Are Central Banks Helping to Cause the Next Crisis?

24 February 2019

Are we going to meet a new bubble?

To date we are in a very particular context, characterized by anomalous situations never seen before, both from the point of view of the real economy and from the point of view of the financial markets. In an apparently healthy economic situation like that of the United States, with positive expectations for the future and a 50-year low unemployment, household debt is extremely high and continues to increase. According to the latest estimates published by the Fed of New York, at the end of 2019 the US private debt reached a new maximum of $14.15 trillion, a decidedly higher level than the previous high of about $12 trillion recorded in 2008 in correspondence with the financial crisis. This situation is worrying as there is no sign of slowing debt growth. What happened in 2008 was born from an excess of debt and today we are well beyond those levels. Overall, the real economy is undergoing an important slowdown. On the contrary, the financial markets are registering maximum values. This highlights how there is an increasingly disconnected relationship between finance and the economy.

What supports markets today, and justifies their complete disconnection with the real economy, are the manoeuvres made by the Central Banks. The intervention of Central Banks is supporting the markets, pushing them towards ever higher levels. Whatever happens, the markets know they are supported, and it is precisely this certainty that distorts their trend. All this diverts the market upwards, despite the lack of a solid and stable economy. We believe that the Central Banks today are carrying out a disastrous policy, extremely weak and without a realistic vision for the future. Instead of supporting the real economy to create a solid base for the financial markets, they flooded the markets with liquidity, pushing prices higher and higher. The extremely low interest rates favoured investments thus pushing prices and markets. By now the markets have taken our hand. This is demonstrated by their behaviour in the face of the spread of Coronavirus, which is seriously affecting the second world economy and consequently the rest of the world. Around the end of January, all the main financial indices slowed down significantly, ending the month in the negative. In early February, the Bank of China injected approximately $175 billion in liquidity to support markets and the economy. Moreover, the Bank of Japan and the Fed have stated that they are ready to intervene in case of need. As a result of the intervention of the Bank of China and the declarations of the other Central Banks, the markets have started their ascent again, recovering all the gap lost in the previous month. This shows how finance, despite the weakening of the real economy and very uncertain prospects, is accepting the institutions support, continuing to grow confident of being covered.

The certainty of being supported by the Central Banks distorts the markets.

It is therefore very difficult to understand what will happen in the future. What will be the next moves of the Central Banks? How will they come out of this circle? The room for manoeuvre left to them is limited. It will be difficult to get out of such high prices with such a high level of debt. The consequences could be extremely serious for the economy.

To Conclude...

In a phase of economic slowdown, the markets are recording levels never seen before. Are we going to meet a bubble? We think it is precisely the policy of the central banks that is fuelling debt and creating a bubble in the financial markets. It is very difficult to think about how this joint will resolve, and to predict how the Central Banks will exit this policy based on the whatever it takes concept. To date, financial markets lack a solid real economic base sufficient to support them. If the Central Banks stopped intervening and supporting the markets, they would collapse, with serious consequences on the already very weak economy.