Of all the central banks around the world, the European Central Bank (ECB) has rarely surprised markets by making monetary policy adjustments without some hints to the market first.
But this is exactly what happened last week when the ECB lowered its benchmark interest rate to a record-low 0.25% in hopes to spur economic growth. (Source: European Central Bank, November 7, 2013.)
This monetary policy change is a much bigger deal than many people realize.
First of all, as I just discussed last week, many investors have been expecting economic growth to finally emerge within the eurozone. This change in monetary policy by the ECB just validates what I’ve been saying for some time: that economic growth is nowhere in sight.
This is not news. How many years has it been since the Great Recession, and where can you find true, fundamentally strong economic growth?
All I see are central banks trying to outdo each other with easier and easier monetary policy (money printing).
With the ECB benchmark interest rate now at 0.25%, how much more ammunition does the bank have left? Does anyone really believe that a quarter-point drop in interest rates will revive economic growth for the region? I certainly don’t.
But this goes beyond just the eurozone. What the ECB is doing with monetary policy is more than simply printing money; it’s trying to lower the euro currency. And while the central bank isn’t explicitly stating that this is its plan, in my opinion, it is still a significant consideration.
Look at what the Japanese central bank has done. Japan has enacted one of the largest monetary policy (money printing) programs ever in an effort to stimulate economic growth. What Japan’s really trying to do, with some effect, is lower its currency to boost exports.
But there’s a problem with that model. Over the long term, no country has ever devalued its way to true economic growth. Sure, over the short term your export industries might get a boost, but the citizens lose their wealth as buying power is eroded.
Even in Japan, exports are benefiting, but citizens are not seeing wages increase and the prices of imports (including energy) are rising.
The entire world can’t simply continue devaluing currencies and printing money forever. For decades, we’ve seen South American nations try the same tactics and ultimately fail.
This monetary policy action by the ECB is yet another shot at trying to boost economic growth by lowering the region’s currency.
So where does this leave the Federal Reserve? Can it really begin reducing its monetary policy program when central banks around the world are printing money like it’s confetti?
If the Federal Reserve does begin to reduce its monetary policy stance, this would (on the margin) drive investors to boost the U.S. dollar versus nations that are more aggressive in their money printing. This action would create pressure on our economy, fragile as it is, by weakening exports.
The situation might then arise where all of the central bankers are looking over their shoulder at each other, waiting for inflation to flare up before reducing their money printing. But it could be too late by then, as bubbles continue to build in many markets globally.
These are difficult times; there’s no question about it. This also means that citizens in nations where monetary policy keeps money printing going at a rapid rate are subject to a loss in purchasing power (wealth).
Central banks are adamant that they want to see higher levels of inflation through monetary policy to support economic growth. The only question is: can they rein in inflation if it gets out of hand? Only time will tell.
Until then, investors should look to hard assets as a store of wealth. As I’ve discussed in this column before, it’s no secret that the wealthy are trading their paper dollars for hard assets, as there is a growing demand for real estate, diamonds, art, and physical precious metals. Having some sort of hedge to any one currency is a prudent move for investors at this point.
This article What the New Record-Low ECB Interest Rate Means for U.S. Investors was originally published at Investment Contrarians
