It's safe to say that as this is written at noon EST on Monday the 24th, every
economic policymaker in this hemisphere (and a lot of sleepless folks elsewhere)
are staring at screens and wondering if this is it. They've been playing with
fire for such a long time, trying to balance incompatible goals of low interest
rates, stable currencies and accelerating growth, that for a while they almost
believed that they would get away with it, that the laws of economics could
be bent to their will forever.
Now they see that this was hubris, that their sense of control was just an
illusion bought with credit on a scale so large that the numbers had become
meaningless.
During the night, emerging market stocks tanked again, led, ominously, by
China. This morning the carnage has shifted to the US, where stocks are down
hard but, more important, interest rates are still rising. 10-year Treasuries,
the key to mortgage rates and pretty much everything else, now yield nearly
twice what they did a year ago. That means massive losses for a whole world
of risk-averse investors who thought they were parking their money in the safest-possible
asset. Presumably the rest of their capital is in riskier places like stocks
and junk bonds, which means they're losing big across the board.
This is a global story, since Treasuries have been everyone's safe haven of
choice for decades. But painful as a 40% haircut for the world's pension funds
might be, it pales next to the impact on growth. US interest rates are, with
a few notable exceptions like Japan, the base of the global yield curve. Everything
else, being riskier, has to have a higher yield. So a doubling of US rates
means a commensurate ratcheting up of everyone else's rates.
Since equities are valued in part in relation to the yield on available bonds,
rising interest rates mean lower stock prices - everywhere. And real estate,
which is generally leveraged, has just gotten a lot more expensive (which means
the other group obsessively staring at screens these days is the new generation
of flippers who recently joined the Southern California and Florida bubbles).
This is the nightmare scenario that keeps central bankers and institutional
investors up at night because, based on Japan's experience with hyper-aggressive
monetary ease, there might not be a fix. If even easier money is met with dramatically
higher bond yields, as in Japan, then there's nothing left to do but to let
the system unravel.
Not that they won't try one more role of the dice. It's just that this time
their odds of getting snake eyes have gone way up, and they know it.
