You know one of the definitions of insanity, right? It’s repeating the same action over and over but expecting a different result. Well, there’s either a lot of insane people running the world’s financial system…or they’re just simply incompetent. Either way, it’s extraordinary.
Let’s be clear: central banks are out of ideas. Their policies pump up stock prices. Meanwhile, the real economy has gone on strike. It refuses to react in the way the academics in government and finance expect. Let me just give you two quick examples.
First, Japan’s growth rate fell by 50% in the third quarter (between July and September). GDP grew at an annualised pace of 1.9% for the quarter. But it’s been slower every quarter this year. It was 4.3% in the first quarter and 3.8% in the second quarter.
The bloom is off the cherry blossom for Abenomics. Promising to double the monetary base drove down the yen for a bit, which boosted export earnings. Stocks raced ahead. But all the momentum is gone. Emerging market demand (which is not boosted by QE) hasn’t recovered.
The chart above shows that the Nikkei is at the top of the trading range it’s been in since late July. It’s not looking over-bought on a relative strength basis. But this shows me that if you’re looking for the next blue chip rally driven by QE, you’re not going to find it in Japan, at least not without some new big, bold stimulus.
US stocks, on the other hand, flew like a gaggle of drones hunting for a strike after Janet Yellen fronted the US Senate Banking Committee. The nominee to replace Ben Bernanke as Chairman of the world’s most powerful banking cartel assured the suits in Washington they could expect the same from her, only more of it. The Dow Jones Industrials are closing in on 16,000 and the S&P 500 hit 1790 (or a year after the beginning of the French Revolution, if you’re looking for historical rhymes).
To chase the US stock rally at this point would be madness. You might make some short-term gains in the next few weeks, but the rocket is nearly out of Fed fuel. And stocks cannot trade at a permanently high plateau merely on the basis of Fed money printing.
That leaves Europe, if you’re looking to take a punt on where the next gains could come from the currency wars. In Europe, there are two pieces of evidence to suggest that money is about to flow from the European Central Bank (ECB) and into stocks.
The first item is that GDP growth in Europe is even weaker than Japan. The 17-country Eurozone grew by just 0.1% in the third quarter. That’s an annualised rate of 0.4%. And it’s so low as to be statistically inconsequential, assuming it’s not flat-out made up. The ECB now has plenty of economic justification for hitting the gas pedal (even if Japan’s experience shows that the effects of doing so are temporary).
Next is what ECB executive board member Peter Praet told the Wall Street Journal earlier this week. He said that, ‘All options are on the table‘ for the ECB to fulfil its mandate of promoting growth, stable prices, and low inflation. That’s just as ridiculous as Janet Yellen committing to 2% inflation. You can’t have stable prices if your policy is designed to increase them (you CAN have asset inflation though, which is what the finance sector loves).
But it appears that ‘asset purchases’ are now on the table in Europe. The matter may have some added urgency, given the weak GDP figures. And if the US and Japan are a precedent, the biggest beneficiary of the ECB’s next campaign ought to be large cap European stocks; hence my recommendation of an Aussie-listed ETF.
One final note on the ‘currency wars’. Let’s not forget that low interest rates aren’t just good for the financial sector. They’re great for governments with large fiscal deficits. These days, that’s pretty much every major Western government.
Governments would face an immediate 20% increase in debt service costs if interest rates went back to 2007 levels, according to a new study from McKinsey and Co. The study shows that suppressing official interest rates has ‘saved’ governments $1.6 trillion in lower interest payments since 2007. Regrettably, while governments are winners with lower borrowing costs, savers and pensioners can go suck eggs, as the chart below shows.
The study is a good read, if you have time. There are lots of pretty charts and graphs. But the fundamental conclusions are inescapable.
Interest rates are at 30-year lows and can’t go any lower, at least in nominal terms. They could go negative if central banks start charging interest on the excess reserves. If you were a bank, you’d have to pay to deposit money overnight with the central bank.
But really, what this means is that asset purchases are the only tool left in the central bank toolbox. They’ve tried it and it hasn’t worked. All that’s left is to try more of it and see if that works. It won’t. But they’ll do it anyway and we’ll know they’re either incompetent or insane.
Let’s not rule out devious, either. This could all be deliberate. It’s a modern version of feudalism, only the peasants and serfs don’t realise they are wage slaves who are asset poor. If you have a high definition television and a full stomach, you can stand a lot degradation in life.
Besides, who needs castles and moats and armour and crowns when you control interest rates, have the only legal printing press in town, and own all the politicians?
Where all this is headed is anyone’s guess. A financial problem (too much debt and poor risk management) has become an economic one. The economic has become political. And the political has become social and cultural. It may not end in another French Revolution. But one regime – the global fiat money standard – is about to lose its head.
These are some of the ideas we’re going to talk about in Melbourne late next summer. If you click on this link, you can add your name to a list. Once on it, you’ll be notified when the conference – what we’re calling World War D – goes live.
Dan Denning+
Editor, The Denning Report
