It is above all a question of printing money by the central bank. The purpose of today’s super-easy monetary policies was to prop up demand through the ravages of foreclosure, but they also sent a new rocket under asset prices, worsening an already massively driven investment environment. an ever more desperate search for yield.
Globally, the prices of stocks and bonds have risen roughly in proportion to the amount of money created. This is not to say that the rise in stock prices is entirely a monetary phenomenon; there is at least some logic in the madness.
Businesses have used the pandemic extensively to restructure, while there have been many businesses where the struggles of the past two years have been a positive boon – tech, home entertainment, home delivery, digital economy, and more. The big losers have been in relatively smaller industries such as hospitality and physical retailing that are already in rapid decline.
You don’t have to be an investment genius to understand that a stock market inflated with ultra-low interest rates will suffer greatly once this support is removed. I guess central banks, already caught off guard by the speed and strength of the inflationary surge, are going to have to act much more vigorously to tame the inflationary tiger than they realize.
According to the latest US Federal Reserve dot plot, the majority of Open Market Committee members expect to increase interest rates at least three times in 2022. But that would still leave the Fed Funds rate at less than 1pc, compared to 0.1pc. currently, and is more than taken into account by the markets. Anything significantly more important, however, would cause big problems for stock prices.
If the degree of inflationary pressure determines the future course of interest rates – not necessarily the case, moreover, as central banks seem increasingly captive to fiscal domination – this is the strength of the economy. which will determine the degree of inflation.
So far, things look pretty bleak. Taking the UK as an example, economic confidence has collapsed again amid the surge in Covid infections. In addition, recent data shows a marked slowdown in wage growth, which, until a few months ago, more than kept pace with inflation.
The Resolution Foundation predicts that wages will actually fall below consumer price inflation this year, compounding the damage to disposable income from rising taxes and energy bills. Still, if I’m right about Covid, then the current drop in demand will soon be behind us; staff shortages would again be the main problem, putting further upward pressure on wages.
Much higher energy bills are already forecast for the coming year, but the pressure is on major oil and gas producers to dramatically increase their production levels. If they don’t, the current squeeze risks pushing the global economy into another recession, which would be far worse for them than simply meeting current levels of demand, not only leading to lower prices, but their collapse.
In any case, on the real economy at least, if not the stock markets, I am half-full rather than half-empty glass. With that, and if you’ve made it this far, happy new years everyone.