After a long time of ultra low interest rates, the lowest recorded in history; the central banks are raising them while telegraphing their intended way in advance. The Federal Reserve is leading the trend (which is ironic since it has not reserves), but Europe seems not to be far behind, especially the Bundesbank, that warned markets just recently.
One might ask the question – why now? It is my opinion that the rates are going up to address the looming pension crisis. The fixed income markets need a higher return to meet their obligation.
But the regime of low interest rates brings up something interesting – it means that inflation expectations are low (you can still buy a 10 year Treasury bond with a yield of less than 3%).
So here is the question – what happened with the massive amounts of money created by the FED and the European Central Bank as part of quantitative easing and asset buying programs? The answer is quite simple – the money sits as “excess reserves” at the Fed earning interest. And every European bank worth their salt is placing their money there through US subsidiaries to avoid negative interest rates back home.
The truth is that inflation can come only from labor. Tight labor markets encourage people to move around and demand higher wages, which in turn mean higher prices. It all spirals up.
This was the order of the world after the second war, with relatively closed national economies. Then, after inflation got out of hand in the 70’s, we experienced what Mark Blythe calls “capital friendly revolution,” or globalization, for short.
Labor lost its power – a wage increase demand has been met with production moving to lower cost countries. There has been no inflation and capital rules the day. Labor has been beaten into a bloody submission. They take increasing amounts of debts to make up for stagnant wages; just hardly anybody wants to admit that.
But you can’t stop human nature – something has to give. And give it does – we see it with Brexit, the Trump phenomenon, Spain debacle, Greece and more.
Balance must be restored.
So globalization is the real train wreck, but reality will eventually re-assert itself. I thing we’re starting to see it now, however slow the process to be sure, it is underway.
So where did all the money go? It went into gains that are not counted as inflation. If the S&P500 goes up 20% percent a year is that inflation? The earnings of the companies that compose it surely didn’t go up that much. Hell, some of the hottest ones are not even capable to make a buck (I am looking at you Amazon and Tesla).
If real estate flies high it doesn’t count either, it is the “rent equivalent” that goes into statistics. And the fortune just sits at the Fed earning interest.
Be very careful people, this is the stuff revolutions are made of. There is a term in psychology called “preference falsification”. People tend to display it lot, but at some point they stop - it’s all good until it isn’t. And the unrest spreads like a forest fire.