The biggest risk for global stock markets and asset prices in 2018 is that the central banks of the G7 countries (led by the Fed) are finally trying to normalize their monetary policy 9 years after December 2008. The US central bank began quantitative easing.
Since the end of 2008, the central banks of the G7 countries, including the Fed, the Bank of Japan, the ECB and the Bank of England, have committed to expand the balance sheet (through the purchase of public debt).
Together, their balance sheets continued to grow during 2017, although the Fed stopped expanding its balance sheet in November 2014.
The total assets of the central banks of the G7 countries grew by 17.2% to $ 15.2 trillion as of the end of 2017 compared to $ 4.3 trillion in early 2008.
The fact that the Fed began to lower its balance sheet since last October is a risk for stock markets, as it leads to another form of tightening monetary policy, in addition to raising interest rates.
And the fact that this has not yet led to market consequences reflects two factors:
- The Fed begins to act very cautiously, reducing the reinvestment of the principal amount of debt from bonds whose maturity has already arrived.
- Other central banks of the G7 countries together still expand their balance sheets, albeit more slowly.
That is why a lot of attention will be focused on the actions of the ECB in the coming months. Now, it seems that the balances of the G7 central banks will begin to decline in 2019, and not in 2018.
Unexplored territory of expansion of balances
How difficult is it for central banks to normalize monetary policy in practice and what will be the consequences of such a policy for investors if central banks continue to carry out a balance reduction? While this is uncharted territory.
The only precedent for expanding the balance of the central bank over the past 10 years was during the Second World War, while the public debt and assets guaranteed by the government now make up a larger share of the central bank's balances than during the Second World War.
It is clear that the purpose of this expansion of the balance of the central bank in the 1940s. was assisting the tax authorities in financing the war.
Quantitative easing has helped the rich
The expansion of the balance sheet since 2008 supposedly aimed at stabilizing the “aggregate demand” in the neo-Keynesian sense of the word (to reduce borrowing costs, raise asset prices in the hope of stimulating broad economic activity).
The real goal was to stop the liquidation of debt and prevent lenders, whether bankers or bondholders, from losing money.
This is the cause of growing inequality, which has received so much attention recently.
The rich got benefits, just as being owners of stocks and real estate, they benefited from rising asset prices since 2009, caused by quantitative easing.
Global Economic Obstacles: Debt and Demography
Another point is that the reduction in the balance of the central bank after the Second World War was achieved mainly by reducing the balance sheets relative to GDP without actually reducing the assets in nominal terms.
This balance reduction was only possible due to the strong economic growth observed after World War II.
For comparison, real US GDP grew by 4.4% year on year between 1949 and 1969. Japan's real GDP increased by 9.7% per year between 1955 and 1970.
Today the situation is completely different: the aggregate level of debt in the developed world is much higher, and demographic indicators in developed countries are much less favorable for sustainable growth.
The real growth in US GDP since 2009 was only 2.2%, in 2009 it was 1.3% in the eurozone and 1.7% in Japan.
The crisis of confidence in central banks
Another issue raised during the period of quantitative easing was the inevitable decline in central bank independence with respect to tax authorities when the central bank buys government bonds so actively.
For example, the Bank of Japan owns 42% of the Japanese government bond market.
This reduces confidence in the central bank.
As for the risk caused by the Fed’s attempt to normalize, the stock market may force it to reverse this course, and with such a turn of events there is a much greater risk of loss of confidence of the central bank.
This is because markets can decide that central banks can never get out of what is called unorthodox monetary policy.
Money circulation rate remains low
In such circumstances, it is possible that the circulation of money contains what economists call the "velocity of circulation" (the rate at which money is spent), especially if the cost of debt guaranteed by the state is called into question.
Gold is the only way to hedge this development.
The money circulation rate has continued to decline since 2009, despite the insane printing of money by the central banks of the G7 countries. Indeed, it is at a record low.