Primer on pitfalls of printing money
The past month has been historic in that global central banks have employed a bazooka monetary stimulus approach in proportions never seen before across capital markets.
Whatever the acronym, OMT (outright money transactions) or QE3 (quantitative easing) it is simply printing money to reduce the value of a country's or continent's debt.
The numbers being put up are quite amazing and the fact that figures like a trillion dollars have become a normal part of world business vocabulary is frightening.
In my experience of school yard arguments I think we are only left with a zillion before infinity.
To summarise September's events we start in the first week with the president of European Central Bank Mario Draghi announcing the bank "will do whatever it takes" to save Europe.
Which came in the form of acronym number one OMT, where the bank would buy troubled countries' bonds (debt) to keep their lending rates down to a manageable level (provided an official 'bail out' request was made and the country agreed to economic reform).
In week two, the US Federal Reserve chairman Ben Bernanke delivered acronym number two in the form of QE3; where the Federal Reserve will buy $40 billion of mortgage-backed securities (housing debt) per month and keep interest rates at zero through 2015.
And just to ice the cake they will continue to do this until there is improvement in the economy and actually beyond - so there is no timeframe.
In week three, the Bank of Japan (BOJ) announced a 10 trillion yen expansion to its asset purchase program (of treasury discount bills and Japanese government bonds) to 80 trillion yen.
The BOJ also extend its buying program until the end of 2013.
Will week four see a Chinese stimulus package?
Although the country's growth has ground to a halt and the government has announced increases in infrastructure project spending there has not been a formal Central Bank response.
The effects of low interest rates and surplus liquidity (cash) can have a profound impact on financial markets. Investors need to consider what can eventuate on the back of 'money printing', especially when it is so large and on a global scale.
Recent history would indicate:
·Share markets have a tendency to rise (if they haven't already priced in these events). As for the ASX the $A may have to weaken for this to occur which would mean the RBA would have to reduce rates.
·Commodity prices at least initially strengthen, benefitting from a flight to hard assets away from paper due to printing reducing its value. This generally filters through down to soft commodities including grains.
·There is the increased risk of inflation down the track. An increased quantity of 'cheap' money chasing a fixed amount of hard assets causes inflationary pressures.
Share market investors need to be wary, as with so much intervention there is the risk of overlooking company fundamentals which should ultimately determine a company's share price.
And although markets may indicate that this money printing is positive (because they tend to rise) the fact is that for Central Banks to be continually intervening there must be deep ingrained problems (excessive debt) that at some stage are going to raise their head, meaning somebody is eventually going to have to pay the bill.
·To subscribe to Adam Farrall's weekly market update, contact him on 9225 0020 or email firstname.lastname@example.org
_Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time. _
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