Received wisdom states that the stock market runs about six months ahead of the economy. If there’s any truth in that, then the economy is heading into some seriously choppy waters.
And this time things could get a lot worse than during the 2008 crunch. The government and the Bank of England have already used up their ammo on the last skirmish.
But if you think that the Bank of England is about to throw caution to the wind and just print more sterling to magic us out of this mess, then you may be surprised.
Today I want to explain why I don’t think we’ll see quantitative easing (QE) for a couple of years – no matter what happens in the US.
Here are three reasons why.
1. We can’t afford a weak pound
First there’s the weak pound. Weak currency is all well and good – it’s certainly helping to get our manufacturing industry back on a sounder footing. But we simply can’t afford for sterling to drift much lower from these levels.
We are an island in the middle of Europe – we are dependent on imports. And our imports will start to get impossibly expensive if the pound heads towards, or below parity with the euro.
The States, on the other hand, is a massive bloc. They can produce much of what they need within the federation.
Trashing the dollar with more QE won’t bother them too much. If it keeps trade sloshing around within the 50 states and cuts imports – then great.
We don’t have that luxury.
2. We also don’t have the reserve currency
The States has the reserve currency – that gives them an advantage. You’ve probably heard the quote “The American dollar is our currency, but your problem.” Why is that?
It’s because the dollar remains the currency of international trade. And it’s also seen as the ultimate currency for savings. For foreign investors, their dollar savings get trashed as the dollar goes down. For US investors, the damage is hidden.
Even as news of the US credit downgrade is being absorbed by the markets, investors still want the dollar. US bonds are still trading around historical highs.
The paradox is brilliant. The markets are on tenterhooks as fear of a US default gathers pace. And as fear hits the markets, cash heads off to the perceived safety of the US dollar and the very Treasury bills that are causing all the heartache. Beautiful!
3. The Bank of England is not the Fed
The Monetary Policy Committee (MPC) is charged with keeping inflation low and maintaining a stable pound.
Now clearly, neither of these things is compatible with QE. The only excuse for QE would be if inflation heads into negative territory. And that’s what I think will happen. But it could take ages for deflation to win over inflation. This is likely to be a slow grind downwards.
The Fed, on the other hand, is viewed as having a looser mandate. As well as stability issues, the Fed is expected to keep the economy healthy and support employment.
Sure the Bank of England is supposed to create an environment that fosters growth. But when Labour surrendered interest rate control back in 97, it was pretty clear that the big idea for the MPC was to keep a lid on inflation.
And let’s not forget the individuals involved. Ben Bernanke is an academic and his specialist subject is the Great Depression. He reckons he understands what policy makers did wrong during the thirties. His academic brilliance will keep the US economy out of trouble. Helicopter Ben will drop dollar notes all over town if that’s what’s required.
Our MPC, chaired by Mervyn King, is a more robust and conservative group. It’s a committee – and though there’s undoubtedly political influence behind the choice of its members, there is at least a diversity of views and a reasonable slug of independence.
Things will have to deteriorate very quickly for more QE
The Bank of England has pushed the QE boat as far as it can for the moment.
The British population has been screwed over. While bankers have taken fat commissions from investing newly minted money, the rest of the population has paid the price through inflation.
But a decaying economy will at some point bring on calls for policy action. Even from those who’ll suffer from it.
Now not everyone will agree with me. As Right Side reader ‘Elvis Presley’ pointed out last month:
“Vince is dropping gob loads of hints that QE 2 is on the way; I don’t think the plonkers at the BoE will wait anything like 2 years for a big crash.”
But I can only see two things that’ll spur the Bank into action sooner.
The first is a savage market rout. Many investors were expecting it today. And as I write, the market is tumbling. But once the panic subsides, I suspect we’ll continue broadly sideways for years.
The other biggy is Europe. If the Europeans are forced into their own form of QE to pay off southern Europe’s debt, then that’ll be a game-changer.
It’ll send the euro down and effectively give an open invitation to the Bank of England to join in with a bit of QE.
But I can’t see it happening. Europe isn’t the US of A. Why? Because it’s got Germany at the heart of the project.
To my mind Germany would rather leave the project than go down the money printing route. And so long as they remain within the euro, then no QE for them means no QE for us.
Good news for gold
For the moment, we’ll have to make the most of US QE. And a great way to play that is a spread bet on gold.
If we get more US QE it’s likely to bring the dollar down. As the dollar goes down, gold goes up. And with a spread bet, you’re paid out £1 in sterling for every $1 gold goes up.
Brilliant.
But just remember to be careful. Using a leveraged bet means you could lose more money than you put down.
Be sure you know what you’re doing and place your stop losses at sensible levels.
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