This is What Happens When Stimulus Stops…

Do you still think interest rates are about to rise?

You don’t do you?

We hope you don’t.

Because interest rates aren’t going up.

They’re not going up here in Australia…or in Europe, the UK, the US…and definitely not in Japan.

It turns out that, despite printing trillions in yen, the Bank of Japan just can’t get the inflation that it’s looking for.

It’s a lesson for investors everywhere. Don’t expect rates to rise anytime soon…

We’ve warned investors about this for the past three years.

Interest rates are low and they’re staying low.

We’re not the only one to hold this view. Global strategist and Washington ‘insider’ Jim Rickards told his Twitter followers last year that interest rates would stay low forever.

‘Forever’ is a long time. No doubt he was just making the point to emphasise that rates aren’t about to rise in the near future.

And you can look to Japan for the blueprint on how things will play out.

The West is following Japan’s ‘blueprint’

As the Financial Times notes:

The Bank of Japan will be forced to cut its growth and inflation forecasts this week, but officials are signalling that extra economic stimulus is unlikely for now.

Japan’s central bank is set to move its inflation forecast for the 2015 fiscal year down several tenths of a percentage point from the current 1 per cent and shave its growth forecast from the current 2.1 per cent, even as its quantitative easing programme buys Y80tn (673bn) worth of bonds each year.

Japan has had interest rates close to zero for 20 years.

So what makes anyone think that the US Federal Reserve will begin raising interest rates after just six years of zero percent rates?

And what makes anyone think that Aussie interest rates will go up either?

This is the reality of money printing. As long as the central bank is printing money, folks think that it is working.

That’s because you tend to see an improvement in economic growth, and even an uptick in the inflation rate.

The politicians and central bankers think that they’ve done their job. So they start talking about raising rates.

But then the unexpected happens (unexpected for them anyway). Once they stop printing money, the economy sinks back into a hole again.

Does that give the central bankers pause for thought? Do they think that maybe money printing isn’t such a good idea after all?

Not a chance. Their response is that it would work…if only they could do more of it.

So that’s what they do. Again, Japan is the blueprint for that approach.

Why governments hate deflation

For the moment, Japan says it won’t print any more money…yet.

But don’t expect that to last.

Without money printing, Japan’s growth rate will slump and deflation will reappear.

No central bank or government wants deflation, because it makes it harder for the government to pay off debts. Remember, even with deflation, the nominal amount of debt stays the same, but tax revenues fall as wages and prices fall.

The only way the government can counter that is to raise taxes, which wouldn’t go down well with voters at a time of falling wages.

So when the establishment talks about the fear of deflation, they’re not worried about the impact it will have on you; they’re worried about the impact it will have on tax revenues.

That means interest rates staying low. Here in Australia, odds are the Reserve Bank of Australia will cut rates on 5 May. Although, having guessed wrong the last two times, investors aren’t willing to firmly bet on it.

According to the latest futures market prices, investors only think there is a 52% chance of the RBA cutting. It would be naïve to think the RBA doesn’t look at this number.

As we’ve said before, the RBA wants to make sure folks know who’s in charge, so it’s probably more likely to cut when investors don’t think it will.

An invaluable service

That means there’s still time to top up on your dividend stocks before the big cut (assuming the RBA does cut). Our old buddy and new colleague Matt Hibbard has recently launched the income investing advisory Total Income.

The aim of that service is to fight back against the RBA’s ruinous attack on savers. Matt is showing investors how to gradually build income-paying positions on the stock market, but without getting caught up in the ‘hunt for yield’ frenzy.

It’s an invaluable service. You can check out the details here.

This is important. We know folks will tell you that Japan is different, and that the same thing won’t happen here or in the West.

That may be partly true. But look at the US and Europe now. The US Federal Reserve cut interest rates to zero six years ago. Most mainstream analysts thought rates would quickly rebound.

That hasn’t happened. And that’s because it can’t happen. As soon as the central banks try to withdraw stimulus, the economy and markets slump.

The West is only six years into its super-low rate interest rate experiment. If Japan is the blueprint (as we believe it is), the era of low interest rates has much longer to run.

Cheers,
Kris

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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