Neil Macdonald: The illusion of growth

Stock markets have jumped recently because central banks have been gobbling up safe long-term investments in a deliberate attempt to force private investors into riskier assets, like stocks. It's a high-stakes form of market engineering, writes Neil Macdonald, and how it all unwinds is anyone's guess.

How central bank stimulus is creating a global 'bubble economy.' Power Shift, part 2

Investment guru Mark Grant in Florida: It's a global bubble and the party is going to end soon. (Louis Deguise / CBC)

Mark Grant sits on the aft deck of his yacht in South Florida's spring sun, ostentatiously relishing his wealth as only an American does, and dispensing advice. He's made his money, and he likes to wear it.

Grant's personality is as big as his mansion and as flashy as his collection of exotic cars — he actually calls himself "The Wizard," a tribute to his own financial acumen.

While we are talking, his cellphone rings intermittently, and the callers are usually serious moneymen. Bill Gross of Pimco, the world's largest bond agency, is a friend; his praise adorns the dust jacket of Grant's recent book.

Inevitably, the callers are seeking investment advice.

A nearly 40-year Wall Street veteran, Grant is currently the managing director of a Texas-based investment bank and the author of a daily must-read investment commentary called Out of the Box.

His advice these days to tycoons and small investors alike is simple and direct. For heaven's sake, seek safety. Preserve your capital. "Keep what you have."

To Grant, the central banks' money printing has distorted the financial universe beyond any sensible dimensions.

The Federal Reserve alone is churning out $85 billion a month, or just over a $1 trillion a year. The combined balance sheets (which reflect created money) for the European Central Bank and the 17 individual banks of the eurozone stand at $3.45 trillion.

The Bank of England, the most energetic money printer in the world relative to the size of the economy it serves, has printed £375 billion (roughly $576 billion US), and is probably going to print more. The Bank of Japan has just launched an aggressive money-printing program of its own, planning to double the size of its balance sheet within two years.

In all, at the end of 2012, the balance sheets of the world's largest central banks, those of the G20 nations and the eurozone, including Sweden and Switzerland, totalled $17.4 trillion US, according to Bank of Canada calculations from publicly available data.

That is nearly a quarter of global GDP, and slightly more than double the $8.5 trillion these same institutions were holding at the end of 2007, before the financial crisis hit. 

The idea behind all this central bank largesse is to reflate the world's money supply after the disastrous meltdown of 2008 and, at the same time, push interest rates down as far as possible in an attempt to get people — and companies — borrowing and spending again.

To date, however, the results have been mixed. The U.S. economy has been inching forward, while Britain's is teetering on a triple dip into recession. Much of Europe is also deep in recession and sinking under the weight of high unemployment.

Whether the massive money-printing program known as quantitative easing has prevented an even worse situation is debatable. But this much is certain: It's simply impossible to unleash such economic forces without serious consequences, intended and unintended.

Bubble economies

Just about everyone agrees the Dow Jones industrial average — the measure of blue-chip America — did not reach an all-time high recently because of vibrant economic growth or fabulous performance by the companies listed in that index.

Markets are where they are principally because the Federal Reserve has been gobbling up U.S. treasury bills, the safest investment on Earth, in a deliberate attempt to force private investors into riskier assets, like stocks.

It's a high-stakes form of market engineering.

The Fed has been acting in rare concert with central banks worldwide to encourage borrowing and spending — and risk. And because all the new money being unleashed has to flow somewhere, it's been flowing, among other places, into the equity markets.

At the same time, the super-low interest rates resulting from all this money printing have heated up real estate markets in big cities worldwide — Toronto and Vancouver being perfect examples.

Grant says the markets and governments have developed an addiction to easy, cheap money to finance irresponsible borrowing.

"All this printing of money is creating a market that rests on a fantasy," he says.

For the first time ever, there isn't a single bubble out there, but an "entire world in a bubble. Every asset class, everything you can think of. Everything is in a bubble and something is going to prick it.

"The party," he says with great certainty, "is going to end."

An enormous bet

Think-tank economists, who rely on econometric models and speak a language so encoded as to be incomprehensible to most people, tend to look down their noses at analysts like Grant, referring to them as "the newsletter crowd."

But Grant has shown prescience. He was among the very first to predict Greece's financial implosion, and he has correctly pointed up the book-cooking and outright fraud in other eurozone economies.

He is also far from the only one contemplating a bad ending.

