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Poor Stephen Roach.
It seems that the hard times may have arrived for the global economy. But Morgan Stanley’s global economist, once the biggest bear in mainstream economics, doesn’t even get to say: “I told you so.”
Clearly tired of waiting for the crash, his May 1st investment missive began: “It seems like eternity since I was last optimistic on the world economy.” He went on to describe why he had become cautiously optimistic on the outlook for the global economy.
Less than three weeks later, the FTSE 100 has fallen 6%, the Dow Jones is down 4% from its peak, and the Nikkei 225 down 7%. The dollar is diving and fear of inflation is rampant.
Talk about bad timing…
It’s hard not to feel sorry for Stephen Roach. After all, it’s oft-declared that a bear market can’t truly get underway until the last bear has turned bullish – so perhaps his misfortune was inevitable.
So what prompted the change of heart? Well, you can read his whole piece here – Is the world economy really on the mend? – but in essence he argues that the good news is that the G7 and the IMF have realised that they need to deal with the US trade deficit, and central banks have realised they can’t keep flooding the world with cheap money.
A combination of a falling dollar, and gradually rising interest rates are evidence that the “global economy finally seems to be taking its medicine.”
Mr Roach’s heart is in the right place. He recognises that the US trade deficit is a serious problem, and that central banks have been way too lax with monetary policy. His only real mistake is to trust in the ability of politicians and governments to do anything other than make a bad situation worse.
Anatole Kaletsky, writing in The Times, has a completely different view from Mr Roach – but still expects the government, in the form of the Fed, to sort everything out.
The trade deficit has nothing to do with the weakness of the dollar, he declares.
Why not? Easy, he says. “The US trade deficit has been consistently denounced as ‘unsustainable’ since 1980, yet it has been sustained since then without any trouble and without… diminishing the dollar’s long-term value at all.”
The idea that a situation must be permanently sustainable simply because it has been ongoing for the past 26 years is a peculiar one. The British Empire lasted a lot longer than 26 years, but it eventually collapsed. And the gold standard lasted a lot longer than the British Empire, but it too eventually made way for the dollar standard we currently have.
(Though that may be a temporary blip, if you believe The Daily Reckoning’s Justice Litle. We published Justice’s piece on how gold could replace the dollar yesterday, but if you missed it, click here: How the dollar’s collapse will lead to a new gold standard)
Let’s leave that to one side for now. So what is to blame for the fragile state of stock markets?
Mr Kaletsky pins the blame squarely on Federal Reserve chief Ben Bernanke and the way he has confused and unnerved Wall Street by first giving the impression that interest rates were definitely on hold, and then gradually back-pedalling from that position.
But never mind. Mr Kaletsky is “convinced that the Fed will eventually pass this test…and that the dollar will re-establish itself as the most trusted currency in the world.”
This is a remarkably optimistic outlook, to say the least. Central bankers don’t have magic wands – not even Mr Bernanke.
The truth is, as Dr Marc Faber points out, the Fed chief can’t win, regardless what he does. If Mr Bernanke hikes rates aggressively to target inflation, it will burst the already hissing US housing bubble and “have a lethal impact on US consumers”.
This is not a palatable option. So the Fed is more likely to “err on the side of inflation more often than not”, says financial commentator David Fuller.
This will mean a “generally soft US dollar”. That’s good news for gold, “which could easily rally by a multiple of its current price over the next twenty years.”
He also remains bullish on the resource sector and emerging markets – though he plans to wait until ‘the anticipated medium-term correction has gone far enough for many people to suspect that we are in a bear market.’ In other words, hold off investing until everyone else thinks stocks are going to keep falling – and then start buying.
Sounds like a good plan to us. You can visit our Investing in gold page on the website for more information on the yellow metal. And one emerging market we’ll be keeping a close eye on is India. There’s more on how to invest in Indian property, plus three top share tips, in the latest issue of MoneyWeek, out today.
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Turning to the stock markets…
The FTSE 100 ended almost flat, shedding 3 points to close at 5,671 after a volatile day’s trading. Telecoms group BT surged 8% to 226.25p on strong full-year results, while retail stocks such as DSG International made gains as April retail sales were stronger than expected. For a full market report, see: London market close
Over in continental Europe, the Paris Cac 40 fell 11 points to 4,908, while the German Dax rose 13 to close at 5,666.
Across the Atlantic, US stocks kept falling as investors continued to worry that interest rates have further to rise. The Dow Jones Industrial Average fell 77 points to 11,128 while the S&P 500 dropped 8 to 1,261. The tech-heavy Nasdaq shed 15 to 2,180, and is now at its lowest level in over six months.
In Asian trading hours, the Nikkei 225 ended a volatile session up 68 points at 16,155. A government report showed that rising consumer spending is helping the economy to expand more quickly than analysts had expected. The economy grew at a 1.9% annual pace in the first three months of the year.
This morning, oil was a little higher in New York, trading at around $69.70 a barrel. Brent crude was also higher, trading at around $69.20.
Meanwhile, spot gold headed higher to around $683.25 an ounce. Silver was trading at around $12.70 an ounce.
And here in the UK, shares in British Airways have soared as the group reported better-than-forecast fourth quarter profits. Rising business passenger traffic from Heathrow airport was the main driver of the gains.
And our two recommended articles for today…
How badly will the weak dollar hit the US economy?
– The US is suffering from a massive current account deficit, unequalled by any other major developed country. An adjustment is inevitable, says Jeremy Batstone at Charles Stanley – in fact, it’s already begun. But how much further will the dollar have to decline? To find out what previous current account adjustments can teach us about how this one might play out, click here: How badly will the weak dollar hit the US economy?
Where are the best buys in Asia?
– At the beginning of March, MoneyWeek invited some of the top experts on investing in Asia to share their views with us. To find out how vulnerable Asia is to a US slowdown, and to learn which sectors and markets they favour, click here: Where are the best buys in Asia?