The problem with addictive substances is that while they may
be pleasant, they are also addictive. Global monetary policy setters are
finding that out; well, actually, we all are, as the QE juggernaut rolls on. In
the beginning, as the ruins of Lehmann Brothers were swept from Wall Street,
central banks, particularly in the developed world, struggled to prevent a
complete meltdown of the economic system caused by the weight of public and
private debt built up in the boom years of the preceding decade or so. QE –
effectively creating new money to pump into the economy to try and stimulate
demand - was one of the preferred choices of action. Over the last cycle, the
Fed has been feeding $85 billion per month into the US economy through a programme of
Now, every good thing must come to an end, as my mother used
to tell me. So speculation has been growing that the Fed would begin to taper
that amount, reducing it by perhaps $5 billion a month; that’s not really a big
reduction, and in fact, given that we are talking about an overall increase
in money, reduction is probably the wrong word. It’s a slowing of the rate of
increase. Nevertheless, just that partial expectation of something that may
happen caused a 1% rise in 10-year US bond rates.
That increase has an
effect not only domestically in the US but also around the world. In
a rise in bond rates is a precursor to higher mortgage rates and across the
globe the effect it will have is to cause investors to withdraw funds from
perceived higher-risk assets. In other words, a rising (nominally) risk-free US bond rate
lifts the hurdle rate of return investors will require to invest in riskier
assets. Amongst those riskier assets, obviously, are international stock
markets (particularly those of developing nations) and commodities. Clearly,
industrial metals are also part of this asset class. So there is a lot riding
on the Fed’s decision, domestically and internationally, because the money
created under QE does not stop in the US; it flows throughout the global
Lack of Confidence
The fact that they have decided not to begin the tapering
now tells us a couple of things about their sentiment as to where the economy
stands. It suggests that the people at the top of the US monetary policy making
are not that confident in the strength of the recovery there, and that they
would rather face the potential of a dose of inflation than risk exploding the
property market (again) by seeing mortgage rates increase. I think it also
signals to us outside the US that the US is prepared to set the price of money
to suit its domestic situation; that may sound obvious – what government
wouldn't do that, after all? – but it sits uncomfortably with the US dollar’s
role as the world’s reserve currency, because one day the tap will have to be
turned off. What the policy makers are betting on is that they can ride the
wave for the moment and hope that they can stay afloat in the maelstrom when it
breaks. But up to now, we still have to ask the question of whether QE is any
more than a band-aid stuck over the wound, hoping that it will heal.
Looks OK on the surface, but can we really see what is happening underneath?
So far, since the decision was announced on Wednesday (18th
Sept) we have seen the predictable rally in stock markets across the globe,
commodities have picked up (poor old aluminium still looks unhappy, though) and
I am sure the putative rise in US mortgage rates has been put on hold for the
moment. Also, the US dollar has weakened against its major trading
counterparts. That, of course, points to the danger; the countries in the world
with growing surpluses – mostly in the Far East
– hold a lot of their surplus wealth in US dollar-denominated assets. That
creates a potential problem, as well, because ultimately they are going to
question the reason to keep reserves in a currency being devalued by its own
government to protect the domestic economy. That doesn't chime with the role of
global reserve currency.
Addiction, or not?
So that’s the problem with addiction; if you keep on,
everything looks rosy, but the long-term effects just keep on getting worse.
Stop, and the pain is immediate. Up to now, the policy-makers have gone with
the former; at some point, they will have to choose the other course.
Next week’s article – by a guest writer – paints a far more
apocalyptic view; one I don’t necessarily share, but good for the gold bugs. It
will appear next Thursday or Friday.