhang.
These are structural headwinds to inflation that will last decades. Central banks and governments will try and even succeed briefly to reflate but the downtrend for prices and yields is set.
Given there will be no interest rate “normalisation” in post-crisis economies, inflated financial asset prices (equity and bonds) are the rational new norm, not necessarily “irrational” or “bubbles”.
Ironically, the same cannot be said for the assets in those economies yet to make the adjustment to the widening deflationary circumstance.
