Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Havenstein’s Dream. Dr. Rudolph Havenstein was a very smart man. So smart, in fact, that he was given the weighty responsibility of directing the operations of a major national bank. The economists of the day lauded his choices and encouraged more of the same. Likewise, the news media built him up as a national icon – a man of action, making the right choices in challenging times. The markets were well pleased in 1919.
Opinions, of course, do change. By 1923, with the utter destruction of the German mark occurring via the Reichsbank’s disastrous monetary policies, Havenstein’s dream had become a national nightmare. (He died in 1923, we trust by natural causes.)
Today, we reflect on the popularly held opinion that low interest rates till 2013 and the monetization of various paper assets are vital to keep markets functioning normally, and feel like we too may be dreaming. What in moderation can help can in excess be deadly. What will we wake from over the next 36 months? Nothing Weimaresque, we hope. But we are fairly certain that opinions of what constitutes “credible” monetary policy will be changing, even though Dr. Benjamin Bernanke is a very smart man.
Bernanke, Dudley, and Yellen have the support of academics the world over. Reinhart and Rogoff (whom we respect), Alan Blinder, Donald Kohn, Nouriel Roubini, Paul Krugman (Nobel economist or communist?), and many others are encouraging not only accommodation but in some cases a third official round of quantitative easing. Monetization of sovereign debt is a weekly occurrence via the ECB, and may again be a common practice by the Fed by the end of the month.
Why sooner than later here in the US? Time is running out. Just a few months remain before the election is in full swing, and as it approaches the Fed will not want to be seen as a White House puppet (which it has never been). We are also in the roughest season for equity performance, which will serve as cover for the Fed’s decisions should it announce QE in the September to October time frame.
Of final note on the Fed: Watch for swap lines with Europe to open again in a big way as their bank crisis intensifies, leaving open the possibility of a glut of European sovereign paper sitting on the Fed’s balance sheet. In a panic, the Fed will step in and be the global lender of last resort (reminiscent of 2008). Such a move may have noble intentions, but would leave our central bank looking like a waste bin, collecting all throw-away paper from Europe. What is the price of stability? Stay tuned.
2. The Swiss Do Love Their Chocolate! And You Should, Too. When primary exports begin to lose competitiveness due to currency strength, what will (not should) a central bank do? You know the answer – it will protect industry. Chocolate is not the primary export, but you get the point.
The peg to the euro at 1.2 or less will be gold supportive as the safe haven status of the Swiss franc is taken down a notch. But we doubt that the SNB has either the resolve or the pocketbook to maintain the peg, so we still favor the franc over the dollar.
Emphasis (not ours) is shifting from inflation concerns to global slowdown, both in the US and in Europe. Trichet has opened the door to lower rates, stating that inflation is “broadly balanced.” Sweden and Australia have paused in their rate hikes, and the markets are gearing up for a formal Greek default. The cost to insure Greek paper from default is now at a record 3045 bps, which represents a $3,045,000 yearly premium to insure $10,000,000 in bonds. The probability of default is now at 91%.
Meanwhile, the Chinese have announced London as a primary exchange for their international currency trading, and it seems that 2015 may be the target date for full convertibility. This is an ambitious timeframe, as other Asian countries (Taiwan and Korea) have attempted this goal and have yet to complete the process over many years.
As stated in China’s latest five-year plan, the gradual moves to convertibility will take time. If the schedule is accelerated, we can only guess at the reason – ours is that the urgency is due to global concerns. The dollar is under great international pressure, and a significant opportunity may be possible sooner than anticipated. Of course, the dollar moved above its 200-day moving average this week, signaling short-term strength.
Next week we’ll look at August PPI, CPI, and Retail Sales figures, and perhaps provide a note or two on the 2010 poverty report – due out mid-week. For this week, we saw the US trade balance narrow. Taking inflation variables, oil price swings, and other seasonal factors into account, the deficit came in at $45.3 billion – down from $50.3 billion in June. This may offer a small boost to GDP figures, but we’ll look to August numbers for confirmation.
US jobless claims at 414,000 confirm one of the key underlying issues in the US and global economies: Without an improvement in employment, without an improvement in household income, without an improvement in household spending, the economy will remain challenged (compared to expectations, which we find unreasonable to begin with). Maybe it’s time to lower our expectations, in light of a changed credit backdrop.
Dr. Bernanke said this week that the strangely absent element in the current economic recovery (if you listened more to the good doctor, you’d know we were in a recovery!) is an improvement in household spending. Indeed, it is absent, but it is not strangely absent. Consumers are paying down debt and remain unable or unwilling to re-leverage their balance sheets. Stephen Roach makes this point in a recent missive, “While misguided Washington policymakers would like nothing better than for consumers to return to their old risky ways of spending again, over-extended American households now know better. The heavy artillery of monetary and fiscal stimulus is being wasted on attempts to short-circuit balance sheet repair.” Roach points out that household debt has come down from 130% of disposable income to 115%, but remains well above the 1970-2000 average of 75%. Don’t count on the consumer anytime soon.
If we can count on neither the consumer nor governmental stopgaps to revive the economy, shouldn’t we significantly lower global growth expectations – as well as GDP growth figures? Unfortunately, if we lower GDP growth expectations, our deficits go from bad to worse (which they will anyway, in spite of “expectations”), our debt levels increase, and the temptation to print money rises exponentially.
Are we sure we are not in Havenstein’s vortex already? Linger on that for just a moment … but don’t forget to enjoy your weekend!
Best regards,
David McAlvany
President and CEO
MWM LLLP
