You may recall that not even two years ago, the collective mind was convinced that a united Europe was destined to disappear as a serious economic power; too deep were the rifts brought on by a spiraling sovereign debt crisis, mainly affecting the southern nations of the European Union. Earlier this month, all the fuss seemed to be a thing of the very distant past, with interest rates on 10-year Spanish debt noted at levels similar to paper issued by the United States. Stated in oversimplified words, market participants are now viewing the risks related to recently (or still) troubled nations, such as Spain or Italy, as being comparable to the risk of "handing over a check" to the U.S.
Our new risk paradigm is not a coincidence, but mainly the result of continued, concerted Central Bank interventions keeping interest rates low and yield curves flat -- and not even recent tapering efforts by the U.S. Fed have brought a dramatic change to this constellation. The explanation behind the numbers may be a simple one: Our global economy is still in flux, and much of the world is "hooked" on cheap money. The abrupt change or repricing of those conditions could lead to severe volatility in financial markets. At any given price, policymakers would want to avoid such an outcome, and so they continue to fine-tune their messaging: "The economy is better... but it needs a bit more support..."
Different approaches to explaining ideas that are precisely one and the same have been used as long as mankind has been in existence. It was in 1956 that a newly formed "Flat Earth Society" pushed an old idea of the world being flat, rather than an oblate spheroid, or roundish. The society's motivation has been channeled towards different objectives, but, first and foremost, according to the sentiment of a European newspaper, "Flat Earthers" has become the byword for sticking one's head in the sand, despite clear scientific facts. Socioeconomics, these days, is a bit of the same.
Whereas it is a well-established fact that the U.S. income and wealth gap is becoming more pronounced, the actual "flat" developments (for many) are quite astonishing: From 2009 to 2012, the top 1 percent of incomes grew by nearly 32 percent, while the remainder of wage earners saw their incomes rise by only 0.4 percent. The picture in Europe is not much different, united or not, with income inequality having risen quite sharply since the mid-1980s. A recent sustainability study funded by NASA now concludes that, in the context of historic observations, a collapse of our way of life is becoming increasingly likely. The conclusions of the paper are thought-provokingly simple: "A capitalist society with a privileged elite will lead to a downfall of civilization," while a more egalitarian society will not.
Investors need to be reminded that policymakers, in perpetuity, will not succeed in stifling "natural" risk outcomes via accommodative monetary policies. A suppressed financial system will (and has) become inherently more risky, and prolonged periods of heightened volatility will likely be the norm rather than the exception. I am not proclaiming the end of the five-year equity bull market, but will take this opportunity to remind readers of the concept of asset price inflation vs. real value. The world is round, and any "flat aspiration," as it relates to the distribution of risk, income, or the level of interest rates, will tilt the financial system towards more severe imbalances in the future. Plan accordingly.
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