In yesterday’s Money Morning we looked at negative interest rates.
We noted how the Danish central bank had cut the benchmark lending rate to minus 0.1% in 2012.
That means it costs banks to hold money on deposit at the central bank, thus removing the incentive for banks and consumers to save.
Instead, it encourages banks to lend money to borrowers, and it encourages borrowers to borrow money.
The Danish plan has ‘worked’, if working means that stocks have gone up. The OMX Copenhagen 20 index has climbed 160% since the 2009 low. We also mentioned how the US Federal Reserve was creating and would continue to create an asset bubble.
Based on the latest data, its plan is working too…
Yesterday we pointed out that central banks still have many more tricks up their sleeves. The idea that they can’t do anything more because interest rates are already low is false.
They can do plenty more.
One option is to follow the Danish lead and cut interest rates to below zero. That may work in what we could call a ‘second tier’ economy, but it may not cut it in one of the major economies.
After all, you’d think the one country to try such a policy after two decades of low interest rates would be Japan. But however tempted the Japanese may have been to do so, they haven’t yet cut the interest rate to below zero.
The other option, the option central banks seem to prefer, is to be more discreet (devious is probably a better word). That involves using inflation.
Two Reasons Why Central Banks ‘Print’ Money
The central bankers’ most well-known use of inflation in recent years is their policy of ‘printing’ new money in order to buy government bonds. This serves two purposes. First, it creates a guaranteed buyer for government debt.
That means the government doesn’t have to stop spending.
The second purpose is to induce inflation. If the central banks can push more money into the economy it should raise prices, which they hope will also raise incomes, which they hope will make it easier to repay loans, which they hope will make consumers more likely to take out new loans.
We say that it’s a devious trick because the truth about inflation is that it doesn’t increase wealth. In fact, it does the opposite. General price rises inflict harm on savers and income earners because, typically, wage rises lag price rises.
Furthermore, it harms people who stop working (such as retirees or those who become unemployed) because prices continue to rise even though their income earning capacity may have stopped. It’s why even in retirement, retirees still need to try to earn an income and take risks by investing because they know if they don’t inflation will gnaw away at their savings.
This is why we say investors have to invest in riskier assets (where you can get big returns) such as stocks, rather than just staying in cash. Proof of that is in the latest report from the Financial Times:
‘US inflation expectations have jumped to their highest since May, with central banks and investors seeking insurance against the prospect that a recovering American economy will stoke price pressures.
‘Inflation expectations, as measured by the difference between yields on 10-year nominal Treasury notes and Treasury inflation protected securities (Tips), have risen to 2.28 per cent from a low of around 2.10 a month ago.‘
Just remember that the typical US investor who would like to keep their money in a ‘safe’ bank account earns close to zero on their deposits. Thanks to the central banks, which are apparently seeking ‘insurance’ against inflation (the inflation they’ve created), savers have to take big risks in the stock market.
Stocks Go Up, What Could Possibly Go Wrong?
So, the plan is working.
Stocks are going up. Inflation is inflating. And governments can keep spending.
OK. You know that’s a tongue in cheek comment. There’s plenty that can go wrong, which is why you need to be an active investor in this market, keeping a close tab on what’s happening to your investments.
The Aussie market gained 16% last year. It was a bad time to be in cash. A portfolio of individual stocks would have done even better, especially if you had bought into some good dividend payers when we told you to back in late 2011…and again when we suggested increasing your stock exposure at the end of 2012, the beginning of 2013, and mid last year.
Make no mistake. For all the stick we give central bankers, they’re working towards a plan. That plan isn’t necessarily beneficial for you or the economy.
But it is a plan that you can take advantage of to build your wealth, and fight back against the harm caused by inflation.
The way to do that is to pick a select portfolio of stocks priced at a good value, and where possible that pay a dividend.
As we pointed out yesterday and today, central banks have many tricks up their sleeves, so it’s premature to think this latest ‘Great Asset Bubble’ is about to pop anytime soon.
Cheers,
Kris+
From the Port Phillip Publishing Library
Special Report: Five Fatal Stocks You Must Sell Now
