Those who actually create value as opposed to chasing yield with nearly-free money will actually have some traction once the swamp of excess liquidity drains.
When those closest to the money spigots of the Federal Reserve can borrow billions for next to nothing, cash–laboriously saved from years of paychecks–is reduced to trash. What chance does a saver have in a bidding war for a house or other asset against a financier who can borrow essentially unlimited cash?
Answer: none. The saver can leverage his cash at best 4-to-1: a 20% down payment leverages a mortgage of 80% borrowed money. The financier can borrow as much he wants for next to nothing.
The saver will lose every bidding war, thanks to the excess liquidity created by the Fed and other central banks. The reason given for this vast expansion of credit is that if credit is cheap enough, people and businesses will put that nearly-free money to work.
The problem with cheap credit is that it does not flow to productive investments–it flows to safe yields. Launching a new product or service is risky, especially in a stagnant economy, so the safe way to play unlimited credit (i.e. liquidity) is to chase assets that reliably generate returns.
Consider housing as an example. If a saver wants to buy a house to rent out as an investment, he is going to be paying 4.5% or so for the 80% of the money he is borrowing via a mortgage.
The rental income has to exceed his costs–the mortgage, property taxes, maintenance, etc.–by at least 3%. Otherwise he might as well buy a long-term Treasury bond and earn the 3% without the risk of vacancies, unexpected expenses like a new roof, etc.
Since his mortgage costs 4.5%, the yield has to be considerably higher than 5% to make buying the house a good investment. Let’s say the rental has to generate a return of 10% to yield a net return (after paying the mortgage, property taxes, etc.) of 3%.
The financier paying less than 1% for his borrowed money has an entirely different calculus. Since the cost of his borrowed money is so cheap, he can bid the asset price up and still earn a return above 3%. Raising the price of the house quickly raises the costs of owning for the saver, as the interest costs of the bigger mortgage eat away at the yield.
