With their long-term flood of money, central banks have created a bubble in all types of investments, says historian Edward Chancellor. The air is slowly escaping from this “everything bubble” as interest rates rise. The process is highly risky.
The long period of very low interest rates has driven up prices in many real estate markets.
Edward Chancellor is harshly critical of central banks. For years, the renowned British economic historian and bestselling author has warned that the flood of money from central banks has led to an “everything bubble” developing on the financial markets – a bubble of all types of investments. This was created by ultra-low to negative interest rates. If interest rates rise, it threatens to burst.
In recent months, central banks have raised key interest rates significantly. However, the major crash on the financial markets has not yet occurred. In the conversation, Chancellor also expressed surprise that there have not been more accidents in the financial system in recent months. “When interest rates have been manipulated in history and pushed to too low levels for political reasons, the result has always been crises and catastrophes,” says the economic historian.
The crash has not yet occurred
According to Chancellor, however, interest rates are not high by historical standards. “At best, they are on their way to normal levels,” he says. It should not be forgotten that the recent increase has come from an exceptionally low level – after all, interest rates were even negative in many places not so long ago.
The higher interest rates have certainly claimed victims. Chancellor mentions the Silicon Valley Bank and other American regional banks. “With the collapse of property prices in many countries, other banks are likely to get into trouble,” he says. For example, he is concerned that some Swedish banks are heavily involved in commercial real estate. In addition, companies in other sectors are likely to get into trouble due to the higher interest rates. As an example, he cites the heavily indebted British utility Thames Water, which was dependent on cash injections from its investors.
Edward Chancellor
Edward Chancellor is a British economic historian and author who worked for the financial institutions Lazard and GMO. His book “Devil Take the Hindmost: A History of Financial Speculation” was named Book of the Year by the New York Times. In 2002, his work “The Price of Time – The Real Story of Interest” was published. In it, Chancellor draws a broad arc over 5,000 years and the history of interest. Contact with Chancellor came about through the CFA Society Switzerland, a professional association of financial experts.
Economic historian Chancellor believes that the higher interest rates have not yet had their full effect. “There have already been significant shocks, but no earthquake yet,” he says. One of the reasons for this is the strong state of the American economy, although the massive fiscal spending by the government under President Joe Biden has played an important role. Just on Friday, the Labor Department published strong data from the American labor market. Outside of agriculture, 199,000 jobs were added in November, more than economists had expected.
“If these effects expire, there could still be massive economic and financial turbulence,” says Chancellor. He recalls the course of the financial crisis, which reached its peak with the collapse of the American investment bank Lehman Brothers in September 2008. But the crisis began in 2006, when there were first signs of falling real estate prices in the USA, he says.
“At the moment the risks are being downplayed”
The economic historian expects that interest rates will soon fall again. The high level of debt worldwide also suggests this. “It will be difficult for many countries to finance their high levels of debt,” says Chancellor. That is why governments have a great interest in lower interest rates.
As the Institute of International Finance (IIF) announced in September, global debt rose by $10 trillion in the first half of this year to a record high of $307 trillion. After declining for seven consecutive quarters, the ratio of global debt to world gross domestic product (GDP) also rose again, rising by 2 percentage points to 336 percent compared to the same quarter last year.
Geopolitical risks are also currently being neglected on the financial markets – despite the flashpoints in the Middle East and Ukraine. “The risks are currently being played down,” says Chancellor. In any case, many players on the financial markets no longer correctly assess the risks of investments. This is because in recent decades the central banks have always stepped in when major problems have manifested themselves in the economy.
Expensive real estate in Great Britain
“Financial risks have been misjudged in the markets for so long that many players have become complacent,” says Chancellor. For example, real estate in the UK has been so expensive for so long that people have simply become accustomed to the high prices and the corresponding need for debt when buying.
“Today, politicians see interest rates primarily as a means of controlling inflation,” says Chancellor. Its other functions are neglected: they are needed for the allocation of capital, and without them it is not possible to correctly assess the value of investments. As a “reward for non-consumption,” they provide incentives for saving. They also prevent investors from taking excessive risks. From Chancellor’s point of view, interest rates are one of the oldest institutions in human history and absolutely fundamental to the functioning of a market economy.
«Everything bubble» loses air
“The higher interest rates have, however, ensured that the ‘everything bubble’ has been punctured,” says Chancellor. This was observed in 2022, for example, when stocks and bonds posted heavy losses. In 2023, bond prices suffered further losses, while stocks in the US and many other countries rose significantly again.
The American leading index, the S&P 500, is up around 20 percent compared to the beginning of the year. Chancellor points out that the large technology stocks of Microsoft, Amazon, Apple, Nvidia, Meta and Alphabet were responsible for a large part of the gains. Chancellor continues to see a bubble in the valuations of these stocks.
Measured by the Shiller P/E ratio, American stocks are still highly valued, he says. Nobel Prize winner Robert Shiller developed the ratio, which compares prices on the American stock market to the average inflation-adjusted profit of companies over the past ten years. The Shiller P/E ratio is currently at 30.8 points and at an elevated level. The ratio reached its highest point during the dotcom boom at the end of the 1990s, with values of over 40.
The high share prices ensured that the wealth of private households in the USA was at a high level, says Chancellor. “A large part of the wealth in the USA is bubble wealth, it was created by the ultra-low interest rates.” It can be assumed that there will still be adjustments here.
Higher interest rates threaten mortgages
The traces of the ultra-expansionary monetary policy were also evident in the property market. Chancellor cites his home country of Great Britain as an example. Due to low mortgage interest rates, property buyers there have taken on much more debt than in the past. “Now they are more vulnerable to higher mortgage interest rates.” Many of them have taken out mortgages where the interest rate is only fixed for a short period, for example two years. After the period has expired, property buyers then face higher interest payments. This could mean that some people can no longer afford their property and have to sell it.
“Against this backdrop, property prices in the UK look very expensive,” says Chancellor. In the US, property owners have longer-term mortgages than in the UK. Here, however, activity on the property market is expected to slow down. “Given the higher mortgage interest rates, many can no longer afford to buy property.”
Austria’s hundred-year government bond in focus
According to Chancellor, however, some of the air has already escaped from the former large bond bubble. As an example, he cites the much-quoted 100-year Austrian government bond, which was issued in 2017. When it was issued, investors were desperately looking for returns due to the ultra-low interest rates and chose increasingly longer maturities. The Austrian government took advantage of this at the time and issued the aforementioned bond.
Due to the ultra-long term, the paper is particularly sensitive to changes in interest rates – its price has fallen massively in recent months. While it rose sharply after the papers were issued and reached a high of 237 percent in March 2020, it fell massively in 2022 to a low of just under 60 percent. It is currently at 72 percent. The nominal value of a bond is 100 percent. In the bond market, yields increase when prices fall – and vice versa.
Chancellor assumes that yields on the bond market will remain higher or even rise. This is also linked to the development of inflation. He expects further price increases in the coming years. “Inflation will continue to rise in waves, instead of returning to the 2 percent target of many central banks,” he says.
Opportunities for bond investors
The economic historian sees opportunities for investors in the current environment. Chancellor sees good investment opportunities in the bond market, especially in inflation-protected bonds in Great Britain and the USA. There are also opportunities for returns in value stocks from Europe, Great Britain and Japan. Value stocks are often not very popular with investors and are therefore cheaply valued. In addition, investors often receive high dividends on these stocks.
Chancellor also sees opportunities in emerging market stocks, apart from the Chinese market. The economic historian points to the real estate crisis there and the “enormous real estate bubble” that has formed in the Middle Kingdom and is currently deflated.