Central banks have done it again, says Societe Generale’s Albert Edwards. Led by the Federal Reserve, they “have created the conditions for another debacle every bit as large as the 2008 Global Financial Crisis”.
Just as they kept interest rates far too low for too long in the mid-2000s, causing the credit bubble and inevitable bust, today’s “negligently loose” monetary policy, this time with zero interest rates and money printing, has had scant impact on growth, even as it has “inflated global asset prices into the stratosphere”. Now the bubbles are bursting – but unlike in 2007, “this time America and Europe sit on the precipice of outright deflation”.
China’s weak economy, along with the capital pouring out of the country, are putting strong downward pressure on the yuan. The resulting devaluation will “transmit a massive deflationary shock to the West” via lower import prices. Some bulls say that while US manufacturing may be ailing, services are holding up fine. But history shows that, when a recession looms, “it is almost always the manufacturing sector that takes the less volatile services sector by the hand and leads it into a recessionary underworld”.
The renewed plunge into global recession implies a collapse in US-led global markets. Since the late 1990s, Edwards has been worried that the US and Europe were following Japan into deflation and stagnation: his “Ice Age” thesis. In stockmarket terms, this implies a gradual fall in valuations to historic lows.
In this context, reckons Edwards, the post-2000 bear market has unfinished business, because the S&P 500’s cyclically adjusted price/earnings ratio never fell below seven, a typical level for the bottom of long-term bear markets. It only fell to 13 in March 2009. A fall from today’s 26 to seven implies an S&P 500 at 550. Think that’s impossible? Most people thought the same about the 2008 crisis.