Market forces

The three pre-eminent forms of investment are real estate, treasury bonds, and company shares. The price of real estate varies according to the rent it can obtain. And rent in turn depends on the supply and demand for housing or, in the case of farming and mining, on what the land can produce. Treasury bonds have a nominal price and a rate of interest printed on them. Someone buying a bond above its nominal price gets a lower rate of interest, and someone buying it below its nominal price gets a higher rate of interest. Company shares are fractional ownerships that receive corresponding parts of the profits. Here, both share prices and profits fluctuate.

Investments can move around, especially in bonds and shares that are easily and quickly bought and sold. Investments move in search of the best return and, by pushing up or lowering prices, this mobility tends to level the returns on different investments. However, bonds bring a fixed return that only varies as a proportion of the price they have been bought, whereas the price of shares and their dividends can increase or shrink. Investments in shares are more risky than investments in bonds, this means buyers expect a higher return and may get a lower one. Bonds pay what is written on them, X% of Y. Shares pay a fraction of profits, but profits can sink to zero and below.

Investments are speculative because prices go up and down, and speculation can create bubbles when prices outstrip returns. The real estate collapse ten years ago concentrated investments on bonds and shares, which have swollen considerably since then. Bond prices were bloated artificially by central banks, intent on lowering interest rates. They bought up existing bonds at inflated prices, and reduced the discount rate to almost nothing. This meant that new bonds could be emitted at the same very low rates. When the return on bonds is barely above inflation, the last resort is shares. So share prices have risen, and risen, and risen again. And, as potential dividends are more than twice the interest paid on treasury bonds, there is room for more rises. Unless or until interest rates go up, either because central banks decide to increase their discount rates, or because of a slackening demand on the bond market (see China and S. Arabia). A rise in the rate of interest means an automatic fall in the price of existing bonds, and a knock-on drop in the price of shares, which is why central banks are so hesitant, and why the market may decide for them.