Cash can be addictive. Once bankers and investors get hooked on lots of it sloshing around, weaning them off is akin to getting a chain smoker to give up his two packs a day.
That’s what seems to be happening in the global economy right now. After five years of largesse, the Federal Reserve is faced with the daunting task of exiting from the unorthodox stimulus programs that have flooded the world with dollars. As a result, financial markets seem set to endure all the nervousness and tetchiness of nicotine junkies deprived of their smokes.
The proof can be found in the tumult in world stock and currency markets in recent days. Last week, global investors expected Federal Reserve Chairman Ben Bernanke to announce that he would begin to “taper” his program of quantitative easing, or QE, in which the Fed buys $85 billion of bonds a month to support growth. Yet in a surprise move, he didn’t, citing uncertainty about the strength of the U.S. economic recovery.
“We want to make sure that the economy has adequate support,” Bernanke said in a press conference, “until we can be comfortable that the economy is, in fact, growing the way we want it to be growing.”
You’d think such a statement would scare investors. After all, the U.S. is the world’s largest economy, and any indication its recovery may be sputtering (again) should be a negative for markets. Not so this time. Stock markets around the world soared. Even the stocks and currencies of emerging markets like India and Indonesia, which had gotten battered in anticipation of the taper, rebounded strongly.
The reaction is a sign that investors have become more worried about liquidity than fundamentals. Like a smoker gladly unwrapping a fresh pack, they let themselves be cheered by the promise of further Fed cash rather than be dismayed by what it might mean. This is understandable. Ever since the collapse of Lehman Brothers in 2008, bankers, corporate executives and investors have become accustomed to operating in a global economy where money is cheap and easy to obtain. Central banks in the developed world have kept interest rates extremely low, even near zero in the U.S. and Japan, to support sagging economies.
Those efforts continue. The Bank of Japan is undertaking a QE stimulus program of biblical proportions in an attempt to finally resurrect the country’s perpetually stalled economy. These policies may have prevented the Great Recession from becoming a depression, but they are also abnormal, and the cheap stuff can’t keep coming forever. Eventually, executives and bankers around the world are going to have to get used to investing, borrowing and lending in the “old” normal — the precrisis environment when the cost of money was higher.
The problem is that the easy-money policies have already influenced global markets. Low interest rates have encouraged corporations and consumers to take on debt in Asia, for instance, and have pumped up property prices in places like Hong Kong. With dollars so readily available, companies in Indonesia and India have borrowed heavily in the greenback. Unwinding all this won’t be easy, and the gyrations in financial markets over the past several months show the delicate game the Fed must play in managing it.
Bernanke tried to engineer a peaceful retreat by giving the world’s bankers ample notice of his intentions, signaling the Fed’s plan to taper way back in May. That failed. In response, investors stampeded out of emerging markets from South Africa to Brazil, tanking currencies and roiling stock markets. Speculation on what the Fed may or may not do, and when, has dominated financial markets for months.
The Fed’s decision to delay its tapering has probably just delayed the further upheaval that will result. Research firm Capital Economics commented in a Sept. 19 note that the postponement might have given the more troubled emerging economies some breathing space, but the decision “is best viewed as a temporary reprieve rather than a stay of execution.” Sooner or later, every smoker has to face up to the fact that they have to quit.