The death of cash

The global economy is flushed with cash and liquidity, yet we do not see Weimar levels of inflation. After the Great Financial Crisis, when one central bank after another announced their low interest rate and quantitative easing policies, thousands of economists, business, and financial expert cried out that the era of hyperinflation is upon us. From low to high, gold prices soared 147 percent in dollar terms within three years.

Playing around with the numbers: gold appreciated 2 percent annually since the last World War. Accounting for that ‘natural appreciation’, the market priced 33 percent annual dollar inflation into the gold prices in three years on a compounded basis.

Despite low interest rates and the sea of ‘cash’, the expectations turned out to be wrong. Central bankers are still struggling to reach their inflation targets in the West – except the Bank of England due to special circumstances. Even though easy monetary policy affects the real economy through more than one channel, let me focus on my personal favourite: the wealth effect.

According to the general economic narrative, as household and companies become more affluent their willingness to spend increases too. Despite soaring net worth of the US households, personal consumption expenditure did not catch up, in fact a record low amount of their wealth is consumed in the US.

What went wrong? Well, probably you could partly blame the uneven distribution of the wealth effect, or the increased propensity to save since low interests also inflated future obligations, such as pension liabilities. But there is yet an additional, but crucial factor here: there is no income from inflating asset prices. In fact, it erodes income, creating a lack of cash.

A couple of year ago when the ECB started to cut its policy rate into negative territory, fixed-income investors – including myself – were desperately looking for meaningful yields. I managed to find a promising German real estate managing company. They were on a brink of becoming one of the industry leaders in the EU’s biggest economy, their financial metrics showed resilience, had a growth strategy, the macro background looked supporting, and they offered 4 to 6 percent yield on their bonds to finance their expansion. Perfect value target.

The bonds are about to roll over, and the company already issued new ones to refinance their debt from the market. The new bonds offer 0.5 percent coupon on over 5-6 years. Let that sink in, you technically won’t get paid until the end, there is no cash flow to be discounted, except the terminal one. There are two implications. Firstly, because of low interest rates the company can afford to issue debt on such terms. This means that the new instruments will be extremely sensitive to policy normalisation, since the final cash flow must ‘foot the bill’ of a yield increase. Secondly, you have no income to spend in the meantime.

Unluckily, the shopkeeper doesn’t accept one eights of German corporate bonds when I want to do my weekly grocery shopping. Hence, if I want to invest today it won’t add anything to consumption. I have one question to central bankers around the globe: I want to know where my money is, and I want it right now… I mean real, spendable money. Unfortunately, I know their answer

missing wealth effect


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