Central Bank Bullying: Investor Implications

By: Axel G. Merk

“Bullying” by the Fed, ECB, Bank of England and Bank of Japan has been in place for up to six years, forcing not-so-mighty central banks, savers and investors to deal with the consequences. Understanding the dynamics may help investors to navigate what’s ahead.

First, let’s get one thing straight: it matters little what you; we; or anyone in the blogosphere thinks policy makers should do. We are bystanders that have to deal with the consequences of their actions. The cheapest action undertaken by policy makers is to coerce the markets with verbiage. Their words matter, as they control the printing presses. Having said this, if the words are not followed by action, at some point, the markets may call their bluff.

Not all policy makers are created equal. Some grab the headlines simply because their leaders have access to a microphone, such as Christine Lagarde of the IMF. But the IMF only sets policies for countries that are receiving funds from the IMF aid program. For all practical matters, we would like to encourage anyone to tune out when Madame Lagarde tells the Fed or the ECB what to do. Similarly, the OECD just doled out some advice for the ECB, but – frankly – their input is rather irrelevant. Just as irrelevant as yours or mine would be.

Let’s move a step up from the supra-national organizations to small countries. Now we are firmly in bullying victim territory. When large central banks unleash their printing presses, what are smaller countries to do? We have all been told never to blame the victim, but countries have a choice:

• Take Switzerland. Think of a beautiful house in a bad neighborhood where everyone dumps their garbage in the back yard. To blend in, folks living in the beautiful house also dump their garbage in their own back yard. The beautiful house is Switzerland. The Swiss National Bank has been printing money to prevent the Swiss franc from rising, buying up euro and US dollar denominated securities, amongst others.
• At the other extreme, take New Zealand. The brave island nation has raised interest rates, resulting in a significant currency appreciation, especially versus its bigger neighbor, Australia. For now, New Zealand is expected to take a breather in its rate hiking cycle.
• Australia itself has kept rates low (at 2.5% much higher than many other countries), but is widely expected to start raising rates, likely in Q1 next year. To counter investors flocking to the Australian dollar, the Reserve Bank of Australia recently said, “the exchange rate … remains above most estimates of its fundamental value”

And then there are the big boys – and girls, the bullies. When the Fed sneezes, the rest of the world catches a cold. When the ECB or BOJ act, it sends ripple effects around the world. We are told extra-ordinary measures are temporary. Is seven years (since 2008) temporary? Pensioners have been deprived of income. Easy money has pushed up global real estate prices. Buying a home has become unaffordable to ever more people, even as rates hover at or near historic lows.

One could argue that we, as investors, are also “victims.” But just as any country has a choice on how to react to the bullying of central banks, so does any investor. We can’t print our own money, but we can choose where to place our money. Browsing through stories in recent weeks, one can read that the verdict is out: the bullies have been right. After all, stocks have gone up - a bull market creates many smart people.

Things must be great, what could possibly go wrong? Well, Bloomberg reported on Monday that 47 percent of stocks in the Nasdaq Composite Index are down at least 20% from their peak in the last 12 months. No, not all is well. We have argued for a while that the biggest threat we may be facing is that the policies we have in place are actually working, namely that we are getting economic growth. That’s because throughout the world, we have mostly kicked the proverbial can down the road. Should we get economic growth, the cost of borrowing is likely to move higher, making it ever more apparent that we cannot sustain our deficits. Not in the U.S; not in Japan; and not in the Eurozone. But fear not, the bullies of the world may keep rates low. It’s just that something has to give – we think it will be the currency, with the dollar and yen particularly vulnerable.

In our assessment, odds are high that the bullying will continue. That is, central banks won’t allow asset prices to be reflected by fundamentals, but ‘extraordinary’ measures of some form will persist. For countries being bullied, this means they better be in it for the long haul.

For investors, they have to figure out how to navigate these waters. Many have simply gone along for the ride. And why not, if things go wrong, we can simply ask for another bailout, right?

We propose investors to consider what might be a better alternative: how about contemplating what might be a prudent policy for policy makers to pursue, then putting one’s money on the long-term winner? Of course this requires answering the question: what does it mean for a country to win? You see, with both consumers and government heavily in debt, the U.S. might call itself a “winner” if it can devalue the value of this debt; the ones holding the bag are, after all, foreigners. Is a country a winner that provides the best social services? Is a country a winner that allows market forces to play out? Or is a country a winner that minimizes inflation or maximizes employment or GDP?

We believe in the old adage that the best short-term policy may be a good long-term policy. That’s true if for no other reason that businesses are more likely to invest if they know what policies will be in place in the future. As such, we encourage anyone to look at which countries have sustainable policies. Having said that, any such assessment has to be put in the context of valuation because the best values are sometimes found with countries that are about to turn the corner, meaning the market may re-price better times ahead.

Putting money with a country pursuing “good” policy rather than one pursuing “bad” policy may sound well, but will an investor benefit? And if so, what does it mean to put money into a country? Does one buy the currency, stocks, or bonds?

Since we put this in the context of central bank bullying, let’s consider a “good” policy to be sound monetary policy. Sound monetary policy, namely one that fosters price stability, may bode well for a currency. In the context of other central banks trying to debase their currencies, it may lead the currency of a country pursuing sound monetary policy to appreciate. Those fighting the hardest against currency appreciation may win the currency war, but impose losses on those buying the currency.

The call for currency debasement is usually associated with the fear that a strong currency suffocates a domestic economy. As such, at first blush, equity markets in such a country might be at risk. But small countries can have rather odd mixes of domestic versus international revenue for large players. Take New Zealand for example, whose fate is mostly dependent on soft commodities (notably milk powder exports to China); or Switzerland that houses headquarters of various multinational companies, although much of the revenue is from abroad. Many of these countries also have sophisticated currency-hedging operations in place. Importantly, we believe the countries that embrace their strong currencies and adjust accordingly will be better equipped as the bullying of large central banks may continue.

The good news about the recent run-up in the dollar is that it may provide an opportunity for investors to diversify outside of the dollar. Notably, just as the dollar has appreciated with rising equity prices of late, the dollar may not be the safe haven should equity prices fall back down to earth. Given that a downturn in equity prices in the U.S. may drag down equity prices worldwide, investors might want to consider staying on the cash side of things, outside of the dollar, thereby embracing currency risk as a potential opportunity.

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The pound and September: a torrid month for Britain's currency

 

Sterling's worst moments in the past 100 years have generally come in this month, so Scotland's vote could not be worse timed

Black Wednesday - 16 September 1992. How newspapers reported the sterling crisis. Photograph: Harris/PA Archive/Press Association Ima

April is the cruellest month, TS Eliot once wrote. Not for the pound, it isn't. Without question the month that holds the maximum danger for sterling is September. What's more, this week – the week in which Scotland decides whether it wants to become an independent country – tends to be the scariest week of the scariest month.

Consider the evidence. There were five big sterling crises in the 20th century, and four of them came to the boil in September. In the circumstances, it's not hard to see why foreign exchange dealers will be at their desks early on Friday morning to await news from Edinburgh about the referendum vote.

The story starts in 1931, two years after the Wall Street Crash and six years after Sir Winston Churchill had, with some misgivings, put Britain back on the Gold Standard at its pre first world war rate. This involved a revaluation of the pound, a move that made UK exports more expensive. Industry's pain intensified when global trade started to contract in the early years of the Great Depression.

The Labour government of James Ramsay Macdonald found that it could only balance the budget by imposing spending cuts that led to a split in the party and the formation of a coalition. International investors were spooked by a mutiny of sailors at Invergordon and capital flight was not staunched by an austerity budget. Sterling left the Gold Standard forever on 21 September 1931.

Roll forward 18 years and Labour is back in power, this time led by Clement Attlee. An ailing Sir Stafford Cripps is chancellor of the exchequer and the British economy has been hit hard by the cost of six years of total war, and is struggling to meet the twin commitments of high military spending and the welfare state.

Sir Stafford Cripps, former chancellor of the exchequer, discussing aspects of the devaluation of the pound. Photograph: Planet News Archive/SSPL via Getty Images

With the German, French, Italian and Japanese economies all in much worse shape than Britain's, the Attlee administration sees an opportunity to rebuild the economy through an export drive. This though is hampered by the level of the pound, pegged at too high a level against the dollar. Eventually, with Britain's gold and foreign currency reserves dwindling, Cripps agrees to a 30% devaluation. The date: 19 September 1949.

In 1949, Denis Healey was a would-be Labour MP, yet to enter parliament. Twenty-seven years later he was at the centre of the next big September meltdown for sterling, one that eventually resulted in Jim Callaghan's government seeking financial help from the International Monetary Fund.

