Interest Rate Roundup

Thursday, November 09, 2006

Money, Money everywhere

What do falling long-term yields ... incredibly low spreads on risky debt vs. U.S. Treasuries ... hundreds of billions of dollars in private equity deals ... still-elevated gold and energy prices ... plunging capitalization rates on commercial real estate transcations ... and multi-decade low dividend yields for some REITs have in common? Glad you asked.

My answer: Money. Money everywhere. An ocean of liquidity sweeping through the global capital markets. We can't get a look at M3 here in the U.S. anymore, because the Federal Reserve decided several months back that the indicator wasn't useful (I think that's nuts -- the MORE data, the better -- but that's an argument for another day). But M4, the U.K.'s broadest measure of money supply, surged at a 14.5% annual rate in September -- the most since 1990. European M3 surged at a 8.5% year-over-year rate, up from 8.2% in August and almost twice the 4.5% rate the European Central Bank has flagged as risky in the past. And in other countries, the story is the same. Money and credit growth is enormous right now, and that money is helping drive up the value of all kinds of assets, regardless of credit risk, historical valuations, low/falling yields, etc. It's also fueling a gigantic wave of buyouts -- private equity funds may end up raising $400 billion this year, versus $283 billion a year ago, according to Private Equity Intelligence.

The Fed still seems focused purely on benchmark economic data -- employment, CPI, productivity, etc. But I think it's a real mistake to overlook the impact of this excess liquidity. It distorts financial decision-making and asset prices, and the fallout can be quite painful. Just look at what too much liquidity did to the residential housing and mortgage markets: Created the largest housing bubble in U.S. history. Do we really want to see malinvestment in other sectors, too? Food for thought...


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