The Bank for International Settlements made front page news on Monday with the stark warning that financial markets have become detached from reality. The Bank appears to be drawing the conclusion having watched the stock market's rally whilst not seeing a major improvement in the global economy. “The rise is driven by ultra low interest rate policies and that these policies should be reversed”, they are quoted. They also warn of risks in emerging markets and point in particular to China’s banks. To our mind there is nothing new there, emerging markets are already considered risky by definition. The comment that caught our eye was where the Bank calls for policy makers to reduce debt burdens and increase productivity. We could not find anywhere in the article for suggestions from the Bank as to how policy makers make achieve this without the aid of a magic wand.
We wrote last week that we believe with the world such an indebted place, markedly higher interest rates are not practical. What we believe is this balance of loose monetary policy will remain; consequentially allowing companies to fund growth cheaply, hopefully to improve revenue and profitability, thereby improving tax receipts to the government, which they can then use to pay down the debt burden. Governments will continue to look for ways to tax individuals and corporations in an effort to maximise receipts. It is worth noting the IMF, in contrast to the BIS, has been calling for central banks to do more. There is an old saying that economics is the only field in which two people can share a Nobel Prize for saying opposing thin — not so much of a saying as it happened in 2013.
The debate about interest rates and the central bank policy toward them was once again ignited last week as the outgoing deputy governor of the Bank of England, Charlie Bean, suggested it may be ten years before rates go back to normalised 5%. Tom Stevenson, writing in the Sunday Telegraph, refers to a piece of research from Fidelity pointing out that this is not the first time in history central banks have used interest rates and bond purchase programs to stimulate the economy. After the 2nd World War the Fed bought treasuries until the early 1950's. Once they stopped, rates rose for the next 30 years. He also points out between 1949 and 1968 the S&P 500 rose 16% per annum. In the past 30 years we have lived through a period of rising bond prices and rising equity markets. Many current fund managers, we would wager, have never lived through a period of rising equity markets and rising bond yields. Actuaries have been moving their asset allocation during the last 20 years from equities to bonds. A reversion back to rising bond yields and rising equity markets would definitely put a spanner in the works.