Harsh reality is about to pop central banks’ bubble over painless tapering

Financial markets really seem to believe that monetary easing can go on forever without consequences. The beautiful bubble in which reality seems to be forever suspended will strike the craggy side of the equity and debt mountains it has created and pop

Anthony Rowley

Published: 4:00am, 6 Sep, 2021

Why you can trust SCMP

One witty commentator asked recently how you “un-bubble” a bubble such as the one we are seeing now in asset prices, stocks and real estate especially. The answer is that you do not. Either you pop it or it bursts spontaneously, although some bubbles float on for a while until they hit sharp reality.

That reality is looming close now after US Federal Reserve chairman Jerome Powell signalled to the virtual Jackson Hole central bankers retreat that the Fed could soon start reining in its massive monetary stimulus programme. Yet, the belief persists that Powell can do the impossible and un-bubble the bubble.

The Fed is expected to begin tapering its monthly bond purchases by the end of this year while the European Central Bank, faced with rising inflation, is expected to be considering tapering. Some argue this does not mean they will start raising interest rates then, but this is a philosophy of false consolation.

Are demands for government spending in the United States and elsewhere – where central banks will fall in line behind the Fed – supposed to magically decline despite the Covid-19 pandemic and the need for spending to fight climate change, not to mention the need to finance US President Joe Biden’s infrastructure package?

A Union Pacific Railroad freight train runs alongside US Highway 99 past farmland though Tulare county in the Central Valley, near Pixley, California, on August 26. The US Senate has passed a bipartisan infrastructure development bill that would see a US$1.2 trillion investment in roads, bridges, water pipes and high-speed internet across the United States. Photo: AFP

Who will fund these increasing demands for funds? Why, the bond markets of course. But who will be the buyers in bond markets if the Fed and others are curbing their own voracious appetites? Private financial institutions will buy, but unlike the Fed they do not have a mandate to keep down interest rates.

They will demand yields, and that will put upward pressure on interest rates. Will the Fed then reverse itself and start buying big again? As Merryn Somerset Webb said in the Financial Times, “the developed world is in as hideous a monetary policy trap as it is possible to imagine”.

Financial markets really had begun to believe that monetary easing could go on forever and that there was no difference between bubbles and balloons – both could be blown up and then deflated again. Even now, markets do not appear to understand the difference.

The world needs a financial crisis now like it needs a hole in the head, at a time when the sky is threatening to fall because of Covid-19, the climate crisis is escalating, US-China tensions are mounting, Afghanistan is in crisis, terrorist threats are reappearing and so on.

Should investors run for cover? Yes, but not for the hills or for the debt mountains that will see their peaks crumble in a massive landslide of bad credits and debt-derivative morasses. Neither can investors turn to the mighty but crumbling peaks of equity markets, and certainly not to cryptocurrencies.

02:27

Cryptocurrency volatility highlighted by China’s recent crackdown and Elon Musk comments

For a while, cash will be king again and mattresses might well become the favoured repository for stashing away the stuff rather than digital wallets or bankbooks. A financial world suffering from panic will step back – at least for a while – from virtual to real money.

But that is not where the future lies. We will need to get money back into real assets to meet massive real-world challenges. As observed here before, new vehicles for channelling investment into long-term projects to save the planet will need to be hybrids of public and private enterprise.

The days of frivolous financing and market magic are drawing to an end, and that end will inevitably be painful for many. But the whole experiment with quantitative easing (QE) and then quantitative and qualitative easing (QQE) by central banks contained the seeds of its own destruction from the start.

Hong Kong unemployment to continue falling but ‘hard times’ ahead: finance chief

From the period of the “dot-com bubble” in the late 1990s through the aftermath of the 2008 global financial crisis and then in the wake of the Covid-19 pandemic in 2020, QE and QQE were undertaken to stave off systemic financial failure, economic recession and mass unemployment.

People recognised that the creation of financial asset bubbles along with rising debt levels that accompany a drop in interest rates, plus some distortion of bond and other financial market functions, could be among the consequences of rapid and huge monetary easing.

02:34

Delta variant drives Covid-19 surge in southern US as unvaccinated are urged to get shots

But this appeared – to some, at least, especially politicians motivated by the exigencies of the electoral cycle – to be an acceptable price to pay for staving off immediate and severe economic pain. In theory, all this could go on for longer, but the bubble looks close to bursting now.

Sadly, it cannot be painlessly “un-bubbled” like letting air out of a balloon at a measured rate. The beautiful golden bubble in which reality seems to be forever suspended will strike the craggy side of the equity and debt mountains it has created and pop.

Financial markets and central banks aided by policymakers seem to have been addicted to blowing bubbles from the time of the “tulip mania” in the 17th century to the South Sea Bubble nearly a century later. They are follies of market capitalism but less so of state capitalism, where pre-emptive clampdowns tend to be enforced, as is the case now in China.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs