Fed, ECB Throwing World Into Chaos?
Ultra-loose monetary policies by the Federal Reserve and the European Central Bank are throwing the world into "chaos" rather than helping the global economic recovery, Nobel Prize-winning economist Joseph Stiglitz said on Tuesday.
A "flood of liquidity" from the Fed and the ECB is bringing instability to foreign-exchange markets, forcing countries such as Japan and Brazil to defend its exporters, Stiglitz told reporters in a conference at Columbia University.
"The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy," Stiglitz said. "It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing."
The U.S. dollar has weakened about 6.5 percent against a basket of major currencies since the beginning of September as prospects for further monetary easing by the Fed have led investors to seek higher returns elsewhere.
That flow of dollars caused currencies to appreciate in many emerging market countries such as Brazil, which offers strong growth prospects. The Japanese yen has also hit record highs against the dollar on expectation of additional greenback weakness.
Recent actions by those countries to curb the strength of their currency were "necessary," Stiglitz added.
"It's natural in that context for them to say -- we can't just let our exchange rates appreciate and destroy our exports," he said.
On Monday, Brazil doubled a tax on foreign investment into local government bonds, while Japan lowered the target for its benchmark interest rate to a range between zero and 0.1 percent.
The Bank of Japan also pledged to buy 5 trillion yen ($60 billion) worth of assets, in a strategy similar to the one adopted by the Fed to pump funds into the economy.
But additional monetary stimulus will "clearly" not solve the problems caused by lack of global aggregate demand, Stiglitz said.
"Lowering the interest rates may help a little bit, but that's much too weak to address the problems facing the United States and Europe," Stiglitz said. "We need fiscal stimulus."
What we really need to boost aggregate demand is jobs. According to Stéfane Marion, Chief Economist at the National Bank of Canada, there is scope for some optimism on the jobs front:
The American Staffing Association (ASA) reported that its index of temporary & contract employment rose to a level of 100 during the week of September 26. This means that current employment in the staffing industry – which tends to be a leading indicator of overall trends in U.S. labour markets – is back to a level comparable to that of 29 months ago. As today’s Hot Chart shows (see above), however, the improvement in the ASA index has yet to be reflected in the official BLS data. This divergence cannot last. If the past is any guide, we would expect the BLS data to converge on the ASA index.
I expect some improvements in the labor market, but obviously not enough to give a sustained boost to aggregate demand. As for currency warfare, I think you should all go back to read the comment on the death-defying US dollar. With global ZIRP firmly entrenched, we shouldn't be surprised to see competitive devaluations. I once quipped that the world is heading towards parity, and it seems like central banks are going to throw everything but the kitchen sink to fight the specter of global deflation.
The policy remains reflate & inflate. Some think this will lead to "chaos" but the reality is there isn't much choice. And while Warren Buffett is the latest to warn of a bond bubble, Niels Jensen of Absolute Return Partners wrote an absolutely brilliant piece arguing for lower bond yields, aptly titled Insolvency Too. Mr. Jensen concludes:
We'll see if interest rates start going up for the "right reasons", but I do agree that you have to be selective in this market. I am less convinced that pension funds need to pay 2 & 20 for active management, especially if they have the expertise to do it internally. But Mr. Jensen is talking up his industry. Can't blame a man for promoting his livelihood.
So what are my conclusions? For all the reasons above, I continue to be bullish on bonds. Remember what I said earlier this year about inflation being difficult to engineer when you need it the most? Unfortunately, this is truer than ever. We could really do with a bit of inflation and the higher bond yields which would probably follow (it would fix an awful lot of problems in the pension industry), but it is when you need it the most that it is least likely to happen.
Another question altogether is, where does this leave equities? I believe it will ultimately be the bond market that holds the answer to when it is time to buy the stock market aggressively again. Long term readers of this letter will know that I have argued for over 6 years now that we are stuck in a secular bear market (i.e. a market characterised by falling P/E ratios). This doesn’t mean you can’t make money in stocks. Plenty of people do every day. But you need to be selective. Don’t buy the market yet. It is still premature. Invest with active managers capable of delivering alpha. The time to buy the market again will probably be when the bond bull finally decides to call it a day. There is only one caveat. Interest rates must go up for the right reasons, but that is a story for another day.