Mario Draghi will âact accordinglyâ and is âwillingâ to keep monetary policy low for as long as it takes. That was the sum result of the great manâs press conference yesterday. The European Central Bank board met and decided to do nothing. But that didnât stop them from talking. And markets â because they have to these days â listened.
The Draghi press conference was perceived as âdovishâ by observers. What that means is that central banks in the âadvanced economiesâ (US, Japan, EU, UK) donât want to raise rates. Except maybe the Fed. And maybe just once later this month. For show.
Itâs not me saying that. Itâs a leaked memo from the G20 finance ministersâ meeting in Turkey. âIn line with the improving economic outlook, monetary policy tightening is more likely in some advanced economies, which may remain one of the main sources of uncertainty in financial marketsâ, is how the joint statement may read, according to Bloomberg.
Well, investors who are used to cheap credit and low interest rates wonât like that. S&P, Dow, and Nasdaq futures are all down around 1% as I write. This despite Japanese Economics Minister Akira Amari telling reporters in Ankara that the fall in Chinese stocks does not âreflect economic fundamentalsâ in the Chinese economy.
There are two ways of looking at that. First, that nobody really knows how good or bad Chinaâs economic fundamentals are in the first place. Chinaâs stock market has become a Frankenmarket, supported by government money and home to speculators fleeing low interest rates in the banking system. In other words, Chinaâs stockmarket has nothing to do with Chinaâs economy.
If that were the case, then thereâs really nothing to fear from Chinaâs stockmarket collapse (down over 40% from the peak). It was a bubble. It popped. The rest of the world can go along with monetary policy tailored to conditions in each particular economy.
Except thatâs not what happens in a currency war when a country devalues like China did two weeks ago. It exports deflation by forcing competitive devaluations in other countries. The purely financial becomes also economic. And thatâs the second way of looking at Chinaâs âeconomic fundamentalsâ. That they are very bad. And in response to their badness China has upped the ante in the currency wars.
Can anyone know? Can you really plan and plot a strategy with so many variables out of your control? The safe answer is ânoâ, so donât even try.
China will have financial panics as it grows, just as the US did in the 19th and early 20th century. But the long-term economic narrative â the rising living standards of 1.4 billion people whoâve joined the global economy â justifies any investment risks over the short term. Make your asset allocation decisions, buy the market on the dips, and ignore the news.
That is more or less the view of some of the key analysts here at Friarâs Bridge Court, although I donât want to put any words in their mouths. And to be fair, most of the time, doing nothing is better than panicking at the wrong moment. This is the challenge of the contrarian. Do you want to be safe? Or do you want to be sorry?
Nick and I spoke about this yesterday in our debut Capital and Conflict podcast. Evolution rewards behaviour that promotes survival. For human beings, going against the crowdâfor most of our history at leastâmost certainly did not promote survival. To get along, you went along. Generally, there is safety in numbers.
But itâs different in markets, especially markets driven by a mob mentality. I would suggest that easy-money conditions have created a mob rather than a market. A market is made up of buyers and sellers who have different views on values. A mob is made up of a lot of people with the same view, baying for blood and profits.
In a bull market, everyone moves in one direction: up. In bear markets, itâs each man for himself in a rush for the exits. But the mob mentality prevails. There is no safety in a mob. Only emotionâfear, panic, aggression.
Itâs important to realise this is a deeply ingrained emotional kind of behaviour you fall into. You lose your identity as a member of a mob. You have to work very hard, consciously, to resist falling into it. If youâre lucky (or just weird like me) you were born always feeling like an outsider, or always resisting the urge to do what youâre told or to go along with the consensus view. To doubt.
This overwhelming psychological instinct to find safety in the herd should be resisted. If you can develop the habit of doubt, youâll avoid becoming a member of the mob. If you develop the habit of doubt, itâs easier to follow Buffettâs dictum to âbe fearful when others are greedy and greedy when others are fearful.â That still leaves you with a decision now. Greedy? Or fearful?
âWe cannot live on a permanent basis with extremely low interest ratesâ, says Luxembourgâs finance minister, Pierre Gramegna. âThat we would have to reverse that tendency was obvious; it is the timing that is always the difficult issue.â Somebody buy the man a beer!
The time to ânormaliseâ interest rates was when markets were rising. That would have produced a nasty shock and correction, much like what weâre having now. But it would have left central banks with room to lower rates again when a genuine crisis came around again. But they missed their timing because they were lazy and itâs always easier to have another beer instead of going home to sleep it off.
Here we are, then, in the new âabnormalâ. Rates canât be raised without shocking the market. Yet the market is already shocked, and any rate rise now will make things worse. Yet things are already bad, or at least they appear to be. When in doubt, markets tend to fall.
There will be a time to buy. But exactly when is what you pay the experts (like my mate Tim Price) for. Tim was in the office for three hours yesterday telling us about his plan of action for British investors. Stay tuned. Hint: heâs more fearful than greedy. But heâs more of a realist than a pessimist.
In the meantime, letâs not forget conflict. Iâve been prattling on a lot about capital markets because thatâs where all the action is. But the conflict part is quietly bubbling away behind the scenes.
Did you see that China apparently sent five warships that encroached on US territorial waters in Alaska? This happened when President Obama was in the state to rename North Americaâs highest mountain from Mt McKinley to Denali (the indigenous name for the mountain). The president also stared down a glacier and pronounced something ominous about climate change.
China, meanwhile, threw a parade. The parade was to celebrate the 70th anniversary of the end of World War II. There were a lot of weapons on display, and none of them Russian. Making its blushing debut at the parade was the Dong Feng 21 âEast Windâ aircraft-carrier ballistic missile. This missile attacks its target at ten times the speed of sound and is thought to be impossible to defend against.
Well there you go. The entire post-World-War II world has been dominated by US and Western naval, air, and space superiority. This is the bedrock upon which Western control of the global banking and financial system rests. The Westâespecially the UKâhas made the rules of the global system on the back of US aircraft carriers, strategic bombers, and information and technology dominance.
Do you think China wants to change all that? Or Russia? Or Iran? Theyâd certainly have good reasons to get out from under the US thumb. But what kind of world will it be? What kind of new global system? And will we get there without some 20th century style conflict before itâs all over?
Or it will be 21st century style conflict? Hackers, financial warfare, systems disruption and the like? What will it be like when the global currency war becomes a more free ranging affair? And how will the authorities respond in Britain as the country gets on a more explicitly war-time footing, even though itâs a brand new kind of war?
More on this next week.
Category: Economics