A Hedge Fund Economy

Hedge funds are investment vehicles best known for borrowing money and then speculating.  Everywhere you turn, distorted interest rates seem to be turning our economy into A Hedge Fund Economy.  The Federal Reserve’s massive efforts to suppress interest rates have impacted the behavior banks and individual investors by luring them to behave more like hedge funds.  Many are speculating on the opium of cheap credit.

Banks are leading the charge.  They have found that it is much more profitable to borrow money from the Federal Reserve and make leveraged investment bets (with taxpayer dollars at risk) rather than abiding by the old practice of acting as a lender to credit-worthy companies.   Their leveraged bets are beyond comprehension:  JPMorgan alone now owns financial derivatives equal to the entire world gross domestic product, at nearly $70 trillion.  Worldwide, the Bank of International Settlement report Over-The-Counter Derivatives equal to $632 trillion at the end of 2012.

Low interest rates are forcing savers and investors to speculate too.  An investor with $10 million dollars in the bank in 2007 could sit back and earn a very comfortable 5%, or $500,000 in short-term bonds.  At the end of 2012, they earned less than $15,000.  This is forcing investors to stretch for income and return by taking on more risk with their capital because there is no income left in cash and bonds.

Finally, central banks around the world, led by the Federal Reserve, have accumulated balance sheet of trillions of dollars of borrowed money.  How will they service the debt?  So far by printing more!  They can keep printing money out of thin air and suppressing interest rates until the crowd one day wakes up to the fact that paper money is worth less and less with every passing day as the proliferation of the Dollar, Yen and Euros continues.  With more and more players in the economy mimicking the behavior of hedge funds where does it all end?  Using history as a guide, we suspect it ends with a heavy dose of inflation as punishment for reckless money printing.