The End of Easy Money

Money is getting less plentiful. The world has been swimming in excess liquidity in the post-recession period. This was good policy that prevented a costly financial market freeze-up. But there were unintended consequences, and as the policy is unwinding, so are the unintended consequences. Some have already unwinding, some are unwinding as we speak, and others effects are yet to come. What should Canadian exporters be watching out for?

EDC Economics’ tracing of this goes back to late 2010. Some key market distortions emerged with the onset of quantitative easing, and these demanded explanation. At that time, the effects of dramatic public spending programs were starting to wear off, but the rebound in commodity prices persisted – despite high inventories and low usage rates. This made no sense, until we considered the huge injections of cash furnished by the world’s central banks. Ready cash was needed to shore up confidence in the system, but nobody really needed the cash for transactions. Consumers were desperately trying to de-leverage, and businesses had overspent on capital and equipment – they had no real need for new investments for a long time. So, where did the money go?

It seems that a lot of it found its way into financial instruments. Recall at the time that at the peak of the economic cycle, certain analysts persuaded many to believe we were running out of basic materials like oil, gas and base metals. Consequently, commodities attracted a lot of investment money, propping up prices. Liquidity drowned the bond market, driving yield-seeking investors to successively higher-yielding, but riskier, instruments. Among other things, this provided relatively cheap financing for risky emerging markets. At one point, yields on Zambian bonds were lower than Spain’s, despite fundamentals that showed this made little sense. And this wasn’t an isolated case. This and other similar distortions made us wonder what other distortions might be out there, and we developed a list of candidates that were shared with audiences across Canada.

If we were right, then we predicted that the eventual withdrawal of liquidity could be ugly. For instance, commodity prices were likely in for a tumble. Analysts greeted this with jeers, but in late 2014 were scrambling to explain why growth was rising and at the same time, prices were plunging. In large part, those new, lower prices have persisted, strongly suggesting that prior price levels were grossly exaggerated.

The next wave of effects was not immediate. In fact, only recently have we begun to see a serious unwind of easy money in the emerging market world. We saw this coming well ahead of time, telegraphing the likely effects in late 2013, specifically identifying Turkey as one of the most vulnerable markets. If it wasn’t altogether difficult to see this coming, it was quite challenging to predict the actual timing. Now that the first wave is underway, the immediate concerns are how far into the emerging world this unwind will extend, and what the broader effects will be on the global financial system. A forthcoming Commentary will delve more deeply into this question.

Naturally, this leads us to wonder what is next. Currencies, the corporate bond market (especially the riskier segment), consumer lending and the insurance market are all candidates – not to mention the irrepressible stock market. All are likely at some point to feel withdrawal effects – although to varying degrees, these will be offset by real economic growth. What adds uncertainty is that this withdrawal of quantitative easing is far from over. The US is well into its program, but Europe has barely started, and Japan is another question altogether.

There is a positive flipside, though. Easy money that was once available to emerging markets will now becoming more readily available to the developed economies. More precisely it will find its way to those sectors of the economy operating at capacity in order to alleviate pressures that developed over the years of underinvestment.

Growth is making money easier to come by. But it’s also meaning that access to money – incredibly easy over most of the past decade – will be tighter from this point on, particularly for riskier ventures. Exporters should be especially aware of this.