Beware the Perils of Easy Money
The Federal Reserve and the European Central Bank are practically giving away money. Experts warn this could create a bubble similar to the one that burst in 2008.
That’s because the European Central Bank, mirroring a U.S. Fed program that pulled the American economy out of recession, took the unprecedented step this week of buying European Treasury bonds with negative yields to help spur growth. The scheme could backfire because it undermines one of the basic principles of a sound economy: Bonds are a safe place to keep your money because they typically provide a modest yet consistent return on investment.
No one is sure of what happens next simply because this hasn’t happened before. But few expect it to be good.
“I am in shock and awe. How long can this keep going on?” Marilyn Cohen, president of Envision Capital Management, told Foreign Policy.
“I don’t know how this ends, other than institutions losing a lot of money,” she said.
Here’s why: If yields are too low, investors leave the safe haven treasuries provide. Instead, they put their money into risky assets in hopes of a turning a profit, according to Kristin Forbes, a member of the Bank of England’s Monetary Policy Committee.
“This could drive up prices in these other markets and potentially create bubbles,” she said in a February 24, 2015 speech in London.
Americans are all too familiar with bubbles, an economic cycle that provides an easy way to make money, even if it inevitably falls apart. The collapse of the 2008 housing bubble sent the global economy to the brink of depression and lead to a global recession and Europe’s sovereign debt crisis. The ECB’s program is an effort to pull the European Union out of that crisis’ wake.
Jesse Colombo, an economic analyst who tracks the possible formation of bubbles, believes the implosion of the current credit bubble could cause fallout far worse than what the world experienced in 2008. He said central banks’ meddling in the free market is the root of the problem.
“This is leading to an artificial, bubble-driven economic recovery,” Colombo told Foreign Policy.
These warnings are now making their way to Wall Street. In recent weeks, high-profile money managers have sounded the alarm on negative rates.
“Low interest rates globally destroy financial business models that are critical to the functioning of modern day economies,” Bill Gross, head of the Janus Global Unconstrained Bond Fund, wrote in a March 2015 investment outlook.
Or, as Ciaran O’Hagan, head of European rates strategy at SocGen in Paris, told Bloomberg, “It’s like the ECB is chasing its own tail.”
Photo Credit: Alex Wong