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‘Possibly the easiest act for any human being is to spend money which does not belong to him,’ wrote Robert L. Smitley in his 1933 classic, Popular Financial Delusions.
It gets even easier when other people’s money is cheap.
But the big difficulty with cheap money is that it’s worth so very little. No matter how much you beg, borrow or steal, it simply won’t buy much of anything – as today’s row over the £400,000 cost of London’s 2012 Olympic logo just goes to show.
And as ever, the true cost of cheap money has now wound up in the price of life’s bare necessities…
Spend £1 on the High Street today and you’ll get less than half what £1 bought in June 1987. Sterling buys less than one-third of the bricks-and-mortar it bought a decade ago.
Measured against the Pound in your pocket, in fact, the cost of heating and fuel, education and health care has never been more expensive. Thanks to cheap credit flooding the financial markets, buying a pension – by saving money at the lowest rate of interest after inflation since 1981 – has become almost as hard as buying your first home.
‘Almost anyone will risk funds in an enterprise when the funds are not his own,’ as Robert L. Smitley went on. That’s why private equity groups keep bidding up shares regardless of value.
Hedge funds and the big City institutions have helped bid up junk bonds so high, they now pay only a fraction above US Treasury and UK gilt yields. Mortgage-backed bonds continue to find buyers, meantime, while outstanding bets on derivatives contracts are now valued at eight times the entire global economy according to the latest IMF and BIS data.
What might happen if a handful of these credit-fuelled promises fails to pay up? The knock-on effect could prove dramatic – and the mere threat of higher interest rates is enough to make professional strategists very nervous right now.
‘Investors are taking far too much comfort from global liquidity,’ says Teun Draaisma, chief European equities analyst at Morgan Stanley. His model now forecasts a 14% drop in UK share prices by Christmas, reported The Daily Telegraph yesterday, because ‘markets always return to fundamental value. People could be in for a rude awakening.’
The trigger, says Draaisma, ‘may be rate rises by the Bank of Japan, or a widening of credit spreads.’ But the trigger for a sharp sell-off on Wednesday was just the mere idea that interest rates might perhaps have to rise.
Fearing that the Bank of England may offer cash savers a whole 1.25% above inflation when it announces UK base rates today, the City yesterday sold London stocks 1.7% lower. The FTSE dropped 110 points on news that UK consumer confidence – a key piece of data for the Bank of England to mull over this morning – rose to an 18-month high in May.
You might think it a strange world we live in when rising consumer confidence acts as a ‘sell’ signal for the City. But that’s the twisted outcome of too much cheap money for too long. Investors come to rely on it.
Stocks also stumbled on Wall Street yesterday, after the Labor Department said the cost of employing staff in the US rose 1.8% between January and March, three times faster than Washington’s previous estimate.
‘There are inflationary pressures coming from the labor market,’ said Julia Coronado, a senior economist at Barclays Capital in New York, to Bloomberg. Yet US productivity growth slipped over the same period – and President Bush’s own team of economic advisors yesterday cut their 2007 growth forecast from 2.9% to 2.3%.
Added together, yesterday’s figures from Washington risk spelling out the dread word ‘stagflation’. And just like the Bank of England, that leaves the US Federal Reserve stuck caught between a rock and a hard place.
Raise rates to stall inflation, and asset prices are sure to tumble. Cut rates to defend asset prices, and inflation will only shoot higher again. Investors using either leverage or cash might want to take care.
Borrowing to speculate is easy when money stays cheap. But repaying your debts when interest rates rise – or asset prices fall – will surely prove a lot harder.
Turning to more of today’s financial action…
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In London, interest rate concerns helped push the market well into the red yesterday. The blue-chip FTSE 100 index fell 110 points to close at 6,522. All other indices were also lower. The retail sector was hit particularly hard, with Marks & Spencer, Kingfisher and Home Retail Group falling heavily and Sportswear chain JJB Sports heading up the mid-cap fallers with an 11% share price tumble. For a full market report, see: London market close.
Across the Channel, the major indices also notched up triple-digit losses yesterday. The Paris CAC-40 was 100 points lower, at 5,977, and the Frankfurt DAX-30 was 189 points lower, at 7,730.
On Wall Street, shares also ended the day sharply lower. The Dow Jones was off 130 points, ending the day at 13,465. The tech-heavy Nasdaq was 24 points lower, at 2,587. And the S&P 500 closed 13 points lower, at 1,517.
After an early slump, the Nikkei rallied to close 12 points higher today, at 18,053.
Crude oil was little-changed at $65.93 this morning and Brent spot had slipped to $71.77 in London.
Spot gold had risen to $669.80 this morning and silver was flat at $13.67.
Turning to currencies, the pound was at 1.9926 against the dollar and 1.4761 against the euro this morning, whilst the dollar was at 0.7406 against the euro and 121.29 against the Japanese yen.
And in London today, a report by Britain’s biggest mortgage lender, HBOS, revealed that house prices grew at their slowest rate so far this year in May, suggesting that higher interest rates are beginning to cool demand. The average house price rose 0.3% to £196,893 last month. Meanwhile, 58 out of 62 economists polled by Bloomberg said they expect the Bank of England to keep interest rates on hold today – don’t forget to visit MoneyWeek.com at noon today to find out whether they were right.
And our two recommended articles for today…
Investment property: the hottest islands in the Caribbean
– Faced with sky-high property prices and wet weather at home, UK househunters could be forgiven for looking to warmer climes in their hunt for the perfect property. But where? One place which is attractive – but largely overlooked until now – is the Caribbean. To find out which three islands have the best investment potential, click here: Caribbean property: the hottest islands
Which currency is Warren Buffett buying now?
– The Kuwaiti announcement that it is to abandon its peg to the dollar – a move which could be followed by other oil producers such as Qatar and the United Arab Emirates – is yet another chink in the armour of this already cheap currency. So it’s unlikely to have been favoured by Warren Buffet in recent secret but significant bet on the currency market. To find out what he probably did bet on, see: Which currency is Warren Buffett buying now?
Adrian Ash is editor of Gold News and head of research at www.BullionVault.com, the fastest growing gold bullion service online.
www.BullionVault.com, the fastest growing gold bullion service online.