The sharemarket is seeming to suggest that the worst of Global Financial Crisis 2: Sovereign Debt is over, but if Ambrose Evans-Pritchard is right in the UK’s Daily Telegraph, we’re not out of the woods yet.
As Evans-Pritchard explains, ‘stock markets are a bad barometer at the onset of every crisis, not least the blistering rally of late 1929, a full year after the world economy had tipped into commodity deflation’.
Commodity prices have been falling for a while now, and a pick-up in the US housing market has overshadowed a downturn in other US indicators, with money supply contracting, weaker ADP jobs numbers and slowing GDP growth.
A fiscal squeeze worth 2.5% of GDP over the rest of the year will now be imposed on a US economy that has been supported recently by a collapse in the US savings rate. But ‘while falling saving is what the world needs, it is not what America needs. Thrifty Asians are the people who must spend if we are to right the colossal imbalances in the global system ... [and] ... the world savings rate is still climbing to fresh records above 25pc’.
It’s not all gloom, though, because as well as defining the problem, Evans-Pritchard offers the solution: central banks must admit that the bonds they are buying will never be sold back to the market.
This is ‘the next shoe to drop in the temples of central banking’ and support for the idea is coming from influential sources.
The problem with central banks temporarily buying up bonds is that it relies on pushing down borrowing costs, but that’s a blunt tool when no-one wants to borrow. Furthermore, investors worry about the overhang of bonds coming on to the market when the money creation is reversed.
Scaring the horses
‘All this talk of exit strategies is deeply negative,’ Columbia Professor Michael Woodford (the world's most closely followed monetary theorist according to Evans-Pritchard) told a London Business School seminar recently. ‘If we are going to scare the horses, let's scare them properly. Let's go further and eliminate government debt on the bloated balance sheet of central banks.’
Adair Turner, chairman of the UK’s recently disbanded Financial Services Authority, has joined the chorus. ‘We must tell people that if necessary, QE will turn out to be permanent,’ says Turner. But he also takes it a step further suggesting that central banks should be ready to finance current spending through Keynesian public works projects.
Evans-Pritchard describes such flagrant money printing as the ‘ultimate taboo’ in monetary circles, but as Turner puts it: ‘The danger in this environment is that if we deny ourselves this option, people will find other ways of dealing with deflation, and that would be worse.’
Ultimately, these ‘other ways’ could include, Evans-Pritchard suggests, a breakdown in the global trading system, armed conquest or Fascism, ‘or all together, as in the 1930s’.
Firing up the helicopters
It all sounds very scary, but there is at least a simple solution: central banks should stop mickey mousing with ‘twists’ and ‘quantitative easing’ and fire up their helicopters.
Ironically, if this is how it all plays out, then real assets, such as shares and property, may be the best place to be (out of a bad bunch). So maybe the sharemarket is getting things right after all – but I’ll be sticking very much to the high-quality end of the spectrum.