The other day Hans-Jorg Vetter, the CEO of Landesbank Baden-Wurttemberg in Germany, dropped a bombshell when he mentioned that the "mother of all bubbles" growing out of the zero- or negative-yield environment.
“Risk is no longer priced in,” he said. “And these investors aren’t paid for the risks they’re taking. This applies to all asset classes. The stock and bond markets are now seeing the mother of all bubbles.”
This is a serious matter, a warning from the CEO of one of Germany’s banking giants of the risks of financial bubbles which eventually must pop. When they do, the damage will be far greater than in the 2008 crisis.
In the meantime, why should investors care about the risks when they get almost free money from the central banks, which have adopted a near-zero interest rate policy? Easy money pumped in by the central banks has created excess liquidity.
In the euro zone alone, bond yields have turned negative on 2.2 trillion euros of government debt. German government debt is now seeing negative yields up to a 7.5-year maturity, with 10-year yields on the cusp of turning negative. What this means is that investors are willing to lose their principal money by lending to the German government. They have nowhere else to park their excess money amid fears of a sudden shift in market sentiment that might result in further losses.
The financial bubbles can be traced back to missteps by the central banks of Japan, Europe and the US. The economies of the developed countries face insolvency problems over excessive debt that has accumulated to a level that cannot or will not be repaid.
Instead of allowing the markets or the banks to work their way out through debt restructuring or management overhaul, the monetary policymakers have injected liquidity to give the financial system a new lease of life. They have also brought interest rates down to near zero in order to help reduce the carrying cost of banks and enterprises. The result is that excess liquidity has flooded into the financial markets to create bubbles in all asset classes, as Vetter of Landesbank Baden Wurttemberg has stated. Investors are borrowing money freely, which pumps up the debt further. Excess liquidity is also flowing into the bond market to drive up prices and depress yields.
Since 2009 the giant US companies on the S&P500 have spent more than $2 trillion to buy back their own stocks. Last year alone, the buyback amounted to $550 billion. Companies have found it more profitable to reward their shareholders with stock buyback, which pushes up stock prices, then invest for business expansion. Much worse, many companies have borrowed money from the banks to buy back their stocks.
The losers are the common people on the street who have no access to financial assets. This has created a widening of the income gap. Good businesses either can’t compete or have no incentive to compete against those that rely on cheap funding to stay afloat. This environment of easy money is what has led to the “mother bubble”.
When will it pop? Nobody can tell. But looking at the falling trade figures, the sluggish growth rates, the still-high unemployment rates and the deflationary pressure in the developed markets, sooner or later the chickens will come home to roost. And when they do, the central banks’ cure-all monetary policy will be exposed as a sham.