The usual coalition of real estate spruikers and inflation doves were out bemoaning the Reserve Bank’s decision to keep interest rates on hold this week.
There may indeed be room for a little easing. Things are slow here. And the slowing economy of China, mirrored by lacklustre economic releases at home, must have lent the RBA governor, Glenn Stevens, and his board pause for thought.
Inflation, however, is the central bank’s main game.
Things have been deflationary for so long that people underestimate the drastic risk of runaway prices.
Make no mistake. Inflation is coming back. Timing is the only question.
The US Federal Reserve chairman, Ben Bernanke, was out feeding the market chooks this week with his “FOMC” (Federal Open Market Committee) report. The real Fed minutes of the meeting won’t be released until 2018 – they must be full of fear and loathing – but the usual meticulously manicured precis spoke of cautious optimism, what else?
The US economy was recovering – albeit at snail’s pace – so there was no need for QE3, the chairman said. What? No QE? Surely the Fed’s raison d’etre is to prop up markets. They must be “kicking the can down the road”!
The markets were “disappointed”, the headlines were “disappointed”. “QE coming in June,” Goldman Sachs said, just as “disappointed” as the next Wall Street muppeteer.
As Wall Street sulked, global sharemarkets had their worst week in three months.
Most people wouldn’t have a clue what QE is. It sounds like an ocean liner. It stands for quantitative easing. And the European version is the even more recondite LTRO (long term refinancing operation).
But it is these two programs – both of which involve printing money on a grand scale – that may quite possibly have a devastating influence on their lives.
Sadly, QE has been used to prop up Wall Street, addicted to free money as it is. Though its effect in rebooting the listless US economy, the purpose for which it was purportedly designed, has been marginal.
Nonetheless, together the Fed and the European Central Bank have printed $US6 trillion. As if that weren’t stimulus enough, interest rates in Europe, the US, Britain and Japan remain close to zero.
In Europe, much of the massive stimulus from back-to-back $US1.3 trillion LTRO tranches has gone to the banks. It is difficult to know what part has been lent onwards to business for proper enterprise, to stimulate the real economy. But you can bet plenty of it has been allocated to bank clients such as hedge funds to punt.
In the playground of financial markets things have been rosy for three months. In the real world, recession looks like it is hitting Europe hard.
Europe’s banks are leveraged 26 to one – on official numbers – just short of Lehman Brothers’ gearing when it blew up. The system has $US46 trillion worth of assets (loans) against a European Central Bank balance sheet of €3 trillion ($3.8 trillion). One quarter of that balance sheet is Portuguese, Italian, Spanish, Irish and Greek debt.
Two points then: one, the unprecedented creation of new money has done little for European growth while it has been little more than a fillip for an insipid recovery in the US; two, this deluge of money means inflation – unless of course the world is headed for a super funk.
It is not all blue. While it might be idealistic to expect a replica of previous recoveries – the world remains steadfastly in deleveraging mode – there may still be support for equities. Quality stocks, after all, carry a yield, something harder to find in bonds or commodities.
Every bubble bursts, every market turns sometime – yes, even China. And amid the relentless noise of the market machine spruiking its recovery story, a reality check is needed.
Pitted against the backdrop of sheer leverage, the economic numbers simply don’t stack up for a regulation rebound and bull market. There will be fits and starts.
To the timing of inflation then; a 400 per cent rise in the price of gold over 10 years is no accident. It reflects, in part, the debauching of paper currency.
Meanwhile, over the past 30 years, US bonds have rallied. This is the biggest rally in the world’s biggest market. It is also a fair punt that that rally is over.
The yield on US 10-year treasuries, amid the fearful flight to safety last year, fell beneath 2 per cent. That’s not much of a yield for investing in an asset, the US, whose liabilities weigh in at $US60 trillion.
Last year looks like the bottom. The 10-year bond is now yielding 2.2 per cent. If treasuries are the harbinger of inflation then rising interest rates are not too far behind.
It is fascinating to watch what China is up to, too. The People’s Republic sold down its holdings of US treasuries by $US32 billion in December – it owns, ominously, some 7 per cent of America’s debt.
And besides producing 360 tonnes of gold internally last year it imported another 428 tonnes – well up on the 119 tonnes imported in 2010.
Copper imports were up 48 per cent, despite gross domestic product subsiding in recent months. Oil imports hit a record, too.
So China is stocking up on hard commodities and gold while easing back on US treasuries, once deemed the world’s bellwether asset. Despite our keen leverage to a Chinese boom and bust however, this shift towards hard assets suits the Lucky Country better than most.