Just as George Osborne was due to attend a meeting of G20 finance ministers this week, so Healey was due to be out of the country in late September 1976. Unlike Osborne, who scrapped his planned trip a week in advance, Healey was on his way to Heathrow for a flight to Manila, where the annual meeting of the IMF was being held, when he got the news that the pound was coming under intense pressure on the foreign exchanges. The chancellor decided to abort his trip and instead travelled up to Blackpool to attend Labour's annual conference. On the last day of September, Healey urged a sceptical party to get behind the government. The humiliating terms of the IMF loan were announced just before Christmas.

A man weighing gold after the lifting of the Gold Standard in 1931 encouraged people to sell. Photograph: Hulton Archive/Getty Images

The last major trauma was in the 1990s, 16 September 1992 to be exact. This was the date when John Major's government abandoned attempts to keep the pound in the European exchange rate mechanism. It was the date the Bank of England took on the currency speculators led by George Soros and lost. It was the date when the Treasury, then responsible for setting interest rates, announced two increases in the cost of borrowing.

That morning the chancellor, Norman Lamont, pushed official rates up from 10% to 12%. When that failed to ease pressure on the pound, he said the afternoon that rates would be raised to 15% the next morning. The second increase never occurred because by that time, sterling was out of the ERM.

Although there have been no sterling crises since the turn of the millennium, September has continued to be the month when bad stuff happens. September 2007 saw queues outside branches of Northern Rock, the first run on a major high street bank in the UK since the 1860s. A year later, on 15 September 2008, Lehman Brothers went bankrupt, leading within a month to the near-collapse of the western financial system.

That, of course, was in October 2008. But the moral of the story is that even when things don't go pear-shaped in September, there's a good chance of them doing so – 1929, 1987, 2008 – in October. History is just one of the reasons the Bank of England and the Treasury will be ready for action come Friday morning.

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Is the Run in the Chinese Market Over?

by Greg Harmon

The Chinese market has been on a tear lately. So it is no surprise when you look at the weekly chart of the Shanghai Composite below, price is pulling back. It has been an 11% run up from the bottom at 2000. Technically it printed a topping doji candle last week and is confirming it this week with the move down. And this happened at the 200 week SMA. You can see that the price has not closed over that 200 week SMA since April 2010. No one should be surprised if it consolidated or pulls back here. The question though is whether this a short term or long term top. To answer that you need to look at the monthly chart.

The monthly chart presents some clues that any pullback or rest might be short lived. First, the price has consolidated along the rising 200 month SMA since mid 2012 and is rising now. Next it broke above the 5 year down trending channel two months ago and has followed through higher. It also shows a touch at the 50 month SMA and a slight pullback so far. The RSI is breaking above the mid line, very close to the July 2009 high level and is rising. As long as the Composite can stay above the 2200 level it looks ripe for more upside. and potentially a change of character to a long bullish run.

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La stella della sera non è Venere

by Edoardo Varini

La stella della sera non è Venere

Rispetto all'agosto dello scorso anno, in Italia i prezzi sono calati dello 0,1%. I giornali riportano che non accadeva dal '59. Vero: in quell'anno il dato più negativo fu quello luglio su luglio: -2%. Ma già nell'ottobre l'inflazione riagguantò la crescita: +0,6. Al contrario, se di qualcosa possiamo esser certi negli sviluppi dell'economia italiana dei prossimi mesi, è che l'inflazione seguiterà a calare. Per la verità un calo dei prezzi non si chiama più "inflazione" ma "deflazione", ma la parola spaventa troppo e non viene solitamente usata. Lo faremo qui, per amor di verità.

La deflazione deriva da un calo della domanda, che si traduce in un calo dei ricavi, nella riduzione dei costi da parte delle aziende, dunque in un'aumentata disoccupazione, in una riduzione degli investimenti e nel conseguente aumento della speculazione. Insomma, quel piccolo segno meno davanti al tasso d'inflazione è quello che nel trading – perdonatemi la deformazione professionale – chi impiega i grafici a candele giapponesi chiama "evening star" o "stella della sera": candelona bianca, seconda candela con apertura in gap up dal corpo ridotto e terza candela long nera che antecede il trend ribassista, il precipizio.

Fosse l'economia governata dagli astri, forse la stella del mattino e della sera sarebbero la stessa, sarebbero Venere, ma nel mondo della cosiddetta "economia di mercato", governato dal volere e dalle necessità dei suoi operatori, il tramonto e l'aurora sono facilmente distinguibili perché nel primo trovi paura e fame.

