One Foot In The Present, One Foot In The Economic Future

One Foot In The Present, One Foot In The Economic Future

almost 4 years ago4 mins

Mentioned in story

Central banks and government spending in response to coronavirus might be helping fuel the economy now, but analysts are preparing for the worst: that it could hurt the economy and investors in the long run.

🕰️ Recap

  • Central banks and governments have announced unprecedented levels of spending since the coronavirus pandemic struck
  • Some of that cash has gone to workers and the newly unemployed, as well as to major industries on the brink of bankruptcy – like airlines
  • Once coronavirus clears up, there’s a risk all that extra cash in the economy – coupled with a likely rising oil price – will lead to a dramatic spike in inflation
  • Alternatively, the US and Europe may succumb to a low-growth future like Japan

✍️ Connecting The Dots

Back in March, the world’s biggest advanced economies committed to doing what they could to achieve “strong, sustainable” economic growth. In the face of a pandemic, that meant some central banks – notably the Bank of England and the Federal Reserve – cut interest rates to record lows, while some announced major quantitative easing programs. Not long after, governments weighed in by announcing billions of dollars worth of spending – from personal cash injections to super-cheap loans that’d keep businesses afloat until things got back to normal.

With so much additional cash in the system – and low interest rates making it cheap to borrow even more – people and companies are likely to take advantage of any spare money once coronavirus clears. That means consumers might buy more – and companies might invest more – than they otherwise would. In theory, that would power a jump in economic growth, but it could also cause a big rise in inflation as increased demand for goods and services pushes up their prices. If price rises outpace the population’s ability to pay for things, they might stop buying as much and bring the economy shuddering to a halt.

Alternatively, those economies could go the same way Japan has over the last couple of decades. The Bank of Japan (BoJ) has spent the last twenty years or so buying up government bonds in an effort to boost both the country’s inflation and its economic growth prospects – all without much success. Europe and the US are in a similar position now: the European Central Bank owns eurozone debt totaling 40% of its economy’s size, and the Federal Reserve owns about 30% of the US’s. That’s some way off the BoJ, which owns more Japanese debt than the size of the country’s entire economy – but with more spending likely and an economic bounceback less so, the US and Europe might find themselves in the same tight spot soon enough.

🥡 Takeaways

Having continued to buy bonds without successfully stimulating its economy, the BoJ now owns about half the country’s total. And one big owner means fewer Japanese bonds change hands on a given day (i.e. there’s less liquidity), which might put investors off buying in: a government bond’s return is pretty much guaranteed, sure, but that return might not prove substantial enough. There’s a risk that the same thing will happen to the US’s bonds, whose volatility has already dropped to a one-year low. What’s more, as corporate bailouts arrive burdened with tough terms and government-owned stakes, a decline in investor interest and in opportunities for outsized profits could plague stock markets too.

Low central bank interest rates lead to lower interest rates on your cash savings, which could encourage you to move your money into bonds or stocks to generate a higher return. But if, what with the current government and central bank interventions, those investments generate a lower return than they have done historically, the additional risk might not necessarily be worth it. Of course, if inflation does shoot up, then the choice might be an easier one for you: invest, or watch the value of your cash erode over time.

🎯 Also On Our Radar

The tech-heavy Nasdaq US stock index reversed its decline last week and is now in positive territory, reflecting how the resilient and massive tech sector has helped prop up stock markets this year. So while Goldman Sachs recently cautioned that now isn’t the best time to buy stocks, that’s not a view shared by everyone: the world’s largest investment manager BlackRock thinks it's the perfect time to buy – just so long as you have a five-year time horizon.

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