Economic growth is faltering and increasingly desperate measures by
central banks are proving ineffective. Meanwhile, both stocks and bonds
are hitting record highs. It's an each way bet on boom and bust and it's
unheard of, writes Ian Verrender.
John Maynard Keynes
reputedly once said that markets could remain irrational longer than you
could remain solvent after losing a substantial amount of dosh on a
trade gone wrong.
While there's no direct evidence of
him ever mouthing those exact words, he was pretty clued up on just how
irrational the world and markets could be.
Just
consider the past month. Any rational investor would pull their cash out
of the market right now as economic growth continues to falter and as
governments fret about deflation.
But it is not to be.
Wall Street finished the month on a tear, close to an all time record,
just as America revealed second quarter annual growth of just 1.2 per
cent, well below the expected 2.6 per cent.
It was a
result that almost certainly derails the US Federal Reserve's plans to
hike interest rates next month and came just hours after the European
Union reported a similarly tepid economic performance.
Eurozone growth slowed in the second quarter with an annual rise of 1.6 per cent.
Meanwhile,
stress tests of European banks again revealed massive problems in
Italy's banking system while two major UK banks, Royal Bank of Scotland
and Barclays, performed poorly.
The world's oldest
bank, Italy's Bank Monte dei Paschi di Siena, was the worst performer,
and was bailed out over the weekend. It's no minnow, by the way. As
Italy's third biggest deposit taker, it's a too-big-to-fail operation.
Germany's
Deutsche Bank passed the stress test but so far this year has seen its
market value decline more than 43 per cent. It is a similar tale across
much of Europe and it indicates the Continent's banking system is
ill-equipped to handle another crisis.
Meanwhile in
Japan, the central bank on Friday developed a severe case of cold feet,
with a decision to not push even further into the monetary policy
unknown.
It was expected to embrace a new round of
radical policy known as Helicopter Money. While it did announce an extra
round of stimulus, with a policy to pump even more cash into the
economy, it opted not to board the chopper.
Helicopter
Money is a process where the government rains cash down on the country
with direct deposits into citizens' and company accounts.
The
idea is that this would be financed by the central bank buying
government bonds. That, however, is a policy that ultimately destroys
the concept of an independent central bank, as monetary policy is
employed to finance government largesse.
The fact that
it was a close call tells you that not only is it being considered but
that the global economy is in serious trouble.
After
decades of poor performance, Japan has embraced the most radical
monetary policies the world has ever witnessed and on a scale that could
never have been imagined.
It has ramped up its
Quantitative Easing program - a euphemism for money printing - to never
before seen levels and hacked interest rates to below zero, a policy it
swore it would never embrace.
On Friday, Bank of Japan
governor Haruhiko Kuroda merely tinkered around the edges with some
modest extra spending. More importantly, he raised questions about
whether the central bank had gone far enough and said it was time to
assess the impact of their policies.
On Tuesday, our
very own central bank gathers to ponder the very same questions. It will
be Glenn Stevens last meeting as governor.
Pressure is
mounting for the Reserve Bank of Australia to apply pressure to the
currency, to deflate the Australian dollar in a bid to boost inflation
and lift global competitiveness.
At 1.75 per cent, our
rates are the lowest on record. But they are still well above those in
most of the developed world, attracting cash from the globe and pushing
the currency higher. While last week's inflation numbers were weak
enough to allow another cut, it won't be an easy decision.
Having
deliberately fired up the already inflated east coast housing market to
promote a construction boom, the central bank can ill afford for prices
to head further into la la land.
Stopping that will
require it to restrict lending for housing, a policy it has been
reluctant to implement and even more hesitant to enforce.
Then
there is the point Kuroda made on Friday. Would another cut have any
beneficial impact? Would it encourage greater consumption or ignite
business investment?
The answer is probably no.
Australians have the highest household debt in the world and the rate
cuts have prompted many to merely pay down their loans quicker. There is
nothing wrong with that. But the point is, it comes at the expense of
boosting consumption and business turnover.
When it
comes to business, lower rates have had the perverse effect of
inhibiting investment. Shareholders, unable to secure a decent return on
bonds or cash, have demanded ever greater dividends from corporations.
Rather
than reinvest profits into the business, most corporations have
succumbed to shareholder pressure, paying out an ever greater proportion
of their earnings in dividends. Similarly, given the global
uncertainty, they have shied away from taking on massive amounts of new
debt.
In another indication of just how nervous our
business leaders have become, takeover activity, which normally runs hot
when markets are in overdrive, has all but dried up.
When
the takeover for logistics group Asciano last week was wrapped up, it
left a deathly quiet in the mergers and acquisitions departments of our
big investment banks. There's now officially nothing happening.
Meanwhile, the tension between those betting on calamity and boom continues.
US
10 year bond prices rose Friday, slicing the yield to just 1.45 per
cent, after the lacklustre economic growth figures were released.
While
that is not as low as the 1.31 per cent record of a month back, it
indicates the incredible demand for those seeking the shelter of a safe
haven.
Similarly, gold prices continued to push higher.
With interest rates close to or even below zero, gold once again has
become the choice for those seeking a safe harbour.
For
more than two years, bonds and stocks have been heading in the same
direction. Both have been hitting record highs. It's an each way bet on
boom and bust and it's unheard of.
Something has to
give at some stage. Either the global economy will recover, rates will
rise and those holding bonds or overpriced real estate will do their
shirts. Or stock market investors will wake up one day and discover that
central banks have run out of ammunition causing a stampede for the
exits.
Either way it won't be pretty.
Read more click here