La paura dice il Ripa che in allegoria deve avere la faccia piccola e smorta, i capelli ritti e le mani alzate. La fame invece dev'esser, come si conviene, pell'e ossa, e con gli occhi che ti guardano dal buio. Quel buio in economia non è l'ignoto. Si sa benissimo ciò che sta per arrivare. Ma nulla si sta facendo, in Italia, per evitarlo.

Gli investimenti in edilizia sono quelli del '67, le immatricolazioni auto quelle del '79, il reddito disponibile quello dell''86, esattamente come la produzione industriale. Il tasso di disoccupazione è quello del '98 e la spesa mensile delle famiglie quella dell'anno prima, come la loro ricchezza.

Ma non stiamo tornando agli anni '60, perché allora esisteva una politica industriale e il Pil viaggiava intorno al 5% ed il reddito disponibile non era da meno. Ed esisteva la fiducia nel futuro e questo aumentava la propensione al consumo.

No, stiamo tornando molto più indietro. Solo il gas esilarante ci sostiene.

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Revamping Europe’s Tattered Social Contract

by Kemal Derviş

WASHINGTON, DC – For most of the beginning of 2014, the eurozone seemed to be in a state of recovery – weak and unsteady, but nonetheless real. In April, the International Monetary Fund estimated that overall GDP growth would reach 1.2% this year, with slowly declining unemployment, up from its previous forecast of 1% growth. With the threat of unsustainably high interest rates in the countries of the eurozone periphery having disappeared, the path to moderate recovery was supposedly open, to be followed by some acceleration in growth in 2015.

While it is important not to overreact to quarterly figures, recent data, as well as some of the revised data for the first quarter, are deeply disappointing. The pessimism of two years ago has returned – with good reason.

Italy is in an outright recession, and, far from showing hoped-for signs of vitality. French growth is close to zero. Even Germany’s GDP declined in quarterly terms in the first half of the year. Finland, a staunch supporter of firm austerity policies, is in negative territory for the first half of the year.

Nominal interest rates for periphery countries’ sovereign debt have remained extremely low, and, even when taking into account expectations of very low inflation (or even deflation), real interest rates are low. The eurozone now is facing not only a financial crisis, but a stagnation crisis. Tensions with Russia may make recovery even more difficult, and it is unlikely that the eurozone can attain 1% growth in 2014 without major policy changes.

The European Central Bank has announced that it will offer new monetary-policy support and has decided to use all instruments short of direct quantitative easing (it is still not buying sovereign bonds). But it is far from clear whether the proverbial horse led to water will actually drink.

If growth and employment expectations remain dismal, it will be difficult to rekindle demand, particularly private business investment, no matter how low interest rates are, or how many resources banks have for potential lending. ECB President Mario Draghi’s message in his speech last month in Jackson Hole, Wyoming, as well as at his September press conference was a clear call for more fiscal support to boost effective demand.

The essential economic problem is clear: there is an almost desperate need for more fiscal space in the eurozone to boost aggregate demand, including more investment in Germany. But there is also a persistent need for deep structural reforms on the supply side, so that fiscal stimulus translates into sustainable long-term growth, not just temporary spurts and further increases in countries’ debt ratios.

What the “best” structural reforms actually are remains a matter for debate. But in most countries, they include some combination of tax, labor-market, service-sector, and education reforms, as well as reforms in territorial administration, particularly in France.

These reforms should seek to achieve a thoroughly revamped social contract that reflects the realities of twenty-first-century demographics and global markets, but that also remains sensitive to Europeans’ commitment to distributive fairness and political equality, and insures citizens against shocks. It is easy to call for “reforms” without specifying their content or taking into account the social, historical, and political context.

At the same time, it will not be possible to design this new social contract country by country. Europe has become too interwoven in myriad ways – not just in purely financial and economic terms, but also psychologically. It must have come as a surprise to many that it was a German court, not a French one, that banned Uber, the mobile app that is revolutionizing the taxi business.

If the new social contract cannot be forged Europe-wide, it must at least apply to the eurozone to enable the necessary structural reforms. Otherwise, given that the politics and economics of eurozone reform are inseparably linked, fiscal expansion could prove to be as ineffective as efforts by monetary policymakers to foster growth.

