The FT’s Lex column notes that one of the Federal Reserve’s main goals in promising to keep interest rates at near-0% for two years is to encourage people to start taking some risks. If the Fed spoke in plain English rather than central bank-ease, Lex reckons Bernanke would say: “The key to getting through this rough spot is that everyone calms down and sees that they have no choice but to buy risky assets”.
That probably sums it up. But what central bankers fail to realise is that there’s always a choice. It may seem rational to buy stocks and other risky assets, if the Fed is promising to keep interest rates below inflation for years to come. After all, sitting with your money in cash – or government bonds for that matter – is a guaranteed loser, if that’s the case.
But it’s only rational if you trust the Fed (or the Bank of England, or whichever central bank is in charge of your neck of the woods). First, you have to trust that they will continue to be able to prop the markets up. There’s no point on piling into stocks because they yield more than a bank account, only to find that you lose half your capital in the process.
So far, on that count, the Fed’s record isn’t great. Most developed-world stock markets peaked in 2000 and have yet to hit that peak again. The current crash is the third or fourth (if you count the 2010 ‘flash crash’) in just over a decade. Rightly or wrongly, individual investors are starting to lose faith in the ‘stocks for the long run’ story.
Secondly, you have to trust that the Fed will do as it says. But why should you? If there’s one thing that the ordinary investor and saver should have learned over the past few years, it’s that their interests rank below the interests of both the financial sector, and anyone with high levels of debt. The ‘rules’ of the financial world and capitalism in general are being tweaked and fiddled with on a daily basis. Why trust the Fed now, whatever it says?
Thirdly, you have to believe that the Fed can actually create the levels of inflation it is looking for. You’d think this would be a foregone conclusion. But after printing billions of dollars and keeping interest rates at record lows for years, inflation still looks feeble. Now the Fed is saying it will keep rates at 0% for another two years. That’s starting to sound awfully like a Japan-style scenario.
Given all this, investors would have to be unusually trusting and naïve to commit to stocks or other risky assets simply on the basis of faith in the Fed. And as things continue to spiral out of control, that will only get worse.
This is why gold is soaring at the moment, along with demand for cash, and even government bonds. People are more worried about the return of their capital, than the return on their capital. Some are even paying banks for the privilege of being allowed to place their cash with them. Trust and confidence in the system is at a very low ebb.
What will it take to restore it? The problem with confidence – and what many don’t seem to grasp, politicians particularly – is that you can’t create it out of thin air. It’s not about ‘talking the market up’ or shutting up those ‘doom-mongers’ who ‘talk the economy down’.
Confidence is a product of the underlying economic reality. If everyone feels like they’re constantly walking on thin ice that could give way at any minute, then all the ‘jawboning’ (talking the market up) in the world won’t make a difference. Since 2009, playing the market has been all about second-guessing the Fed or the European Central Bank. That’s a market that short-term speculators might love – just look at the surge on forex trading and the growing popularity of spread betting – but it’s incredibly hostile and frightening for long-term investors.
The current crash is happening because we didn’t draw a line under the last one. Rather than tackle the miserable business of restructuring the banks and writing off debts, we swapped a financial sector crisis for a sovereign debt crisis. Now it’s not just companies but entire countries – or continents in the case of Europe – that need restructuring.
What the market really needs is catharsis. It needs this debt disaster to play out and be over and done with. The fact that certain companies and governments are bust needs to be acknowledged, and dealt with. That’s the only way that genuine confidence will return. The Fed should just step back and admit to investors that its interfering can only slow that process down now.