The longer the world lives with its funny money, the funnier things get. 

Here’s a headline from yesterday’s Financial Times: “Central banks pour money into equities.” 

We paused. We collected our thoughts. And we wondered: What the hell? From the FT: “A cluster of central banking investors has become major players on world equity markets.” 

That was the conclusion of a central bank research and advisory group called the Official Monetary and Financial Institutions Forum (OMFIF), which goes on to warn that this trend “could potentially contribute to overheated asset prices.” 

The OMFIF says “global public investors” have increased investments in equities “by at least $1 trillion in recent years.” Although it doesn’t say how that figure is split between central banks and other public sector investors, such as sovereign wealth funds and pension funds. 

The number could go much, much higher. The OMFIF says “central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues.” 

Ironically, the shift by central banks into stocks is been driven by the ultra low bond-yield environment central banks have created. The OMFIF calculates that central banks around the world have lost out on $200 billion to $250 billion in interest income on their bond portfolios. 

A Tangled Web

We’ve devoted a good deal of the Diary to chronicling the tangled web of finance woven by central planners. We see curiosities aplenty – the sort people get up to when they have access to free money. 

It is against the law to manipulate stocks. But the Fed does it in broad daylight, lowering interest rates on bonds to increase the relative value of future earnings streams for the stock market (no matter how trickly and unreliable). 

And it seems to be working. The US stock market has hit all-time highs even as the source of its profits – the economy beneath it – struggles to find its footing. 

The intention – ostensibly – is to light a fire under the economy by pumping up the paper value of Americans’ stock market portfolios… encouraging them to go out and spend on flatscreen TVs, steak dinners and bigger, more expensive houses. 

Why the authorities think they know what other people should do with their money has never been fully revealed. Nor is it at all clear that the world would be a better place if people made riskier investments. 

Still, in today’s world nothing succeeds like failure. The Pentagon has not won a war in 60 years… but it keeps getting the go-ahead to enter another one. 

Central bankers’ record of failure is equally impressive. They never anticipate the trouble they cause… and can be fully relied upon to react in inappropriate and ineffective ways when the trouble starts. 

Now, central banks have been hoisted on their own petard. Thanks to their meddling with bond yields, they are now being forced to make up for shortfalls in income by investing in overpriced equities 

With money they create out of nowhere they buy equity stakes in companies. Otherwise, the companies might have been owned by real people… who earned real money providing real goods and services. 

And so, dear reader, more and more of the world’s real wealth shifts from the people who make it… to the people who take it. 

Regards, 

Bill

Further Reading: We recently attended a private meeting of the ultra-wealthy in London to find out how they manage to make and hold onto wealth in the world of funny money. It turns out they have a private set of “rules” to grow wealth that few people know about. If you want to find out the criteria the super-rich use to select investments – and how you can use it to build independent wealth – go here to learn more.

From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners

If you’re wondering what will follow the world of ultra-low interest rates, the answer is simple: higher interest rates. 

An ironclad rule of finance is that markets mean revert over time. In other words, when prices rise far above their average, they start to head back toward their average. And when they fall far below their average, they rise back to meet their average again. 

Same goes for the price of credit… 

Bloomberg reports that even Ben Bernanke believes the yield on the 10-year Treasury note is inevitably heading into the 3.5% to 4% range. 

That means anything priced off artificially depressed Treasury yields is going to run into major problems. 

That includes US stocks, which as Bill mentioned, are priced relative to the so-called “risk free” rate of return available to investors in the Treasury market. 

It also includes junk bonds. There’s no need to reach for a sub-5% yield in high-default-risk bonds when you can pick up that kind of yield up on a 10-year T-note. 

The consensus is the inflation and interest rate cycles are dead. And that higher inflation… and higher interest rates… are never coming back. 

We beg to differ. As investment legend Howard Marks of Oaktree Capital Management puts it: 

In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, and “sure things” can fail. However, there are two concepts we can hold with confidence. 

Rule number one: Most things will prove to be cyclical. 

Rule number two: Some of the greatest opportunities for gain or loss come when other people forget rule number one.

If you’re not already hedged for the end of the world of ZIRP and ultra-low inflation, make preparations now. 

Gold and exposure to energy-producing stocks are a great way to do that… while they’re still relatively cheap.