INSIDE INVESTOR: How central banks created the stock market rally

How do central banks influence investment?

Each time a new front in the financial crisis has flared, investors have flocked to safety. Traditionally, that has always been US Treasury Notes, another name for US government debt.

In more normal times, that would be enough to drive interest rates lower on their own and that naturally would flow through to US companies and consumers and then on to the rest of the world.

So bad was the 2008 crisis, however, the US central bank undertook drastic action. By printing money – thereby lowering rates to almost zero and depressing the dollar – it forced cash out of interest bearing securities and into the stockmarket. Hence, the great Wall Street revival.

But there are many who believed that solving a debt problem by issuing debt could be a recipe for disaster. Artificially low interest rates are what caused the US property bubble in the first place, they argued, which then led to the global financial crisis.

Unfettered debt prompted by artificially low interest rates in the past has always led to inflation. And the traditional hedge against inflation is gold bullion.

As a result, bullion prices doubled between 2008 and 2011. In recent weeks, however, the gold price has crashed, primarily because Japan’s central bank has embarked on such a mind-blowingly large money printing program that it will stop any further US dollar weakness.

Closer to home, our own central bank also decided the time was ripe to take action about 18 months ago. With the investment phase of the resources boom nearing its peak, and non-resource industries labouring under the weight of an artificially high Australian dollar, the Reserve Bank opted to begin an extended period of rate cutting.

In the middle of last year, that began to work its magic. Lower cash rates forced investors to look for higher yields. And they found them on the stockmarket. It also lowered the cost to businesses and consumers, boosting corporate earnings and consumer sentiment.

But the Australian economy is still very weak in many parts despite some recent signs of an improvement.

Right now, there is furious debate among economists as to whether or not we’ve seen the end of the rate cutting program by the Reserve Bank. The problem is, many economists allow themselves to swayed by what just happened rather than take a longer term, more considered approach.