With their long-term flood of money, the central banks have created a bubble in all financial investments, says historian Edward Chancellor. The air is slowly escaping from this “everything bubble” with higher interest rates. The process has high risks.
Edward Chancellor takes the central banks seriously. The renowned British economic historian and best-selling author has been warning for years that an “everything bubble” has developed in the financial markets due to the flood of money from the central banks – a bubble of all financial investments. This was created by the ultra-low to negative interest rates. If interest rates are higher, it threatens to burst.
In recent months, central banks have raised key interest rates sharply. However, the major crash on the financial markets has so far not occurred. In the interview, Chancellor also appears surprised that there haven’t 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, crises and catastrophes have always been the result,” says the economic historian.
The crash has so far not occurred
According to Chancellor, interest rates are not historically high. “At best, they are on the way to normal levels,” he says. It should not be forgotten that the recent increase came from an exceptionally low level – after all, not so long ago interest rates were even negative in many places.
The higher interest rates have also required sacrifices. Chancellor names the Silicon Valley Bank and other American regional banks here. “With the collapse in real estate prices in many countries, more banks are likely to get into difficulties,” 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 come into distress due to higher interest rates. As an example, he cites the heavily indebted British utility Thames Water, which was dependent on financial 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. His work “The Price of Time – The Real Story of Interest” was published in 2002. In this, Chancellor draws a wide 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.
The economic historian Chancellor assumes that the higher interest rates have not yet fully had their effect. “There have already been significant tremors, 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 played an important role. Only on Friday did the Labor Department publish strong data from the American labor market. Non-agricultural jobs were added in November by 199,000, more than economists expected.
“If these effects expire, there could be massive economic and financial turbulence,” says Chancellor. It recalls the course of the financial crisis, which reached its climax with the collapse of the American investment bank Lehman Brothers in September 2008. But the crisis began in 2006, when there were the first signs of falling real estate prices in the USA, he says.
“At the moment the risks are being downplayed”
The economic historian expects interest rates to fall again soon. The high level of debt worldwide also speaks for this. “It will be difficult for many countries to finance their high debts,” says Chancellor. That’s why governments have a great interest in lower interest rates.
As the Institute of International Finance (IIF) reported in September, global debt rose by $10 trillion to a record $307 trillion in the first half of this year. After declines in seven consecutive quarters, the ratio of global debt to world gross domestic product (GDP) rose again, increasing 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 hot spots in the Middle East and Ukraine. “At the moment the risks are being downplayed,” 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 central banks have always stepped in when major problems have manifested themselves in the economy.
Expensive property in the UK
“Financial risks have been misjudged in the markets for so long that many players have become complacent,” says Chancellor. For example, real estate in Great Britain has been so expensive for so long that people have simply gotten used to the high prices and the corresponding debt required when buying.
“Today, interest rates are seen in politics primarily as a means of controlling inflation,” says Chancellor. Its other functions would be neglected: it is needed for the allocation of capital, and without it it is not possible to correctly assess the value of investments. As a “reward for non-consumption” he provides incentives for saving. It also prevents investors from taking excessive risks. From Chancellor’s point of view, interest is 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 ensured that the ‘everything bubble’ has been punctured,” says Chancellor. This was observed around 2022, when stocks and bonds posted heavy losses. In 2023, bond prices suffered further losses, while stocks in the USA and many other countries rose significantly again.
The American leading index S&P 500 is up around 20 percent compared to the beginning of the year. Chancellor points out that the large technology stocks from Microsoft, Amazon, Apple, Nvidia, Meta and Alphabet were responsible for a large part of the profits. Chancellor continues to see a bubble in valuations for these stocks.
Based on the Shiller P/E ratio, American stocks are still highly valued, he says. The Nobel Prize winner Robert Shiller developed the key figure; it compares prices on the American stock market to the average inflation-adjusted profit of companies over the last ten years. The Shiller P/E ratio is currently at 30.8 points and at an elevated level. The indicator reached its peak during the dot-com boom at the end of the 1990s with values of over 40.
The high stock prices ensure that the wealth of private households in the USA is at a high level, says Chancellor. “A large portion of wealth in the United States is bubble wealth, created by ultra-low interest rates.” It can be assumed that there will still be adjustments here.
There is a risk of higher interest rates on mortgages
The traces of the ultra-expansionary monetary policy were also visible on the real estate market. Chancellor cites his home country, Great Britain, as an example. Due to the low mortgage interest rates, property buyers there have become much more indebted than in the past. “Now they are more vulnerable when it comes to higher mortgage interest rates.” Many of them have taken out mortgages where the interest rate is only fixed for a short term, for example two years. After the deadline expired, property buyers were threatened with higher interest payments. This could lead to some people no longer being able to afford their property and having to sell it.
“Against this background, property prices in Great Britain look very expensive,” says Chancellor. In the USA, property owners have longer-term mortgages than in Great Britain. However, it is to be expected that activity on the real estate market will decrease. “Given the higher mortgage interest rates, many can no longer afford to buy a property.”
Hundred-year government bond from Austria in focus
According to Chancellor, however, some air has already escaped from the former large bond bubble. As an example of this, he cites the much-quoted hundred-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 terms. The Austrian state took advantage of this at the time and issued the aforementioned bond.
Due to its ultra-long term, the paper is particularly sensitive to changes in interest rates – its price has fallen massively in recent months. While this rose sharply after the papers were issued and reached a high of 237 percent in March 2020, it fell massively to a low of just under 60 percent in 2022. It is currently trading at 72 percent. The face 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 increase. This is also related to the development of inflation. He expects further increases in inflation 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 investors in bonds
The economic historian also sees opportunities for investors in the current environment. Chancellor sees good investment opportunities in the bond market, particularly inflation-linked bonds in the UK and US. There are also return opportunities 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 from these stocks.
Chancellor also sees opportunities in emerging market stocks, apart from the Chinese market. The economic historian refers to the real estate crisis there and the “enormous real estate bubble” that has formed in the Middle Kingdom and from which the air is currently escaping.
