News analysis

Things turn topsy-turvy, thanks to central banks

Mr Murray Rothbard would be turning in his grave.

The American economist wrote in his 1983 book, The Mystery Of Banking, that central bank intervention was often disastrous.

Whether the latest round of stimulus, which has generated a slew of negative rates globally, will end badly is yet to be seen, but it's already turned the most basic investment concepts on their head.

Companies are getting paid by banks for swaps, or locking in costs they would normally have to pay a premium for to hedge against market swings.

Swaps used to be one of lenders' most profitable businesses. At the same time, as more than US$8 trillion (S$10.7 trillion) of government securities yield less than zero, investors are buying the debt with one eye on the returns they can get from their price appreciation.

On the other hand, owning stocks for their dividend has never been better, so investors are snapping up shares to get a regular handout.

If the zero-rate policy has turned investment concepts upside down, it's also creating a much too easy and perverse incentive for chief financial officers to juice shareholder returns with borrowed money.

Since Europe introduced the world to negative rates in 2014, companies on the S&P 500 have jacked up dividend payouts while increasing debt versus their operational profits.

Traditional finance says that eventually such a strategy will become unsustainable.

Yields can only go so negative, so at some point, capital gains from bonds will be capped as well.

After all, debentures can't grow their businesses like real companies can. But traditional finance assumptions have been thrown out the window.

Whether that will result in a disaster like the one Mr Rothbard predicted will take a few years to find out.

For now, thanks to central banks, investors can buy stocks for yield and bonds for capital gains.

BLOOMBERG

•This column does not necessarily reflect the opinion of Bloomberg and its owners.

A version of this article appeared in the print edition of The Straits Times on July 15, 2016, with the headline 'Things turn topsy-turvy, thanks to central banks'. Print Edition | Subscribe