How Do People Destroy Their Capital?
I have written previously about the interest rate, which is falling under the planning of the Federal Reserve. The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one here.
Artificially low interest makes it necessary to seek other ways to make money. Deprived of a decent yield, people are encouraged (pushed, really) to go speculating. And so the juice in bonds spills over into other markets. When rates fall, people find other assets more attractive. As they adjust their portfolios and go questing for yield, they buy equities and real estate.
Dirt cheap credit is also the fuel for rising asset prices. People can use leverage to buy assets, and further enhance their gains.
And it’s wonderful fun. A bull market, especially one that is believed to be infinite—if not Fed-guaranteed—seemingly provides free money. All you have to do is buy something, wait, and sell it. You can get your capital back plus something extra.
Many people spend most of this extra. This is their gain, their income. Their brokers, advisers, and other professionals also make their income off of it.
However, there’s a contradiction. Common sense tells us that it should be impossible to consume without first producing something. How can this be possible? How can an entire sector of economy get away with it?
It can’t. There is no Santa Claus. Something else is happening, something insidious.
The falling-rate-driven bull market is a process of conversion of someone’s wealth into your income.
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