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Who’s got the biggest bazooka? Is it Mario or is it Ben?
Poor old Mervyn seems to have been outclassed this time, leaving the title between the other two. The financial world waits with bated breath for the decider.
But, wait a minute – Mario’s already said he will do “whatever it takes” and Ben is going to go on as long as the employment market takes to respond. So there isn’t really much scope for another round. That’s where the problems start.
The kind of monetary stimulus central banks have been providing over recent times is never enough; once the markets get hooked on it, they demand ever-increasing fixes to keep their habit going. That’s why the central bank taps have had to be turned on repeatedly, as each successive round runs out of steam and the market rallies falter.
This time, with the open-ended rhetoric put out by both Draghi and Bernanke, you have to wonder if we are approaching the end-game; if you are already doing ‘whatever it takes’, where else can you go?
We’re seeing the predictable reaction now, with industrial commodity prices soaring, taking with them those parts of the equity markets that are related – mining companies, financial institutions, those that will see an immediate benefit.
The glib reasoning is that the stimulus will ignite demand in the economy and that therefore investors are reacting rationally to that expectation. I’m not totally convinced of that. I think the reason industrial commodities (and indeed precious metals) rally on this kind of news is because of the inflationary pressures that will be created by rampant money-printing.
Therefore, investors buy these assets in an attempt to protect themselves against a currency of decreasing value. That works, for a while.
Simple logic would imply that if there are increasing numbers of dollars (or pounds, or euros), floating around in the economy, they will buy progressively less, so it makes sense to buy hard assets like copper or gold or oil which, it’s not difficult to work out, will get to be worth more of those dollars or pounds or euros. And the stocks of the companies that produce them rise as well, on the expectation of increased profits, as the prices rise. Likewise financial institutions, who get more cash to play with.
But, as I say, it’s an ever-decreasing return, because without continued bouts of stimulus, the effect will wear off; investors will not keep buying industrial commodities forever – there will be diminishing benefits.
There’s another aspect to this, though, that I would suggest appeals to governments. At the heart of the current economic woes is the simple fact of excessive debt; government debt, personal debt, all of it.
We can argue for hours about why and about whose fault it is, but that doesn’t change anything. While the debt is still there, the problems continue. Increasing the money supply, or stimulating economic growth, as the politicians choose to phrase it, is a backdoor way to change the problem. If the effect of newly-created money is to create inflation – in other words, devalue the money – then the relative size of the debt becomes smaller.
If you borrowed $1 million when your annual earnings were $100,000, it might take a while to repay. If the nominal value of the debt remains the same, and your salary – through inflation, nothing else changes – becomes $500,000, then your problem is far smaller. Sure, everything costs more, but the debt looks smaller.
That’s why governments like the policy – it makes the debt look smaller, and right now, the debt is the problem. Of course, the other side of the coin is that the lender of your $1 million, who was expecting to live on the interest you were paying, can no longer do so, because of the devaluation of the money. And interest rates are being held low, again precisely to help control the debt problem.
So big bazookas are fine – in the short term they make things look good; but in the long term they are simply moving the problem forward. It’s a bit like how historic price carries could disguise a P&L, putting off when the loss had to be paid, but at the same time watching it get bigger and bigger. I confess I don’t know how to solve the problem, but just getting into the spiral of continually creating more and more money cannot be a long-term solution.
Lord Copper editorial@metalbulletin.com