3 minute read
Fed Policy
DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle
Markets Crash as Monetary Stimulus Fades
The main issue in the economy is that there are two generations of market participants who have only witnessed expansionary policies. That’s why the most pressing question for investors isn’t where earnings are headed or what the rate of change in economic growth is, but when central banks will pivot.
The Federal Reserve and other big central banks have caused a massive crisis. On the one hand, major central banks’ balance sheets have stayed intact in local currency in 2022, and the path of rate hikes is quite accommodating. On the other hand, markets are collapsing. How is this possible? Because central banks believe that their actions carry no consequences as there’s a legion of economists who twist facts to say that there’s no problem. However, the contrary is true. Markets and politicians are so accustomed to easy money that even the slightest normalization causes havoc around the world.
The first issue is that a great majority of the world’s $90 trillion in reserves is invested in a carry trade against the U.S. currency. The second is that negative nominal and real rates have zombified the corporate world and led governments to feel that debt is unimportant. The third issue is significantly more serious. Investors and governments have been made to believe that announcements of rate hikes and liquidity reductions should be ignored because policymakers ignore them anyhow.
All of this has resulted in an overindebted environment in which corporations with weak strategies found adequate cash to survive and in which multiple expansions in every sector, from listed to private ventures, weren’t an outlier but the norm. And this excess, which has been sustained over the previous 14 years by absurdly lax policies conducted in times of expansion and recession, has fostered an addiction to gradually more aggressive monetary operations.
We’re taught that central banks must choose between recession and inflation. This is a logical fallacy.
Recessions aren’t caused by central banks raising interest rates. They’re the result of years of excessive debt, malinvestment, and reckless risk-taking.
Markets are crumbling because the seemingly unstoppable expansion of prior years was based on a monetary illusion. Monetary laughing gas makes you smile but doesn’t cure.
Many analysts and investors have warned for years about undue complacency and unjustifiable valuations, only to be dismissed as doomsayers because all you had to do was follow the Fed.
With a minor fall in the global money supply, no substantial reduction in central bank balance sheets, and extremely gradual rate hikes announced for months on end, markets have plummeted. However, markets can’t accept even minor changes. The junkie requires another fix, a large and steadily increasing fix.
Some commentators now worry that central banks are tightening too quickly, despite the fact that they were silent during the most strange and dramatic increase in the monetary base in recent history.
Those who championed a $20 trillion expansion in 2020 are partially responsible for the 2022 crash.
The current global economic trainwreck demonstrates the deeply unethical nature of printing money and allowing central banks and governments to become lenders and providers of last resort. It harms the middle class on its way in and destroys it on its way out.
The artificial creation of money is never neutral. It disproportionately favors the first recipients of newly generated currency, the government and the indebted, while severely harming deposit savings and real wages.
The 2020 stimulus plan was the largest ruse ever played on humanity. It was unnecessary in the first place because all that happened was that governments locked us all up because of a health issue. It was unnecessary to incentivize debt, expenditure, or money supply. It just established false bottlenecks in the chain of stimuli, resulting in a worse scenario.
Those who complain about central banks raising interest rates too quickly should have warned about the 2020 lunacy. It no longer matters whether central banks pivot. The fallout from stimulus initiatives is already affecting economic growth and company profitability. Even if rate hikes were slower, markets would have seen a valuation reality check. Bubbles burst. Always. The only remaining question is when.
