One of the key outcomes of the 2008 financial crisis has been a worldwide addiction to easy money – an unintended consequence of over a decade of central banks aggressively pumping vast sums into the system.

It all started in 2008 when, in a desperate effort to stave off financial Armageddon, central banks resorted to quantitative easing and nearly endless money-printing in the hope of preventing a total collapse of the beleaguered global financial system.

This move prevented the collapse, but the central banks have continued printing to this day. What was supposed to be a temporary, emergency fix has become a seemingly permanent dependency.

The U.S. Federal Reserve’s balance sheet is now trillions of dollars bigger, as is that of the European Central Bank’s (ECB) and the Bank of Japan’s (BOJ). And this printing shows no signs of slowing down.

It is astonishing how quickly the world has become addicted to easy money – absorbing trillions of dollars, euros, and yen with an insatiable appetite.

Even more astonishing is that any hint of removing this artificial, economic life support sends the markets into a dizzying tailspin – as we saw in September 2018, when the Fed hiked interest rates to 2.25% and the S&P 500 began a selloff that would take it 17% lower by December.

How we’ll ever break this addiction is unclear… but break it we must.

Greater Fool Theory

Let me put things in perspective.

Right before the 2008 financial crisis, short-term interest rates in the U.S., Europe, and Australia were 4.75%, 3.65%, and 7%, respectively. Compare that to the current rates of 0.09%, -0.48%, and 0.25%.

This, however, is only part of the picture. There’s also the fact that over $18 trillion worth of debt has been issued at negative interest rates. And investors happily buy into this madness. Think about what this means…

I refer to it as a classic example of the greater fool theory. With negative interest rates, somebody lends his money to the borrower, who will work with this money for 10 years – and the lender has to pay the borrower to do this.

Why should someone do this? It sounds crazy. If I lend someone my money, I want to be paid for the usage of that money and for the risk that I might not get it paid back to me.

In this scenario, the lenders hope that somebody will come along after them and pay the borrower even more money for the right to lend his money… thus driving up the price of the bonds. This latter borrower is the de facto “greater fool.”

It’s like a wild game of musical chairs. You just don’t want to be holding the bag of ever-depreciating debt when the music stops playing.

Monetary Bandages

Despite all the easy money and the dramatic lowering of interest rates, the deflationary headwinds are still blowing strong.

Early last year, we came to a critical juncture in the global economy when China – the second-largest economy in the world – came to a near standstill due to the coronavirus. It wasn’t long before other economies followed suit.

Central banks around the world started pumping trillions of dollars into the system in an effort to float their economy out of trouble.

Altogether, since 2007, the world’s four major central banks – the People’s Bank of China (PBOC), ECB, Fed, and BOJ – have added roughly $24 trillion to their balance sheets. Nearly 30% of this happened in the first few months of 2020 alone.

Against this backdrop, global investors continue to ignore the record bankruptcies and terrifying levels of bad loans on bank balance sheets…

And governments continue to underwrite all of these problems with monetary bandages, while hoping the economy will grow its way out of trouble over time.

But don’t be fooled. This is a very dangerous situation. Here’s why…

Out of Ammunition

In the wake of the pandemic, central banks found themselves largely out of ammunition.

It’s no surprise that, here in the U.S., the Fed has been implementing even more aggressive levels of quantitative easing… ballooning out its balance sheet to almost unimaginable levels.

It’s a desperate move, but they have few alternatives.

Will it work? Maybe. But I’m not counting on it. We only need to consider the situation in Japan to understand what happens from here.

Japan has spent nearly 30 years fighting against deflationary pressures, with no success. With their marginal growth, an aging population, negative interest rates, and dismal growth prospects for the future, their mess could continue for quite some time.

Europe’s growth prospects aren’t much better… despite the $3 trillion of excess liquidity sloshing around in the eurozone, not doing anyone any good. If we ever wanted evidence of the limits of quantitative easing by a central bank, this is it.

Meanwhile, the U.S. is already heading towards a long-term cycle of very modest growth, propped up by zero interest rates and massive fiscal spending programs.

It is not impossible that we end up in a similar situation as Japan – in other words, with zero interest rates, pathetic growth, and lousy performance in the asset markets over a long period of time.

Knowing this, a stock market near all-time highs makes little sense. Now is the time to move to a cautious stance, reducing some risk and managing positions with trailing stop-loss orders. You don’t want to be left holding the bag when the music stops playing.


Andy Krieger
Editor, Money Trends

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