It is a widely accepted postulate that excessive debt slows growth while lowering interest rates is a remedy applied to stimulate growth….
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The most recent US economic recovery has registered unusually slow growth in a low interest environment marked by a sharp increase in debt. The US national debt doubled in the course of the Obama administration over eight years. Deficit spending is thought to be a measure conducive to stimulating a sluggish economy. A combination of low interest rates and budget stimulus should have produced strong growth and not growth rates remaining under 2% for years on end.
The impact of QE became less and less effective over time and resulted in a Fed balance reaching record proportions outdone only by the ECB and BoJ although the PBoC has also pushed debt to new levels. The question arises as to why, under such circumstances, growth has been so low.
Contrary to theory, low interest rates did not result in companies investing in CapEx and R & D. What has happened is that company executives elected to borrow money at the prevailing low interest rates and engage in extensive stock buyback programmes, which benefited stock holders, who saw stock prices increase and also the executives, who could sell stock, exercise options and get much richer thanks to their financial prowess.
So instead of investing more in equipment, research and product development, companies have brought about a high-flying stock market with record prices and P/E ratios typical of a bubble. The Fed, naturally, has decided that it is time to prepare for the next recession and has started raising interest rates and also intends to unwind its balance. At the same time central banks have intervened not only in the gold market but have also bought huge amounts of stocks and bonds.
This development makes it less likely that a real stock market crash can take place even though the market is at least due for a strong correction, which this Newsletter has predicted. Now, however, with the Fed tightening up credit and at the same time with central banks intervening in the markets, the bulls may hope that the markets will never falter. RIP price discovery.
The conclusion is that stock market prices do not reflect real economic growth and have become divorced from reality. The same is true in a different way for the bond market. Low interest rates are devastating for pension funds. Instead of helping people to become richer, the Fed is making them poorer. Poor show!