World Is Bracing as Era of Easy Money Is Ending
Posted February 6, 2018 8:33 p.m. EST
Updated February 6, 2018 8:36 p.m. EST
Mere days ago, in what feels like a different era now, the biggest thing that people in control of money appeared to fear was complacency. Stock markets in the United States were surging, enthralled by the regulation-slashing, tax-shrinking predilections of President Donald Trump. Every major economy in the world was expanding.
The worst that could happen, the money masters averred, was that investors would be lulled into reckless investments, taking on too much risk in the belief that the dangers of the marketplace had been tamed.
As it turns out, the dangers were already at work. A decadelong era of easy access to money engineered by central banks in Asia, Europe and the United States was ending, opening a new chapter in which corporations would have to pay more to borrow and ordinary people would have to pay more to finance homes, cars and other purchases.
To digest the wild swings in stocks and bonds from New York to London to Tokyo is to absorb this uncomfortable realization taking hold.
Investors concluded that interest rates would rise faster than they had anticipated, almost certainly in the United States, and perhaps eventually in Europe and Asia, too. They yanked their treasure out of stocks and entrusted it to safer repositories of wealth like bonds and cash.
A wave of selling commenced in New York on Friday, continued in Asia and Europe on Monday, then completed its trans-global journey with a sharp drop where it had all started. While a global rout continued into Tuesday, anxiety subsided in the United States, with the Standard & Poor’s index up 1.7 percent at the close. The gains helped erase some of the losses over the past week, although the S&P 500 is still more than 6 percent off its peak in late January.
No degree in finance was required to divine the lesson of the moment: Markets go down as well as up, a reality often drowned out by the euphoric celebrations to greet one record or another being shattered.
While trading in the United States was clearly the initial source of alarm, the concerns spread to everywhere that money changes hands. The U.S. economy had swapped the frivolity of a stock market party for the grim trappings of a bedside vigil. The result was gloom and anxiety in every reach of the financial sphere.
“The United States is by some distance the largest market on Earth,” said Gaurav Saroliya, director of global macro strategy at Oxford Economics in London. “Growth in the United States has a huge bearing on economies everywhere. If the largest market is selling off, that has a very powerful effect on investment sentiment. It makes people risk averse.”
The fear that seized the United States was the spawn of good times. As the feeling sank in that stock trading was governed by a surplus of exuberance, the odds increased that the Federal Reserve would dampen the festivities by lifting interest rates faster than policymakers had previously telegraphed.
Not for nothing, central banks are seen by investors as crucial yet fun-averse grown-ups charged with solemnly watching for trouble. When crises emerge, they make money available to spur commerce while keeping terror at bay. The global economic expansion underway now is in large part a product of the Fed’s swiftly unleashing an overwhelming surge of credit after the start of the financial crisis in 2008, combined with the slower yet, eventually, effective torrent of cash delivered by the European Central Bank.
But when the party gets raging — when economies accelerate and stock prices ascend to levels out of whack with fundamentals — central bankers play killjoy, lifting interest rates to snuff out attendant dangers.
Higher rates diminish speculation that can end badly by making credit more expensive. They slow economic growth while making stocks less appealing because corporations must pay more to keep up with their debts. Investors can make more just by keeping their holdings in cash or bonds, rather than by accepting the higher risk of stocks.
The bitter irony of the current swoon is that it was triggered by the emergence of something the world has been awaiting for years: higher wages for workers.
Even as unemployment rates have lowered drastically in Britain, Japan and the United States, companies have continued to find new ways to make more products and sell more services without paying more to their employees. This has been a major source of unhappiness among working people and a subject of consternation among policymakers.
Then, last Friday, the latest monthly snapshot of the U.S. labor market revealed that wages had climbed 2.9 percent in January compared with a year earlier. The tight job market was forcing employers to pay more.
This appeared to presage a strengthening of U.S. consumer power. If more working people take home more money, they will presumably be more inclined to buy houses and cars, generating jobs in construction and at auto plants from Michigan to South Carolina. They will fill restaurants, necessitating more truck drivers to ferry the food, and more mechanics to keep the trucks running.
This same so-called virtuous cycle appeared to be amplifying global growth. More cars made in the United States would require more brake linings made in Mexico and more circuitry forged in China, using copper mined in Chile. More construction would require equipment from Germany and Japan and more iron ore from Brazil to make steel.
This interconnectivity has been central to the anticipation that a strengthening economy in the United States would lift fortunes around the world.
But the increase in wages for U.S. workers meant something else. It was a flashing warning to investors about potential inflation, or rising prices, which have crippled many economies. The Fed, always vigilant, wields a standard tool for snuffing out inflation if necessary: higher interest rates.
This is how a positive jobs report, presumably a sign of a strengthening U.S. economy, wound up as the impetus for the dumping of stocks from Taipei to Toronto. It enhanced the likelihood that the Fed would raise rates faster. It prompted investors to wonder how long the European Central Bank could maintain its own ultralow rates. In the past year, Europe has shaken off perpetual worries of a grinding decline to emerge as one of the faster-growing major economies on Earth. Inflation remains weak in Europe, undergirding expectations that the central bank will be slow to take back its free money.
But if the Fed were to lift rates faster, that could prompt Europe and perhaps even Japan to follow suit. Otherwise, the United States would be in a position to capture an outsize share of global investment, as rates presumably rise on U.S. government bonds.
All of this is playing out amid a transition in central bank leadership. At the Fed, Janet L. Yellen, the economist who was the chairwoman of the Board of Governors, on Monday completed her term and handed power to her successor, Jerome H. Powell. Powell is widely expected to continue Yellen’s cautious march toward higher interest rates. Still, as a newcomer taking the tiller in the midst of extraordinary volatility, he is a variable.
Mario Draghi, the Italian who heads the European Central Bank, is scheduled to complete his eight-year term late next year. At the Bank of Japan, Haruhiko Kuroda’s term as governor expires in April, and there is uncertainty over whether he will be reappointed.
Some economists think that the dour talk is overblown and that the stock markets are running on emotion untethered from economic reality, a narrative that gained force as markets in New York snapped back from the depths Tuesday.
The fundamentals of the U.S. expansion remain intact. Rising wages should indeed give people money to spend without resorting to some newfangled credit bubble that ends tragically.
Whatever the interest rates, central banks retain trillions of dollars on their balance sheets earmarked for buying up financial assets, making credit available. And the return to higher interest rates is inevitable, a healthy turn for a world economy that can finally close the books on the global financial crisis that began a decade ago.
“We have gotten used to this low interest rate environment,” said Robert Bergqvist, chief economist at SEB, a global investment bank based in Stockholm. “This is not the normal situation.” The global economic expansion has occasioned hopeful talk that the world now has multiple engines of growth, inoculating it against trouble in any single region. But the events of recent days have challenged that notion, given that a sudden deterioration of stock prices on Wall Street quickly burst into a global rout.
Sentiments are clearly a viral phenomenon. Yet the distress in global markets also underscores the fact that real economic fortunes are fused.
If General Electric, Ford and other multinational companies see their share prices brought down as borrowing costs climb, they could limit plans for expansion. The trend would be felt in diminished orders for computer chips made in Taiwan, flat-panel displays forged in South Korea and auto parts built in the Czech Republic. It could cool demand for raw materials harvested from Argentina to India to South Africa.
“Business cycles across different markets are more correlated than they have ever been,” said Saroliya, of Oxford Economics. “It’s the global supply chain.”