Recently, the Bank of International Settlement in Basel echoed Grant's concern that markets are developing an easy-money habit; and the International Monetary Fund just published a paper acknowledging the possibility of all this money printing (which it calls "monetary policy plus") creating widespread bubbles and difficult adjustments down the road.

Ros Altmann, a pension manager and a governor of the London School of Economics, compares quantitative easing to treating a sick patient with medication that doesn't work, and then, when the patient gets sicker, administering even more.

"It must stop," she says. "It is hugely dangerous. I think history will judge this period very harshly."

Still, the central bankers have at least as many fans as they do critics.

Don Johnston, the former president of the Treasury Board in the Trudeau government and a former director of the Organization for Economic Co-operation and Development, admires them greatly.

"I think they have more credibility than politicians," he says, "and it's been very fortunate that nearly all central banks are independent of the political arm."

Johnston concedes that the central banks' power at the moment is "immense." But he adds: "We had a big fire, and they absolutely had a critical role to play, and they played it, I think, extremely well."

Still, even Johnston, with his deep experience in government finances, allows that he doesn't fully understand the complexities of today's monetary policy, and the arguments for or against opening the spigots as much as they have been.

By acting in concert to push the world in the same direction, the central bankers have made some enormous bets. And, says Johnson, "they'd better be right."

The trouble is, they've been wrong in the recent past.

Central bank economic forecasts in recent years have sometimes been well off the mark, meaning they, too, can be acting on mistaken assumptions.

Also, even someone as seemingly omniscient as Alan Greenspan, the Federal Reserve chief through the Bill Clinton and George W. Bush years, publicly admitted his blunder in refusing to regulate the murky world of credit default swaps, which acted as accelerant in the 2008 disaster.

How to 'unwind'

Conservative economists have predicted for years that expanding the money supply will inevitably lead to inflation, or even hyperinflation. That, of course, has not happened in this instance, mainly because there's been so little economic growth and because the world is awash in the production of consumer goods.

Stability risks

In a recent report, the International Monetary Fund sets out three big "stability risks" it sees in unwinding all this quantitative easing:

  • That a prolonged period of low-interest rates might affect the solvency, and maybe the level of risk-taking, of banks, pension funds and life insurance companies that require regular yield to keep afloat.
  • That, conversely, a quick interest rate spike could weaken loan performances and also hurt banks' bottom line.
  • That unco-ordinated exit plans by the central banks might lead to currency devaluations and trade wars if certain central banks and their governments decide to go their own way.

But the big question, nearly everyone agrees, is whether the central banks can "unwind" the unprecedented situation they've created without massive disruption (not least to their own balance sheets, which are now stuffed with long-term, low-interest bearing bonds as part of the quantitative easing).

It's an impossible question to answer.

The financial markets scrutinize the abbreviated minutes after every meeting of the Federal Reserve committee that authorizes QE, looking for any sign money printing is about to end.

That ending would signal a rise, perhaps even a sharp one, in interest rates, which could hit the housing market hard.

Homeowners with only a small amount of equity and who are already stretched to the limit would be sorely stressed.

Significant interest rate changes could also affect banks, pension funds and insurance companies, as well as small businesses that have been relying on cheap credit to expand payrolls.

And higher interest rates would also slam into government budgets. Politicians have come to rely on cheap money to finance their borrowing and spending.

Of course, the top people at the Bank of England, the Federal Reserve and the Bank of Canada all argue a return to normalcy can be managed.

Just as the central banks have the power to create money, says Canada's Mark Carney, they have the power to pull money out of the system, and will, slowly, as growth returns.

They can begin selling off the assets they've bought with all this new money, and they have the all-important power to set central interest rates. If growth takes off, in fact, they will have to do those things in order to contain inflation.

But no "unwind" will happen soon, says Carney. "The repair is ongoing."

In Florida, Mark Grant tells his clients that there are no good endings to all this, "only less bad endings."

One of the big causes of the 2008 meltdown was too much cheap money, he notes, "and there's a lot more now."

Mainstream economists can't agree on whether an orderly unwind can happen. But then, as Don Johnston points out, "economists don't know what they don't know."

Meanwhile, the central bankers all seem to have landed on the same side of the issue, and are marching in step, urging people to borrow and spend for the good of all.

"Ultimately," says Carney, "history will judge whether we got this right."


Neil Macdonald is a former foreign correspondent and columnist for CBC News who has also worked in newspapers. He speaks English and French fluently, as well as some Arabic.