Italy’s finance minister, Pier Carlo Padoan, is rightly pushing for a eurozone “reform scorecard,” which would enable direct comparison among national reforms. But, beyond such a scorecard, the will to overcome the stagnation trap must be more than a sum of national wills. Germany must be reassured by what is happening in France and Italy; conversely, Southern Europeans must be able to trust that their efforts will gain additional traction from greater investment throughout the region, particularly in Germany.

A new social contract will not appear out of thin air. Now is the time for the new European Commission to propose – and the new European Council and European Parliament to endorse – a political pact to legitimize and sustain the reforms needed to solve Europe’s economic problems.

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A Cosmopolitan Take on the Referendum

By Anthony Lang

Gordon Brown, the former Prime Minister of the United Kingdom, recently wrote the following concerning the referendum on Scottish independence that will take place on Thursday:

So a new idea of citizenship is emerging. It is not cosmopolitanism if that means that national loyalties do not matter. It is a citizenship that upholds national identities while recognising the benefits of shared sovereignty – the kind of citizenship Scottish people can understand: being Scottish, British, European and a citizen with connections with a world wider even than that. It is not abstract: it represents how people now live their lives – connected constantly through mobiles and the internet, able to communicate with anyone, in any part of the world, at any time – involving an identity that is, for individuals, more a matter of choice than at any time in history.

Brown’s intervention is in the context of his support for keeping Scotland as part of the United Kingdom. What is interesting is he puts it in terms of global citizenship, something that one wouldn’t expect in a debate between two sides that seemed very fixed on their understandings of nation and nationalism. Brown’s point, here and in other places, is that the United Kingdom can and will change, but devolving into smaller sovereign nation states is not the way to go. Rather, a new kind of citizenship and a new constitution is necessary to bind the UK together and simultaneously give it the chance to become part of the world in a different way.

His arguments have a strong appeal for me. Brown’s understanding of cosmopolitanism is close to my own – a mix of local, national, regional, and global orientations that allows us to understand and act in the global political sphere in new and interesting ways.

I know that for many in this country, Brown is a polarizing figure. His role as Chancellor under Tony Blair was part of the New Labour process of shifting the United Kingdom toward more neoliberal economic policies. And his tenure as Prime Minister was filled with stories of bullying and poor governance. But since leaving 10 Downing Street, Brown has embodied the kind of cosmopolitanism he describes above – he advocates for his own small constituency in Fife yet continues to speak on issues of national and global importance. Unlike his predecessor, whose cosmopolitanism is the jet setting world of the corporate executive, Brown’s cosmopolitanism is Scottish, British, European and global.

Many friends and colleagues have strong views on the independence debate, and even in my own family we do not all agree on what is the best route for Scotland. Much of the argument for independence has focused on economics and culture, both of which are important. What I like about Brown’s point, though, is that it’s about politics, the kind of politics that I think is most important – citizenship, constitutionalism, cosmopolitanism. Moreover, these are concepts that are not distant and unimportant in the debate, but actually underlie the more prominent issues of currency, pensions, and the future of the NHS.

There are, of course, very good political arguments on the side of independence. They include the centrality of self-determination, disparities in power, and a vision of social justice in Scotland that is more progressive than the current UK government. But too many of these arguments for the Yes campaign remain insular and localised. I believe, like Gordon Brown – and like other important figures such as Pope Francis – that division and borders are not necessarily good things. Rather, I want a Scotland and United Kingdom that is part of the world in a new way.

In fact, the reason I can’t vote in this referendum is partly the result of the sovereign state system that creates artificial barriers. I’m an American citizen who has worked in the United Kingdom for 10 years. Two of my children were born here. Citizens of EU countries and some former Commonwealth countries residing here can vote, but for reasons that perhaps have more to do with the United States than with the United Kingdom, I don’t have that opportunity. Brown’s vision of a different kind of world, one in which a kind of global citizenship creates new opportunities for political engagement might allow me to vote on my own future (truth be told, I have indefinite leave to remain and am only not a citizen because I don’t want to pay the exorbitant fees – but why should I have to pay money to become a citizen?).

An independent Scotland might be able to engage in the world in this new way, and if the vote goes for independence, I hope it will. But I think the danger of nationalism, a negative nationalism that wants to find conspiracies and dangers in those ‘down South’ will only lead to further divisions. I agree with Yes campaigners that having a say in how you are governed is really important. And, there is certainly no guarantee that a united United Kingdom will create the kind of cosmopolitan representativeness that Brown advocates. But it gets closer to the global politics that I support, one that sees through and beyond the insularity of a single sovereign state to a wider global constitutional order.

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