What Central Banks Don’t Want You to Know

The task of today’s Daily Reckoning is to expose the propaganda of central banks and governments. I’ll show you why monetary policy is just a tool to prop up asset prices.

Here’s why it’s important. If this means sacrificing savers, jacking up the cost of living, fermenting bubbles and locking people into a lifetime of debt slavery, then that’s what does and will happen.

That’s the price we all have to pay for living in a rentier economy. Once you see this reality for what it is, your investment acumen goes up a notch.

That brings me to the war on deflation that central banks are fighting. Deflation is falling prices. Anyone with a brain, or without an agenda, knows a lower cost of goods increases the general standard of living. This is so self-evident it’s absurd to point it out.

But central banks have an active policy to generate 2% inflation. They want the general price level to go up. And if they don’t get it, they get night sweats and a twitchy finger at the printing press.

The propaganda from the central banks is that falling prices discourage consumption. The theory is that’s because people delay purchases on the expectation of even lower prices to come.

And if people delay spending, businesses run down their inventories and don’t invest, in response to falling sales. Then we get an increase in unemployment as businesses cut costs, mainly jobs.

The cycle then turns into a vicious circle until even the banks are imperilled. That’s because in deflation the real cost of debt goes higher as incomes and prices fall, making it harder to repay loans.

Here’s what they don’t want you to know: as the Bank of International Settlements’ latest quarterly review shows, there is zero evidence that falling consumer prices have any negative impact on growth. In fact, the BIS perceive it as mostly harmless. My fellow editor Greg Canavan cited this report last week to show you deflation in consumer prices is a bogus reason for cutting interest rates.

What the paper does reveal, however, is that big declines in asset prices — such as stocks, but especially real estate — hit output and growth like a squirrel grip from King Kong.

Here’s the Financial Times reporting on why the central banks will do everything they can ¬— including inflating the currency, buying toxic assets with public money and bailing out bankers — to make sure real estate stays high:

Housing is most people’s principal asset — and is often funded by large debts. All of the growth in bank credit since 1980 has gone to mortgages. At least in the US, home equity extraction has been, until recently, an important source of funding for consumer spending growth, so large house price declines thwack both net worth and real purchasing power, in addition to bank capital.

Unsurprisingly, Borio et al also find that the impact of a given decline in assets values is related to the amount of debt outstanding before the bust.

The central bank does everything it can to keep house prices rising as it makes people ‘feel’ richer, though often much of it is an inflationary mirage. But can you see why over at Cycles, Trends and Forecasts we study the real estate cycle? Even if you don’t own property, or aren’t interested in it, you have to understand it isn’t just part of the business cycle. It IS the business cycle.

That’s because the amount of credit the banks create will drive the extent of the economic boom. Most of that credit will be created against real estate as collateral.

The fact that the Reserve Bank says you can weigh those two facts as equal to the change in the price of a hamburger, a six pack of beer and your next trip to the movies is as stupefying as it is insulting.

They would actually have us believe that because a basket of goods is staying within a narrow price band that they are delivering economic stability. Meanwhile land prices are inflating all over the country as everyone leverages up to get in on the action.

Of course, this is all wonderful for the banks while the going’s good — bank stocks wouldn’t be breaking out into 52 week highs if it weren’t.

There’s a lesson here. Stocks will react to where we are in the real estate cycle. If you know that, you give yourself a big head start on the next investor. Each industry times itself slightly differently, of course. When property starts to fall — and it’s still some time away in my opinion — you know the economy will be on the skids.

But it won’t be because of falling consumer prices. It will be from falling asset prices. There’s a difference, and that difference is everything.


Callum Newman+,
for Markets and Money

PS. Low interest rates are just one effect of this. That’s a problem when you need income. If you haven’t checked out our new dividend income service, you can do so here.

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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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