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Let's Keep Printing Money .

By Marco Pietropoli, 5th November 2010

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The following is market and economic commentary. This is not general advice that should be acted upon unless you have the appropriate understanding of investments. We recommend that you seek Independent Investment Advice from a regulated professional.

 

The second round of quantative easing is underway (QE2). I really can't believe that we are witnessing the systematic destruction of the Dollar. Undermining the reserve currency may seem a good plan if you are an American exporter, but this will create huge problems around the world.

 

The inflation picture in the emerging markets is very worrying and printing more Dollars is only going to make things worse. The US is effectively imposing a “tax” on the rest of the world.

 

In the emerging markets the average persons already spends approximately 50% on food . As food prices rise sharply this will have a very damaging impact on disposable income. For the very poor this will mean having to go hungry and this may well cause significant civil unrest. Printing more money makes the problem a lot worse as commodity prices are negatively correlated with the value of the Dollar.

 

With the interest rate policy as it is, it is practically impossible to generate a real rate of return on deposit in much of the world. It stands to reason that there will be a tendency to start hoarding food as keeping money on deposit does not keep up with the increasing cost of living. This all fuels the fire more.

 

The Federal Reserve printing more money will also make oil prices rise further and massively increase inflation expectations. In my view this is going to significantly reduce the prospect of a sustainable global recovery.

 

So yes, if you devalue money prices rise. If wages do not keep up with the cost of living then the global economy will suffer.

 

How can the emerging markets control their inflation? Well they will have to let their currencies appreciate against the Dollar which will negatively affect their exports. So they are between a rock and a hard place.

 

As the printing presses keep producing more currency this is adding to significant distortions in the markets. We are in total bubble territory in the Stock Markets in Gilts and US Treasuries and a growing bubble in Commodities and Precious Metals. I believe that Commodities have a long way to run in their bull market but the Stock Market has completely lost the plot.

 

There is also a massive bubble in property in many emerging markets. This will have to burst at some point too.

 

The Equity markets are failing as a pricing mechanism. Far from reflecting the fundamentals they are now driving the perception of reality. We are in this absolute state of delusion where we are totally convinced that:

 

• • Interest rates will never rise
  

 

• • The level of government debt that continues to accumulate is irrelevant. The level of national debt in the UK will continue to rise throughout this parliament. At the end of March 2010 the amount of Gilts in issue had already passed £1 Trillion . If all goes well with the deficit reduction plan the projected level of UK government debt at the end of this parliament will be somewhere between £1.3-1.5 Trillion. This is an interest only mortgage that we will have to service for the rest of time as it is very rare that a government actually repays any of the debt. When Labour took office in 1997 the level of national debt was approximately £350 Billion . So in the space of less than 20 years we will have increased the level of headline debt by 4 times. How will be able to service this debt when interest rates rise?

 

• • The level of headline national debt represents all the liabilities the government has. Wrong. Recent studies would suggest that the level of UK liabilities is much bigger than the headline amount of Gilts in issue. If your count the unfunded liability of state and public sector pension that national debt could be twice as big. You then have the growing cost of healthcare and long term care which continues to far outpace inflation.

 

• • All European countries especially Greece, Ireland, Portugal and Spain are all solvent. These problems have not gone away.

 

• • The level of personal debt is fully sustainable when interest rates rise.

 

• • We will never receive a real rate of return by putting money in the bank.

 

• • Governments will continue to be able to borrow by offering negative real yields forever. If you lend money to the US government for 2 years the going rate as of today is 0.34%pa interest fixed . If you lend money to UK government for 10 years the going rate as of today is 2.96% pa fixed . But inflation is already higher than that now and the likelihood is that inflation will remain at elevated levels for years to come. Who on earth is buying this stuff? The Central Banks are actually printing money and buying the government debt keeping the yields at artificial lows.

 

• • The US can continue to run the biggest deficit in history for ever. They are currently borrowing well over $1Trillion per year and this will be the case for the foreseeable future. Unlike most of Europe that in austerity, the US has not even started to consider how to deal with their deficit.

 

• • The continuing lack of credit and the banking industry deleveraging will have no affect on economic growth.

 

• • The weak housing market in the UK and the US and the negative equity position that many are in is irrelevant.

 

• • House price can continue to rise faster than average earnings for ever even if there is limited credit and very few first time buyers.

 

• • Competitive devaluation (or currency wars as the media like to call it) has no impact on long term stability.

 

• • The growing trend of protectionism is irrelevant to international trade.

 

• • You do not need jobs for a solid economic recovery. All that you need is the banks and big business to be doing well.

 

• • Emerging markets can keep growing even if the Western countries are stagnating.

 

• • The age of Austerity in the UK and Europe will have no impact on economic activity and social unrest will never happen.

 

• • Oil prices and food prices can continue to rise without having any affect on economic growth. In the UK prices at the pump are at record levels and set to go higher.

 

 

It was never meant to be like this. Investing in the Stock Market was meant to be a long term plan of partaking in economic growth of an economy. The markets are now a large casino where the rules keep changing and there is constant manipulation.

 

There are repeated booms and busts with big swings in every asset class and currencies. This has a real negative affect of people's pensions and investments as the lay person has tendency to buy high and sell low. The markets are driven by fear and greed after all.

 

People may lose faith in the markets and investments in the next sell off. This will be bad in the long run as many will be too scared to contribute to investments and pension. But we are in “debt is better than saving” society anyway.

 

We are in danger of getting to a point where people lose faith in money. Even worse, we at the stage where capitalism as we know it may become under question. Governments and Central Banks have now used up all their bullets in what has not been a solid recovery that has created jobs and real economic momentum. It is a very fragile recovery paid for by government borrowing and the printing of money. This is not free by the way. We will have to pay for this at some point.

 

I'm all for fiscal and monetary stimulus if it is affordable and has a multiplier effect. But this has not been the case. Most of the money spend has been to help the banks and big business. This has not translated in jobs of the relaxing of credit conditions. Many small businesses are still struggling and are finding it very difficult to access credit at a reasonable price.

 

So when the next financial shock comes, which it will, we will not be able to do anything about it. Well perhaps we will do QE3, then QE4, QE5…….

 

Many believe that the financial crisis was fuelled by too much debt, lose credit conditions, poor regulation and by interest rates being too low for too long. So our answer to all of this was to have interest rates even lower for even longer and try and persuade more people to get further into debt.

The positive side to all of this is that the printing of money is good for those of us that and invested in Index Linked Bonds and Commodities of course. The bubble is stocks will eventually burst and we then make money on our FTSE 100 shorts.

                                                Medway Independent Financial Advisor