Resource World Magazine

INSIGHTS & INVESTMENTS E r ic H oe sg e n & D e nnis H oe s g e n Money is cheap, but be careful L ow interest rates are here to stay. But, if you'd asked us about this in 20082009, we would have said otherwise. Back then, when central banks slashed short-term rates close to zero and started to buy bonds to push down longer term rates, we all thought this would be temporary as the economy started to recover. Not so. Today, the Federal Reserve is still printing money to buy bonds. Recently, Japan also announced a new phase of monetary easing after 15 years of deflation. This so called radical measure is meant to hit an inflation target of 2%. Incidentally, the price of gold did not react well to this news although fundamental thinking tells us it probably should have. This is not good news for gold, but we digress. The Bank of England's mandate has been revised as well to allow rates to stay lower longer. Even the European Central Bank (ECB) may get more aggressive. All of this points to the fact that low interest rates are here to stay. Money will be cheap for the foreseeable future. The effect on financial markets has been great. The S&P 500 and the DOW have both been hitting record levels. Japan's Nikkei index is up roughly 40% since last November too. But, is it really working? America's GDP is showing some signs of growth but Europe's economies seem flat to negative. Overall, rich world growth is likely to be barely over 1% in 2013, which is nothing to write home about. This disconnect between the ups in financial markets and downs in the overall economy is attracting criticism to the central banks. We, at Hoesgen Investment Partners, agree that cheap money is essential for economic recovery but as long as it is done properly. If America is any example, it pays to be aggressive. It is no coincidence that the most assertive central bank (the Fed) has seen the biggest impact on spending by households and firms – nor that the most cautious central bank (the ECB) has seen the weakest growth. America could certainly still use cheap money better though by boosting public investment in infrastructure, etc. The other side of the argument is that low rates simply pump up asset bubbles, distort financial markets and risk inflation. Critics say excessively low rates help to create bubbles because they allow investors to ignore the cost of financing and concentrate on potential capital gains, forgetting about risk and focusing on reward. This makes the inevitable task of returning to normal monetary policy a little bit complicated. The cheap money has not ignited the investment spree the monetary policy was designed to encourage. Firms have taken advantage of the low rates to issue new debt, but they have used the cash to refinance loans or build up contingency funds. 24 www.resourceworld.com The signs are there in that cheap money has clearly had its biggest effect in finance, but other parts of the economy have not been completely ignored – especially in the United States where lower borrowing costs have been pumping house prices, the pace of mortgage origination is 40% higher than a year ago and consumer credit is growing. Higher house prices make people feel wealthier and more willing to spend. What's more, new car loans are at a six-year high. Americans took out 19.9 million car loans worth $388 billion in the first 11 months of 2012. When people feel wealthier, what do they do? Buy a new car! But the party hasn't been fun for everyone. The cheap money has not ignited the investment spree the monetary policy was designed to encourage. Firms have taken advantage of the low rates to issue new debt, but they have used the cash to refinance loans or build up contingency funds. While that may make sense for certain firms, it provides a smaller boost to growth than say building new factories to create new jobs. Businesses are still sitting on record piles of cash ($1.8 trillion in America's listed firms alone). Hopefully, high share prices and low borrowing costs will eventually open corporate America's wallets. In Europe, the prospects are not as good, not only because of worries about the euro and growth but also because cheap money is regional: according to Goldman Sachs, rates for business loans in southern Europe are nearly four percentage points higher than in the north. With unemployment in the United States around 7.8%, economic growth at 1.3% and the stock market getting little to no lift from earnings, the larger question is when companies will start putting that money to work. It is possible companies aren't making M AY 2 0 1 3

• Cover