In an earlier article, “Is QE Sharpening its Teeth?”, we
discussed the underlying reasons why QE was used and the intended consequences
that Central Banks had in mind. Based on the premise that they achieved what
they set out to do, one might say that QE has been a success. The structure and
integrity of the banking system has been maintained, (fraud aside) asset prices
have been held steady and, in the case of stock markets and bonds, have
excelled. What, though, are the unintended consequences of QE, particularly now
we are into the “taper” or the reduction of monetary stimulus measures?
The Black Swan
The phrase ‘Black Swan’ was coined by the Roman poet Juvenal
who lived in the 2nd century AD, and was a metaphor characterising
the rarity of something, as a black swan was presumed not to exist. This
metaphor was taken and used to describe unexpected events of significant
magnitude by writer and academic Nicholas Nassim Taleb in his book “The Black
Swan.” The question now being asked is what is the possibility of a significant
financial event brought about by QE manipulation of the global financial
markets initiating another Lehman moment?
Are the actions of Central Banks and colluding governments likely to
trigger an event that they fail to recognise in their economic models which will
topple the first domino? Let us consider what may be outside the control of the
new normal QE command economy.
Stimulus
Trillions of Dollars, Yen, Yuan, Roubles, British Pounds and
so on have been printed electronically since the outbreak of debt deflation or
bankruptcy in 2008 in order to imply solvency and trigger so called “escape
velocity”, where debt based spending stimulates the economy to such a degree
that increased productivity is achieved. This helps to help reduce deficits to
the point that eventually overall debt loads can start to be reduced. Bah,
humbug, tosh! You can’t borrow your way out of a debt crisis I’m told, so this
must be an exercise in kicking the can down the road.
QE however has had implications, particularly for the US dollar.
The dollar is the biggest problem currency at the moment, not because the
Federal Reserve is printing even more currency than before, but because they
are starting to cut the amount of stimulus. The “taper” is now firmly on the
table. The dollar as the reserve currency has an obligation to maintain its
purchasing power as most international trade is settled in US dollars and thus
most countries have dollar reserves which they rely on to be a good store of
value. However, since the 2008 debacle, the Fed has made it clear to the
international community that the dollar is the American currency to do with as
they (the US)
will, and thus it becomes every other country’s problem. They have printed and
printed until now, when at last stimulus taper is occurring and the Fed is
doing the right thing by the international community. However, as stimulus is
being withdrawn some unintended consequences are rearing their heads and could
potentially trigger another 2008 moment.
Emerging Market Currency Crisis
Even before the taper started for real, when it was “just
talk of a taper,” emerging economies that initially benefited from increased
capital flows chasing yield suddenly saw that money being sucked back to the
safe haven US treasury bond market, which put pressure on some of their
currencies. These currencies generally run hot in inflation terms as their
Central Banks have tended to keep interest rates low in order to remain
competitive in their export sectors. Also, they want to run a trade surplus as
a buffer against foreign capital being withdrawn as happened in the 1997
crisis. High inflation stimulated further by a collapsing currency puts significant
pressure on a low-paid working class, potentially stoking political instability
in the emerging markets. We have seen many examples of unrest and ultimately
deposed governments in countries due to external economic pressure (think Tunisia and Egypt)
and currently there are issues in countries like Turkey,
Ukraine, Thailand, Argentina
and Venezuela.
Black Swan material?
Taper Effects in the US
The US
economy has its own problems with taper. Think of the perceived “safe haven
dollar.” As currency flows back to the US it strengthens the dollar
putting the supposed export led recovery in jeopardy. Structural changes that
are needed for the US
economy require a weaker dollar. The repatriation of manufacturing to the US or
re-shoring can only be achieved with a weaker currency.
The taper also has a significant effect on the paper
markets. Due to its perceived deflationary effect, the fixed income treasury bond
market improves (although that is probably more about its liquidity than
anything else, especially as it is the Fed that now holds most of the treasury
paper); however, the stock markets start to take a hit. In January we saw a
1000 point pullback in the Dow Jones index. This is certainly not something
that the Fed really wants as it is generally felt that a strong stock market
has the effect of bolstering consumer spending (so called growth). The reality
is however that consumer spending is being maintained by consumer credit, more
borrowing which is being driven by low interest rates which the Fed have to
maintain at all costs. If interest rates were allowed to rise, monetary contraction
(deflation) would start apace forcing the Fed to act by restarting its QE
policy once again. The unintended consequence of QE here is that the Fed must
always walk a tightrope of holding off deflation by printing enough currency to
maintain monetary stability while not printing too much and thus having surplus
trading nations losing faith in the dollar and dumping it en masse leading to
potential hyperinflation. This leads us nicely into:
Reserve Currency Status
As we saw above, it is the responsibility of the US to maintain
the stability and thus the purchasing power of the dollar. This has been
brought into question by the policy of QE. China, the global hub of
manufacturing and world trade, is sitting on the best part of $4 trillion in
reserves. We must consider whether they truly believe that their productive
economic hard work is being undermined by US monetary policy. This may be
answered in part by what we are witnessing in the physical gold market.
Thousands of tonnes of gold have been exported from West to East. It would
appear that to protect themselves against continued dollar devaluation the
Chinese are hedging themselves with the oldest of global currencies. If this is
the case then we could be moving towards a global currency reset with gold
being brought back in as a stabilising entity as it is becoming pretty clear
that the dollar is losing its appeal as a “store of value.” Could a Black Swan
be rearing up from a potential dollar crisis or some kind of physical gold
default? Whispers of Comex or LBMA default are coming thick and fast. Where has
Germany’s
gold gone and why has so much gold left GLD (the gold ETF) in the last year?
Time will tell.
Conclusion
Put simply, a Black Swan event may come at any time from any
number of events but it will probably be the one we least expect. QE aside, we
still have an ongoing Euro crisis, military tensions between China and Japan,
Israel and Iran, North Korea
and the world, and the US
pretending to be everyone’s friend providing they can make on the deal. Putting
QE into perspective, it isn’t helping. The QE tightrope we are walking is
stretching; let us hope it doesn’t snap.
This article is written by Richard Horswill. All opinions expressed are strictly his own.