A Little Perspective on a Big Problem

They say it’s the little things that make a big difference, and boy that saying is turning out to be prophetic.

The diminutive Janet Yellen (standing at 5 foot 2 inches) is retreating from moving interest rates a tiny 0.25%. And the end result is big moves on markets.

The Dow is heading into record territory. Gold has surged. The US dollar has fallen. And the hearts of US savers have sunk.

Doing very little has produced a lot of big outcomes.

And why won’t Janet stand on her tippy toes and tweak the interest rate dial just a smidgeon? Because the US economy is a little under the weather. Yes, despite all the ‘it’s getting stronger’ propaganda, the US is weaker than we are being told.

Look at the trend in the ‘doctored’ employment numbers. February +233,000, March +186,000, April +123,000 and May +38,000. Each month the employment numbers are getting progressively weaker.

In identifying this trend, David Rosenberg, chief economist and strategist at Gluskin Sheff, wrote:

I don’t want to alarm anyone but the facts are the facts, and the facts here is simply that this is precisely the sort of rundown [in employment numbers] we saw in November 1969, May 1974, December 1979, October 1989, November 2000 and May 2007. Each one of these periods presaged a recession just a few months later — the average being five months.

No-one in the mainstream is talking about a US recession being on the horizon…least of all Wall Street. The boys and girls at the biggest casino in the world are doubling down their bets on the Fed keeping the market liquored up and cashed up for a lot longer. Game on.

In relative terms there is no doubt the US is faring a whole lot better than Europe.

On Wednesday, the headline of the European edition of The Wall Street Journal was:

‘Low Yields Go Lower In Europe’.

‘Yields on the 10-year government debt of Germany and the U.K. fell to all-time lows, a stark demonstration of the modern era of scant inflation, weak growth and outsize monetary policy.’

Switzerland have just announced a 13-year bond yielding…wait for it…0%. How’s that for a bargain? Zero return each and every year for the next 13 years. Want a bit better than zero for your money? How about investing in a 10-year German bond at 0.049% per annum?

According to Fitch Ratings there is now in excess of US$10 trillion invested in sovereign bonds at negative rates.

So when comparing the barely-there-rates on offer, earning 0.049% or zero is better than negative.

Reuters is reporting the German giant Commerzbank is seriously considering its options in this world of slim pickings:

Commerzbank, one of Germany’s biggest lenders, is examining the possibility of hoarding billions of euros in vaults rather than paying a penalty charge for parking it with the European Central Bank, according to sources familiar with the matter.

Such a move by a bank part-owned by the German government would represent one of the most substantial protests yet against the ECB’s ultra-low rates, which have been criticised by politicians including Finance Minister Wolfgang Schaeuble.

Mario Draghi won’t like that little bit of pushback.

In a world of negative rates, holding physical cash is the best of the bad options.

To prevent the hoarding of cash, we’ll probably see some laws, dressed up as some sort of national security measure, passed to restrict the level of cash withdrawals.

Of course these yet-to-be announced new cash restriction laws will have absolutely nothing to do with forcing us to continue participating in this failed credit expansion experiment (he says with tongue firmly planted in cheek).

We are living in truly extraordinary times.

Little by little we have reached a point where absolutely everything hinges on the merest of movement in interest rates. That’s how chronic our addiction to debt has become.

It’s ironic that the debt that once fuelled inflation is now producing deflation.

Bottom line, there is now far too much productive capacity (factories, ships, mines financed by debt) for far too little consumption (indebted consumers are maxed out).

That’s an over-simplification, but it gets to the core of what ails the global economy and why there is precious little that can be done to resurrect the global economy’s glory days of the past three decades

What I find astounding is the central bankers cannot see (or if they do, cannot admit) the basic underlying reason as to why the world is incapable of a repeat performance of the past 30 years.

The economy is no longer the lean, youthful machine of the early 1980s. Debt has reached morbidly obese levels, and boomers are a lot greyer around the temples.

The dynamics have changed.

Yet, they are hell bent on staying the course with strategies that, over the past seven years, have proven to be woefully ineffective in producing any genuine recovery in growth.

Where to from here?

Best case, more of the same. Lower rates and more asset buying programmes with printed money.

Worst case…now that’s the BIG problem we’ve been building to.

I think deflation is going to tighten its grip on the global economy. In fact, if you strip out all the stimulus and budget deficits that have artificially boosted the GDP numbers, you’ll find the underlying economy is shrinking. Unofficially, I reckon we are in a deflationary world.

As that deflationary outcome becomes more evident and entrenched in the official data, then we are going to see a whole host of consequences.

Share and property markets will move into the negative.

Shrinking corporate revenues will herald in a wave of junk bond defaults.

Consumers will increase savings levels.

This is the polar opposite of what we experienced over the past 30 years…in a world where central bankers targeted specific inflation and economic growth numbers.

The really scary thing is the central bankers will not, I repeat, not, surrender without an all-out assault on their sworn enemy…deflation.

Anything will be considered justifiable in this battle of economic ideology versus economic reality.

How nasty, destructive, crazy and downright stupid the central bankers get in this battle will, with reflection, be the stuff of economic infamy.

And it was all the little things that added up — lowering rates from 18%, deregulating banks, removing the gold standard, easing credit standards, boomer consumers, backstopping Wall Street.

All these cumulative effects over a few decades — while small in their own way — have contributed to a problem that is now so big that it must fail — and spectacularly so — in order to restore a little sanity back into this world.


Vern Gowdie,
Editor, The Gowdie Letter

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

Money Morning Australia