When I first woke up to the unsustainable and incredibly fragile nature of our financial system, I was convinced that the markets – already starting to bubble up in 2011 – would collapse. AT. ANY. MOMENT. And yet here we are, with the Dow over 21,000, more than triple the low that we saw just eight years ago, when it hit 6,627.
So what gives? And what do these record gains (which don’t correspond to any great economic or political developments) mean about the potential for a future crash?
What gives is that the central banks are much more imaginative, and much more aggressive, than anyone thought they would ever be. After the Fed “saved” the world economy by pumping trillions of liquidity into the system, it started changing the rules of the game – such as allowing banks to hide bad assets with “mark to fantasy” rules, introducing “quantitative easing” (ie naked money printing), and reducing the rate of interest to 0%.
Central banks around the world have coordinated their efforts, with several reducing official interest rates well below 0% and printing money – sorry, I mean quantitatively easing – at an unimaginable pace. This chart from Peak Prosperity shows the incredible amount that central banks – in this case, BOJ and ECB at the moment – are printing money to shore up the global economy:
Where is that money going, and why? Well, it’s going into financial assets mostly. The Bank of Japan is directly buying Japanese index funds; the Swiss National Bank is one of the top holders of Apple stock. And in aggregate, central banks’ portfolios of stocks and bonds continues to grow.
But why? Most people think it’s for the “wealth effect,” where people see their portfolios grow, feel better about the economy, and go spend money. And that might be part of it, though a record low percentage of Americans (52%) own any stocks at all.
No, I think the reason is much larger, and more critical.
When the Fed lowered interest rates to 0%, they helped borrowers (who we desperately need in a debt-based system). Who did they hurt? Savers – people who need a return on their investment. For most of us, that means older people trying to live off their investments, and certainly those people have been devastated. But the category also includes pension firms and insurance companies.
Traditionally, pensions and insurance firms invested quite a bit in bonds, which used to be a safe place to get a reasonable return. But now, with no return to be had, they’ve had to shift to riskier investments: The stock market. Pensions are already underfunded somewhere between $2.3 to $6 trillion, and that assumes they get really high returns – something like 7% or 8% per year on their investments. If the stock market crashes, they’ll be completely wiped out. And when pensions and insurance companies go down, they’re taking the rest of the economy with them.
So I no longer think we’ll see a stock market crash – at least not one that we’ll then recover from. Central banks will keep this going as long as they can, crash-free regardless of world events. But if it does actually crash, then buckle up – because it will CRASH in a way we’ve never seen before.