5 Lessons From QE And The Credit Crunch For Investors

The credit crunch is long behind us but QE, the chosen cure for the crash, and the long depression that followed is still lingering.

The crash of 2007-2008 was different from crashes of the past in that it was longer and deeper than all but the crash of 1929 and the depression that followed.

To compare the modern crash with the Great Depression, we are currently in 1936. This could be worrying on a number of levels, the most important of which is that 1936 was a herald for the second world war.

Let’s hope history doesn’t repeat. Instead let’s look at some lessons for investors.

Lesson 1: Free markets are dead

There was a time when markets ran free but it was only a short period from Reagan, which ended arguably with the dotcom crash when central bankers stepped in and softened the blow of the technology crash.

In a true free market prices float freely. As such, the markets have never really been totally free because governments via their bankers normally set rates periodically rather than in real time. Interest rates influence currency, trade and equities; interest rate policy is the tool of choice to tune a country’s economy. Once they were for nudging the mostly free market, now they are a halter and leash used to dominate economic outcomes. This leaves the investor dragged away from investment fundamentals and focused on the competence or otherwise of government interest rate policy. It makes for long trends. It means in a nutshell, “don’t fight the Fed.” It leads on to point 2.

Lesson 2: Trends are your friend until the bend in the end

Central banks are in control until they aren’t. Make no mistake, the debacle of the credit crunch was the fault of government. They regulate interest rate policy, credit policy, the financial companies themselves--all the rules of the game driving money.

The credit crunch was the outcome of a game whose playing field and rules were owned by government and their agencies. Governments rely on credit to tax it. Taking the proceeds of credit is what keeps the budgets of most states a float. Governments want you to have credit, want you to own property because it’s their income base. They grew credit and taxed it at unsustainable levels until the whole merry-go-round imploded. Then government had to clear up the mess.

Before 2007 central banks seemed “masters of the universe,” boom and bust had apparently been banished. Instead all those small economic perturbations were stored up into one massive whirlwind. Risk wasn’t cancelled, it was dammed up. So right now it looks like the Fed and the ECB, BOJ and BOE are once again in full command, but instead they are just suppressing the real problems that in a freer market would be lanced every now and again. Instead, at some point there will be another rupture and once again few will see it coming.

Central banks have a tiger by the tail, again. Watch out for changes in long-term trends.

Lesson 3: Hard assets are the chosen route to direct economies

Private property and stock markets are now a distribution method of new money into falter economies. In the old days, governments would simply hand out money to their employees to stimulate the economy. When the printing press was switched on, governments spent the money on bridges, pointless employment, subsidies and such like to get the money out there.

Now new money is produced by supporting asset prices. By suppressing interest rates resources are shifted to the economically active and government borrowing costs are lowered.

The feel-good factor of high asset prices and the ability to sell them for cash or use them as collateral for borrowings leads to a trickle down. It supports the cash cow of the private sector too. It’s a system that appears to avoid runaway inflation.

This means that property and the stock market will be the first stop for any economy wishing to give itself a boost. This will sustain a very long trend indeed.

However, as the proverb goes, “trees don’t grow to the skies.” Sadly nothing goes up forever.

The consequence is, therefore, that both property prices and stock market valuation will trend upwards but will be the very undoing of the system used to create stability and prosperity in the first place. The new economic cycle is now driven by house prices and stock market valuations and it’s a game that even if you do not choose to play in it, is the one that will call the shots.

Lesson 4: Public sector austerity is the solution to a weak economy but governments can’t and won’t implement

There is a lot of talk of austerity in Europe but there hasn’t been any. For example, the U.K., which is apparently notorious for austerity, has had a year on year increase in government spending. Austerity often means more taxes so states can continue with large deficit spending. With all this austerity, not one country has lowered its debt levels. The upshot is, profit is not in retrenchment but continues to be growth at any price and the outcome of deficit spending, pump priming and credit creation. Buy the dip is still the way to go.

Lesson 5: When you slow a crash you retard the recovery

The credit crunch kicked off one of the longest recessions in the modern era and it is the opinion of many that if the crash had been left to run its course without a colossal intervention and the creation of trillions of dollars of new money, that while the crash would have been even deeper the recovery would have been faster. This is probably true, but the consequences of leaving economic nature to run its course would have been far more traumatic to many than it has panned out for most. However, the economy of the U.S. and Europe has wallowed in recession for many years. This wallowing is fast coming to an end. There will be a boom and it is starting in parts, there may be a bubble to come.

We are through the extended recessionary period of this elongated cycle and there is a strong possibility a boom period will also be shallow and long. As such, investors need to avoid being fixated on the problems of the past and keep at least one eye on opportunities that could be offered by a boom and bubble period. As a cautious bear it is hard for me to swallow but we have to accept we are living in a new kind of economic regimen with tight central control and long trend.

There is no going back.

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Clem Chambers is the CEO of leading private investors Web site ADVFN.com and author of Be Rich, The Game in Wall Street and Letters to my Broker.