How cheap money took over the world

'And why shouldn't he sell up? It's not like he'll ever make that much money grilling cheese toasties or pouring coffee...

'He's been doing that every day for the last 40 years. Now his caf and the flat upstairs are worth £2.5 million [just shy of $5 million]. He can get rich overnight.

'And so what if Costa Coffee or one of the other big chains move in? So London's famously cool Soho district loses a little character...and it loses a little institution, too. But who cares? This guy certainly doesn't. He cashes out and never has to make a frothy coffee again.

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'The owner gets to retire rich. The chain store or some City outfit gets prime location, and the estate agent takes a fat fee plus there's sales tax on top for the government. Everyone's a winner, or they would be...if only Soho weren't becoming as bland as the rest of London.'

You've got to wonder is nowhere safe from the mischief of cheap money? A friend told me this story at a christening on Sunday!

But super-low interest rates down towards zero and below versus inflation aren't only talking too loudly in church. They have also driven West London house prices up by one-fifth in the last 12 months according to the gossips at the font. And they're turning big governments and small savers alike into full-time financial speculators.

'Wave of petrodollars hits UK,' reports the Financial Times today. One Saudi fund now owns 3.1% of HSBC, one of the world's largest banks. Dubai International Capital owns another big chunk. Funds controlled by Qatar own 17.6% of Sainsbury, the UK's No.2 supermarket.

British investors of a certain age may shiver at recalling this pattern. 'Gulf money has flooded into the UK before,' as Simeon Kerr, the FT reporter, notes. 'In the 1970s, the Kuwait Investment Authority led the way, buying slices of large western groups such as BP.' When the Saudi money turned tail and fled right alongside a collapse in oil prices driven by tight money and higher interest rates worldwide the Pound Sterling suffered a five-year collapse from $2.50 to just $1.00 vs. the Dollar.

'The current wave of Gulf money, driven by an oil boom that has seen oil prices peak at $78, has been on a different scale,' says Kerr. The late 1970s was the last extended period when borrowing cash made you richer than saving it. Now real rates of interest on the Dollar, Sterling, Euro, Yen and Swiss Franc sit near to zero again.

Tip the Chinese Yuan into the mix, and is it any wonder oil prices have trebled in the last half-decade? The flood of money is simply washing back whence it came.

'Thanks to huge trade surpluses in Asia and massive oil revenues in Saudi Arabia and Russia,' reports Reuters today, 'sovereign wealth funds designed to maximize returns on part of a country's currency reserves have blossomed in recent years.'

'The 13 biggest funds manage assets totaling of $2.1 trillion, according to estimates by Lehman Brothers,' says the newswire, 'potentially allowing them to exert hefty influence on global asset prices.'

Government-run agencies, in short, now control liquid assets through investment funds equivalent to a whole year of China's GDP. Yet there's only more mischief ahead.

'OECD says monetary policy to blame for buy-outs,' announces Yahoo. The Organization for Economic Co-Operation & Development said today that 'private equity plays a valuable role in helping to transform under-performing companies [but it could create] adverse consequences for investors.'

'The current boom in private equity, as a share of the economy, is much stronger than the previous late-80s leveraged buy-out boom,' notes the OECD report, 'which did end in tears and a number of criminal charges by 1991.'

Who's to blame for the criminal charges that will be brought against leveraged buy-outs in 2008 and beyond? 'If one fixes the price of money in parts of the world economy,' says the OECD, 'one will not be able to control its supply. The recycling of this [fixed-exchange] money is an integral part of the arbitrage opportunity that is driving the private equity boom. Easily the main contribution to the measure of global liquidity in 2006 is Chinese foreign exchange market intervention.'

Tied to the Dollar, the Chinese Yuan fails to reflect China's surging economy or so goes the theory. Either way, China's super-low interest rates remain well below inflation. The overnight rate charged by the People's Bank of China the PBOC's version of the Fed Funds rate fell to 1.57% per annum earlier this spring. That was 12 basis points lower than where it stood in June 2006 according to the economists at Northern Trust. It was also just HALF the official rate of consumer price inflation.

As a result, China's broad money supply keeps surging ahead...up by more than one-sixth year-on-year in April, alongside a gain of 54% in the Shanghai Composite Stock Index since January alone. But the bubble in Chinese money is inflating asset prices far beyond the domestic exchanges. Blackstone's $3 billion deposit from the Chinese government this week marks just the start.

'The Chinese government wants to increase its access and role in the global private equity market,' says one corporate advisor. 'It should be, or will be, part of a trend,' adds Stephen Schwarzman, co-founder of Blackstone itself.

'Blackstone is the first [recipient] but over time I would suspect there would be others.'

Back here in London, meantime, the government is fast building its own monuments to cheap money. Besides hoodwinking local town planners with talk of a 'shortage of housing', Whitehall wants to cream all that it can off the speculative froth.

'Planning shake-up paves the way for new runways,' says the Daily Telegraph today. 'Push towards pay-as-you-go roads,' chips in the BBC. New plans revealed this week could see UK drivers paying nearly $2.50 per mile on the busiest routes.

Such rent-seeking is only to be expected amid credit excess. But it hardly makes earning a living nor investing in productive businesses any easier. Creating value is fast losing out to just taking profits.

Higher inflation, impossible asset values, and a flattening of choice in where to buy coffee.

Make that a cheap-money bubble to go.

Adrian Ash is head of research at BullionVault.com, the fastest growing gold bullion service online. Formerly head of editorial at Fleet Street Publications Ltd, he is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.