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  • Writer's pictureWilliam Webster

Time for the exit

Now all eyes are focusing on tapering you could be forgiven for thinking that rates will bound up just as fast as they went down. As central banks now seem to target employment rather than use it as an indicator this is unlikely.

The only spanner in the works being a collapse in confidence and hot money (out) flows - this has happened before and it causes rates to rise fast. (Watch out for bond and stock holders running to the exit all at once).

On a more mundane issue some central bankers have been trying to convince us that QE is wealth neutral. This of course depends on how you are invested.

Their argument is that falling returns on cash are offset by capital gains on longer duration assets. Not bad for a well balanced portfolio. This is however only part of the story.

When rates eventually rise (as surely they will) equilibrium is restored. But the cash investor has experienced a permanent loss of interest. With rates being low for so long it would take very high real rates to reverse this situation. Something that I point out above is unlikely to happen unless sentiment changes in a big way.

Regardless of what central banks may tell you the policy that’s been adopted is a direct transfer of wealth from those holding variable rate assets to those with variable rate liabilities.

This has social consequences that need to be considered but are conveniently sidestepped by policy makers. Furthermore it means the normal process of liquidating inefficient businesses is temporarily suspended. The longer it remains the less economic sense it makes.

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