FYI | Aug 11 2011
GaveKal offered the following observations this week: Since the beginning of the summer, we have expressed the view that global financial markets would enter into a liquidity squeeze, and that liquidity squeezes usually end with four things:
a) Equity markets reach very attractive levels of valuation,
b) oil prices decline,
c) somebody big, somewhere, goes bankrupt (we’ve called this the ‘whale’), and
d) a profound change in policies.
Today, there is little doubt that equity markets are attractively valued in both absolute and relative terms (to bonds, real estate, gold etc…), while oil prices have fallen close to –30% since April 29th. We are, however, still missing our ’whale’ (Italy? Spain? An French or German bank? A US bank?…), but have nonetheless already witnessed two important changes in policies: two days ago the ECB ate its hat and started buying Italian and Spanish debt, while yesterday the Fed came out and promised to keep rates “exceptionally low” until mid 2013 (meaning real rates are likely to remain negative for another two years). The question is whether these changes are what is needed to turn the ship around? We are unsure for the following reasons.
First, the Fed’s latest decision rekindles the entire debate on how successful ZIRP will prove to be. On the one hand, Anatole will argue that the only way for Western governments to tighten their fiscal belts is for monetary policies to be simultaneously kept extremely loose. On the other, Charles will argue that without a cost of capital, capitalism cannot work and that continued capital mis-allocations can not (as Japan showed) blaze a path to prosperity. Zero interest rates encourage investors to pile into zero-duration assets and create bubbles in assets priced not on their productivity (i.e.: tech, machine tools, ships…) but on their scarcity (gold, fine wines, collectibles, trophy properties…). This is the worst kind of bubble, for when these come to an end, one is left with no more gold, diamonds or fine wine then what one started with and capital is simply destroyed.
But secondly, the Fed’s decision also raises the important question of what ails our economies? Specifically, are we suffering from a dearth of capital? Or a surplus of labor as the world globalizes and takes on millions of workers who until now were toiling the earth for meager results? Or have our welfare states perhaps over-reached and become too much of an impediment to economic progress? On this last point, and without wanting to sound like a Marxist, it is true that the world is comprised of labor, capital and governments.
Of course, Marx’s mistake was to assume that governments needed to side with labor against capital and that the interest of labor and capital could not instead be aligned (as an old joke had it, capitalism is the exploitation of man by his fellow man; communism is the reverse). Having said that, the challenge of our age is that today, ‘capital’ (in the form of the millions of rentiers now getting negative real rates on their savings) feels spoilt, while ‘labor’ feels hard done by (see London’s Riots), angry and that the decks are stacked against it (see the backlash against bankers, etc…).
But is this not the golden rule of politics at work, namely the law of unintended consequences? For decades, our well-meaning Western politicians have sought to help and protect the weakest members of our societies. And the Fed’s ZIRP experiment is just a further step in that direction. What Professor Bernanke is clearly trying to attempt is a reduction in the US unemployment rate while at the same time protecting the value of US equities (though one might perhaps think that protecting US growth, preventing inflation and supporting asset prices all at the same time is a lot to achieve?).
But combine this with the July 2009 massive increase in the US minimum wage and should we be surprised that US unemployment is stubbornly high? And should we also be surprised by the anger now exploding on our streets? After all, if policymakers do everything in their power to stack the deck against low-end labor: first by increasing its price; secondly by regulating it to death—as Charles likes to quip, in France two (or three, or four…) consenting adults can do whatever they want to each other without the state getting involved, except, of course, work for one another—and thirdly now make robots and other machinery as competitive as possible by collapsing their cost of financing to zero.
Undeniably, these policies have left us with very profitable companies; but they have also left us dislocated societies and a massive under-class.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
For more information, visit www.gavekal.com
