Stock markets bounced off the weak start to 2015 and rallied sharply to new highs in most major global stock markets in February (actually the market low for the year was on January 15th).  Investors merrily ignored the risks of debt default by Greece, escalating tensions between Russia and the Ukraine, slowing earnings growth, weakened 2015 guidance, stock valuations near record highs and anemic global growth and bought back into stocks because they are the ‘only game in town’. The bullishness continues to come from the one and only source of comfort for all ‘risk’ investors: the zero interest rate policies of almost all of the world’s central banks. It’s the central banks’ world, and we’re just living in it.  I can safely put away all of my economics textbooks from university because the policies being implemented can’t be found in any of them.  Never in history have the monetary machinations so dominated financial markets and economies. As in Star Trek, they have “gone boldly where no” central banks have gone before—pushing interest rates below zero, once thought to be a practical impossibility.

A graphical representation of what the US central bank (Federal Reserve) is up to is shown in the chart below.  After maintaining a relatively clean balance sheet for most its existence, the Fed has gone on a ‘bond buying binge’ in the past few years in order to force longer-term interest rates lower.   Prior to this the Fed had used short-term interest rates to implement their policies.  But after taking short-term rates to 0.25% they had nowhere to go so they had to actually borrow money to buy bonds and drive all interest rates lower.  The theory was that these lower interest rates would provide the stimulus necessary to get the economy revved up and return growth to normal levels after the 2008 financial crisis.

Money Supply Supports Markets

While the debate continues as to the ultimate success of this policy in stimulating economic growth, there can be no doubt as to the impact on financial markets, which has been unequivocally positive.  But the intention was to stimulate economic growth, not to create a bull market in financial assets, unless the theory was that investors would take that newly found wealth and spend it on real goods and services.  However, the ‘central bank fever’ has spread!   After numerous sessions of QE in the United States, Japan jumped into the fray with their own version of central bank intervention, nicknamed ‘Abenomics’ for Japanese Prime Minister Shinzo Abe.  The Japanese version was even more aggressive as they targeted not only bonds but also stocks of Japanese as well as foreign companies.  While this also lead to the best three years the Japanese stock market has seen since the 1980’s, it has really done nothing to ‘jump-start’ economic growth as the Japanese economy remains mired in their post-Fukushima recession.  Other central banks such as the People’s Bank of China also got into the act with a low interest rate policy and loosened lending restrictions which helped state-owned enterprises increase their borrowing.

Then the European Central Bank (ECB), lead by Mario Draghi, decided to get into the QE game by proposing a bond-buying program of around US$60 billion per month for the next 18 months.  While getting 18 central bankers to agree on a major policy is always a stretch, particularly when the most influential member is the ‘always conservative’ German Bundesbank, they did manage to get everyone on board and announced this QE program early in 2015, validating Mario Draghi’s promise to do ‘whatever it takes’ to get growth turned back up in the Euro-zone. After watching the S&P500 stock index in the U.S. soar to an all-time high, the Europeans were clearly anxious to kick the same can down the road and sacrifice their balance sheet for some near-term recovery.  They seem to have gotten their wish for now as European stocks have been global market leaders so far in 2015, with many of the members’ stock markets moving to all-time highs.  The resultant ‘crash’ in the Euro has helped to improve economic growth in the region as well.  That would be unremarkable if central bankers had created true prosperity.  But real, currency-adjusted global growth will most likely come in unchanged in 2015.  Not since the 1930s have central banks of countries around the globe so actively, and desperately, tried to stimulate their domestic economies. Confronted by a lack of domestic demand, which has been constrained by a massive debt load taken on during the boom times, they instead have cut rates and depreciated their currencies to try to grab a bigger slice of the global economic pie.  Unfortunately, not everybody can gain a larger share of a whole that isn’t growing—or may even be shrinking. That was the lesson of the “beggar thy neighbor” policies of the Great Depression.  Stock markets may be at all-time highs, but the underpinnings that have gotten them there are neither real nor sustainable.  Like the Greeks are painfully discovering, those massive debts will come back to haunt you at some point in time and you can’t ‘kick the can down the road’ forever.

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