Beware the liquidity trap

Beware the liquidity trap

Beware the liquidity trap
Larry Berman is a well-known name in Canada. The CEO and co-founder of ETF Capital Management began his career as an investment advisor in 1989. A Chartered Market Technician, he also holds the Chartered Financial Analyst designation. As well, he is a U.S.-registered Commodity Trading Advisor. Prior to co-founding ETF Capital Management in 2006 he was chief technical strategist and managing director for CIBC World Markets. He founded the Independent Investor Institute and has been president of the Canadian Society of Technical Analysts. So he’s busy. He gets around.

He’s never short of something to say.

In a recent and enlightening conversation he ranged over a fascinating number of ideas. At the heart of his discursion, a thoughtful, if worrying take on what’s to come now that the Federal Reserve has set about winding down its historically unprecedented Quantitative Easing (QE) program.

The story of markets over the past few years, of course, has been the story of QE. Since the Great Recession the Federal Reserve has used a variety of unheard of techniques to inject liquidity into capital markets. Stocks have responded positively. But the worry is that markets are moving, not according to economic and corporate events, but only in reaction to indications from the Fed about the future of the QE program. This is odd. Government fiscal stimulus is driving markets, not real events. This is not how markets are supposed to work. But the really big question is this: What’s coming post-QE?

What happens when the stimulus that has been driving markets is withdrawn? The Fed has indicated the program is winding down. Will 2015 bring the first of the interest rate increases in years? Larry Berman doesn’t think so.

“I think the central bankers are going to try to raise interest rates,” he says. “The Fed in particular….not Europe….But this is going to be radically difficult. The Fed will attempt to raise rates in the years ahead. But I don’t think they will be able to.”

That is to say, don’t expect those fixed income returns to improve. What is coming is a broad realize that the world has changed; that the economy is too delicate to handle rate hikes; that the U.S. economy is moving into an era of more permanently lower growth.

“The reason things have recovered, has a lot to do with demographics.  The boomers are retiring. They are no longer spending like younger people do. They’re holding on to their money for the retirement years. And this means below-trend growth for years,” says Berman. 

He goes on to suggest that the Fed is set to realize that it is now, like Japan, in a “liquidity trap.” The Fed will try to raise rates but will find that there is a massive amount of debt in the world and sub-optimal growth. “The economy will immediately tank if they try to raise rates. And so the Fed will find it has to step on the accelerator again. This is perpetual. The new aggregate demand is going to be lower in the future. And so rates will have to stay low,” says Berman.

This has been the case in Japan for some time now. “You look at Japan…they don’t like immigration. Their population peaked in 2007….and so they’ve been doing QE since 1997. Japan is not coming back anytime soon. The average of the workfare is 58. The cost to the government for caring for an aging population is huge. The Dependency ratio [the rate of people below 22 and the number of people over 66] for the next thirty years is terrible. More people are going to hit 65 and begin living off their savings. And that’s deflationary.”

Actuaries have warned about this stuff for years. Western populations are aging. Overall consumer spending in the economy (70% of the economy) is going through a secular shift. The old-style growth is done. Rates will have to remain low to generate whatever little bits of economic growth are possible. That is, don’t expect interest rates increasing significantly any time soon. No matter what the Fed says about a post-QE world.

Coming up next week, Berman lays out the strategies for how to play these future markets.
Larry Berman is the CEO of ETF Capital Management. You can find the company at