The Wealth Effect is Expiring

In the aftermath of 2008, central banks and governments concocted a plan: If we lower interest rates to zero and inject liquidity, cheap credit and make assurances to the market that we’ll support it, monetize debt and buy mortgages, there will be a wealth effect felt by the general public and they’ll go back to borrowing and spending.

The money will flow from Wall Street banks to Main Street mom-and-pop businesses and households, and the recovery will be strong and swift.

This was the theory of the 2010s and they carried out their plan, but the wealth effect didn’t trickle down, as was conceived in central bank models.

The trickiness of simplistic centralized behavior-pattern analysis, which aims to predict economic activity in the same way that a parent is likely to correctly understand that if he puts a child in his room without toys, TV or any form of entertainment, then the child will be so miserable that he’ll agree to anything the parent says, doesn’t work in the real world.

What happened in the 2010s was that instead of banks making loans to the public (the sensible outcome of zero-interest rate policies), the public decided to park their funds in the banks, even though it didn’t make sense and the banks decided to jack up the lending requirements.

The wealthy – or better phrased, the financially-savvy – saw the trends that were forming and gave their money to Wall Street to manage, so banks were drained of liquidity and growth companies were able to receive obscene sums, even before ever showing a profit.

It was only towards the later stages of the recovery, in 2018 and 2019, that the trickle-effect made it to Main Street and they participated in the rally of the leftover crumbs, after a lengthy bull market in stocks, bonds and real estate.

Fast forward to 2022 and the central banks want the exact opposite. There are too many people feeling a misguided sense of riches, the “wealth effect” has spread far and wide, because of stimulus checks, the ease with which making money in stocks and real estate has become in 2020, and the huge demand for employment from corporations who need jobs filled.

The FED is trying to destroy this falsified wealth effect that they birthed in 2009 with zero interest rates and QE.

As they were then, their actions are now extremely aggressive; they aren’t messing about.

Back in 2009, with Quantitative Easing and slashing interest rates, the FED attempted to incentivize the public to generate loans and get back in the saddle. Instead, the public turned fearful and kept everything in banks, complaining about the situation and unwilling to assume any debt.

The wealthy institutions took full advantage of the lack of competition over real estate and stocks, and bought aggressively.

We think the opposite is transpiring today. The rich are abandoning Wall Street and don’t want stocks or real estate; they’d rather park money in the bank and earn a nice, juicy yield, while the public, who is finding it easy to stay employed and originate mortgages or loans, will be the chief buyers of assets as prices come down – a TOTAL FLIP.

Banks will see a surge of deposits, an influx, a tidal wave of cash coming in from the big boys, who want to be liquid, and the public will be driving the activity instead.

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Courtesy: Zerohedge.com, Bloomberg

Notice for yourselves how the red and black lines have now reversed.

The red line is now leading the black one, which means that liquidity is drained from the system and you can see how sharp of a squeeze we’re in.

The consensus, up until recently, was that the FED must capitulate and pivot at some point, which is why many have kept buying the dip, but not Smart Money — they understand the paradigm shift happening.

Yes, the FED will pivot, just like they did with QE programs, which ended in 2014.

It took them five years, though, to fully expire.

This means we could see QT (Quantitative Tightening) in some form until 2026-2027.

If the last decade was dominated by the rise of a concentrated few tech companies, who gained enormous market caps and dominance, this decade will prove to be more challenging, and blindly buying index funds won’t seem so smart.

Best Regards,

Lior Gantz
President, WealthResearchGroup.com