It’s fascinating.
Only last week, everyone was asking what would happen when the US Federal Reserve raised rates.
Yet now that Janet Yellen and co have decided against raising rates, all the talk is of when we’ll see a fourth bout of quantitative easing (QE).
So what’s it going to be, and what does it mean for your money?
The US looks OK – but much of the rest of the world doesn’t
The tricky thing for the Fed is that the US economy looks OK. Regardless of what you think might really be going on with the US (plenty of people reckon it’s on the verge of recession), looking purely at the official figures – which presumably the Fed has some faith in – then there’s no real reason not to raise rates.
As demographics expert George Magnus notes in the FT, US unemployment is “now at the same level as it was when the Fed initiated its last tightening cycle in 2004”, while inflation wasn’t much higher back then than it is now.
So if it was all about the US, then the Fed would be hard-pushed to justify keeping rates where they are.
But it’s not just about the US, notes Magnus. He points out that twice before in recent history, “Fed tightening cycles and a robust US dollar have been associated with emerging market crises”. In the early 1980s, Latin America took the hit, while in the mid-90s it was Asia.
“This time, a change in US monetary policy would not so much trigger a China or emerging markets crisis that has already started, as accentuate it.” But the question, says Magnus, is “how long can this stand-off go on, given that China’s travails, for example, are not going to end any time soon”.
The basic issue is the US dollar. The dollar is so important to global trade and as a reserve currency (everyone owns some of it) that changes to Fed policy are transmitted across the world via the dollar strengthening (tighter policy) or weakening (looser policy).
The problem – as is always the case with easy money – is that investors and governments take too many risks when money is cheap, and pump money into projects and assets whose fundamentals don’t justify the investment. In short, a lot of effort is put into schemes and plans that only work for as long as money remains cheap. This is what Austrian economists call ‘malinvestment’.
In China, notes Magnus, that’s left behind “a structural real-estate overhang and chronic industrial overcapacity, not helped by the continuing shortcomings of state enterprise reforms”. In short, there are more buildings and factories than anyone actually needs.
When monetary policy tightens, that has to reverse somehow. And that is – at least in part – what’s happening now in China.
Will the Federal Reserve start up the printing presses again?
Magnus argues that the Fed needs to articulate the tough choices it faces, and that putting off making a decision will only mean “more disruptive policy adjustment and greater instability”.
But others already think we’re too far gone for that. John Burbank of Passport Capital – a hedge fund that’s done very well this year by betting on a collapse in commodities and emerging markets – also argues to the FT that this is all due to the “misallocation of capital”.
In short, “the wrong people got the capital – emerging-markets countries and corporates and a lot of cyclical companies like mining and energy, particularly shale companies – and this is now a major problem for the credit markets”.
He reckons that things are only going to get worse, sparking a financial crisis in emerging markets. And that in turn will “slow down capex and hiring and consumer buying in the US, and that will make the Fed realise they should be easing and not hiking”.
He’s not the only successful hedgie who reckons that a fourth bout of QE is on the cards. Ray Dalio of Bridgewater Capital recently argued a very similar point, prior to the Fed’s hesitancy last week.
So what’s the answer?
The reality is that we can’t know for sure. However, it’s pretty clear to me that the Yellen Fed will not raise rates until it is forced to. The Fed is very happy to use China as an excuse to avoid doing so.
Meanwhile, the bubbles that were burst by the strengthening US dollar – commodities and shale production among them – are still in the process of deflating. The fact that we haven’t yet seen the big bankruptcies coming through is partly down to monetary policy remaining remarkably forgiving. But it’s only a matter of time.
And when the fallout from that hits the economy, the chances are that the only ‘loosening’ option left to the Fed will be to return to the printing presses. By that point, the big question will be: does anyone have any faith left in money printing?
We’ll be looking at the implications of the Fed’s latest non-move in more detail in the next issue of MoneyWeek, out on Friday.
Actual martial law
By Dan Denning
Well, here Tim Price and I were, worried about the gradual imposition of something like financial martial law in Britain. And instead, we should have been worried about actual martial law. It goes to show you that you can never be too paranoid these days.
What am I talking about?
A theoretical Jeremy Corbyn-led government could face “mutiny” if he threatened to pull out of Nato, scrap Britain’s nuclear deterrent (Trident), or otherwise “emasculate” the British Army, according to comments from a British general in the Sunday Times.
The unnamed general, who served in Northern Ireland, reportedly said: “The army just wouldn’t stand for it. The general staff would not allow a prime minister to jeopardise the security of this country, and I think people would use whatever means possible, fair or foul, to prevent that. You can’t put a maverick in charge of a country’s security. There would be mass resignations at all levels, and you would face the very real prospect of an event which would effectively be a mutiny.”
As a colonist (American and Australian), I’m not familiar with the British constitution, other than that there really isn’t one. But even if you have a cursory knowledge of British legal traditions, the above comment from a senior military official sounds like the sort of thing that you could be court martialled for. Of course, that would be military court, not a civilian court. But you take my point.
Granted, the whole premise of an armed mutiny against a democratically elected Corbyn government is entirely theoretical. But how radical has British politics become when a) the Left elects a man who has more in common with Britain’s enemies than its friends and b) senior military officials leak quotes to the press about mutiny.
Everything is proceeding as I have foreseen, to quote the emperor in Return of the Jedi. A mismanaged financial crisis has generated an economic stalemate. You have low interest rates, low wage growth, and low GDP growth. The world is cracking up. The crack-up creates political fractures, which you’re seeing all over the world.
But perhaps that is a pessimistic view. Yesterday I received Stephen Bland’s Dividend Letter. He’s just launched his High Yield Portfolio No. 6. There’s something definitely comforting about the idea of buying stocks, never selling them, and collecting the income from them for the rest of your life.
This is also the idea behind Cris Heaton’s Lifetime Wealth. The premise of both is that you should probably just ignore all the macroeconomic and geopolitical stuff. You can’t do anything about it anyway. So don’t worry. Buy income!
Still, I can’t help worrying. It’s in my nature. And it’s probably in human nature too. Nature rewards behaviour that promotes survival. Thinking about future threats and risks – that’s just prudent. Let’s talk, briefly, about China.
China: friend or foe? The UK should be “China’s best partner in the West”, according to George Osborne. He gave a speech—pointedly made at the Shanghai Stock Exchange—to make the case for why the UK and China need to “stick together”.
Is it a new ‘special relationship?’ Has the old one gone stale? Or is that just the way the world works? You cosy up to the powerful because it’s in your interests to do so, no matter who they are?
Chinese companies will issue short-term debt in London, according to the FT yesterday. This is another development to emerge from the chancellor’s trip to China. It will be the first time Chinese countries issue debt outside China. The People’s Bank of China will issue renminbi-denominated notes later this year. This follows the UK issuing its own renminbi bond last year.
The countries are studying a link up of stock exchanges right now. The chancellor said he wants the UK to be, “the natural western hub for renminbi trading” and “China’s bridge into Western financial markets”. It’s like a new silk road, only one built to get Chinese capital into the City. Hmm. I’ll have to see what Merryn says about that when I see her later today.
In the meantime, Standard & Poor’s has changed its rating on China’s banking industry from “stable” to “negative”. It cited rising “bad loans”. And those are just the ones we know about.
To be fair, the ratings agencies haven’t fully recovered the trust of the public after their failure during the last crash. They either misunderstood or underestimated the risks of debt instruments linked to the value of residential US mortgages. We all know what happened then.
The situation is different today. Global debt has grown by $57trn since 2009. Much of that is on public sector (sovereign) balance sheets. The risk is hiding in plain sight.