Fans of the writing of AA Milne will remember that Winnie-the-Pooh always liked a “little something” at about 11 o’clock in the morning. They might also remember the occasion at Rabbit’s house when he was asked if he would like honey or condensed milk on his bread.
“He was so excited that he said ‘Both’ and then, so as not to appear greedy, he added, ‘But don’t bother about the bread, please’.” He ended up stuck in Rabbit’s front door where he remained until a honey-free diet slimmed him down enough for Christopher Robin to yank him out.
You will see where I am going with this. The eurozone is Pooh. The European Central Bank’s (ECB) super-low interest rates are the honey, quantitative easing (QE) is the condensed milk — and structural reform is the bread, the bit no one is much bothering about.
After all, if the ECB is going to create enough money to buy €60bn of assets in Europe’s markets every month until 2016 or until they are convinced they have forced “a sustained adjustment in the path of inflation”, who needs flexible labour laws?
This is not to say I am not pleased with the ECB action. I’ve been telling you for rather too long that the contraction in bank lending in Europe meant that a massive QE programme in Europe was inevitable, and that you should be buying into Europe in expectation of a QE boom. That’s what I’ve done, via the Montanaro European Smaller Companies investment trust (where I am a non-executive director).
So it is something of a relief to see that this announcement involves the kind of QE that pushes up markets. Rather than going straight to the banks and getting clogged up in their deleveraging process, the new money will go directly into markets.
And just as surely as too much condensed milk makes bears’ tummies bigger, so this kind of QE makes currencies fall and markets rise and rise again. It won’t necessarily do much for the fundamentals of the economy as a whole; QE doesn’t exactly force structural change, and when your banks are dead set on cutting their lending, it doesn’t do much for small businesses either.
But given the effects it will have on the market and for the profits of the many high-quality companies there are in Europe (in the exporting small and mid-cap sectors in particular), you will want to hang on to your European stocks for some time to come.
This might also be a good time to look at your gold holdings again. I am reading a new book by former White House adviser Pippa Malmgren*, which looks at the various signals that economies send us and which we should react to. The biggest question in economics is whether we live in inflationary or deflationary conditions.
The answer is both, and the ECB’s signal this week shows that. All other things being equal, QE is clearly inflationary. Anyone who thinks they ‘can’t see inflation’ hasn’t been looking at prime real estate prices, or at stock markets, and certainly hasn’t been paying much attention to rising real wage demands in the US, UK and China, or to global protein prices (the price of beef in the US hit a new high pretty much every month last year).
But debt and deleveraging is deflationary: anyone who ‘can’t see deflation’ hasn’t been watching global CPI (inflation) numbers, the balance sheets of Europe’s banks; the oil price; or the way in which collapsing currencies in the likes of Japan and Europe export deflation via their exports; and certainly hasn’t noticed how the global debt burden has kept rising even with interest rates at historic lows.
We don’t just have inflation and we don’t just have deflation. We have the two running in parallel. This, says Ms Malmgren, is one of the reasons why our world is as unstable as it is. Debt and low growth make governments work to default on their social contracts — either by inflation or, failing that, what the British now refer to as ‘the cuts’.
Food inflation makes other governments reinvent geopolitics; it is why China is reaching for energy and food assets in the South China Sea and why Russia is doing its best to hang on to increasingly valuable assets such as the food production of Ukraine.
To paraphrase Prussian strategist Carl von Clausewitz, the rise of global conflict can in part be seen as “a continuation of monetary policy by other means”. It’s easy to make modern economic policy sound perfectly rational if you just repeat the words “stimulating growth with an expansion of the asset purchasing programme” to yourself over and over for a couple of hours.
But it is important every now and then just to remind yourself of where we are. National debt in the UK is more than 80% of economic output (before off-balance sheet stuff like pension liabilities) and still rising. Our governments have no clear idea of how to bring government spending into line with tax revenues. Interest rates remain the lowest they have been for over 300 years (did you notice that Canada cut rates this week?) The US and the UK have printed more money than you can imagine to buy their own debt. Japan has been doing the same and now Europe has crossed the Rubicon too.
This is stunning stuff with nastily unpredictable long-term implications. Some day there’ll be payback time. Too much honey and not enough bread will mean our economies will get stuck in the equivalent of Rabbit’s doorway. The unwind back to normality will be just as painful for us as Pooh’s honey-free diet was for him.
Against that backdrop, you need insurance, something that has a history of protecting against inflation, deflation and all manner of extreme events. I’d hold gold, physically, via a good exchange-traded product or less directly via some gold-mining equities.
The footloose among you might want to move to a gold proxy in Tyndrum, Perthshire, where Scotgold Resources has just announced that its Cononish mine contains some $200m-worth of gold. A huge detached house there with a garden that “is a haven for red squirrels” will currently set you back a mere £350,000. Not bad for a five-bedroom foothold in what could be Britain’s next Klondike.
*Signals has been crowdfunded and is available from Indigogo.com.
• This article was first published in the Financial Times.