Too early to celebrate
Paul Krugman, writing in the NYT yesterday warned that the so-called green shoots, which we have been hearing a lot of recently isn’t sustainable:
On one side, the inflation worriers are harassing the Fed. The latest example: Arthur Laffer, he of the curve, warns that the Fed’s policies will cause devastating inflation. He recommends, among other things, possibly raising banks’ reserve requirements, which happens to be exactly what the Fed did in 1936 and 1937 — a move that none other than Milton Friedman condemned as helping to strangle economic recovery.
Meanwhile, there are demands from several directions that President Obama’s fiscal stimulus plan be canceled.
Some, especially in Europe, argue that stimulus isn’t needed, because the economy is already turning around.
Indeed, on the same day Bloomberg reported that (misguided) optimists on the other side of the Atlantic have been making the case against monetary and fiscal intervention for the same reason:
June 15 (Bloomberg) — Group of Eight finance ministers began drawing up contingency plans for rolling back budget deficits and bank bailouts as the economy shows signs of recovery and investors start worrying about inflation.
Officials meeting in Lecce, Italy, over the weekend said it’s prudent to consider what exit strategies to deploy once global growth is secured and asked theInternational Monetary Fund to examine how to do so without reigniting the two-year crisis. At the same time, they said it’s premature to rein back more than $2 trillion in stimulus packages.
Still, data last week showed the situation is fragile. European industrial production dropped by a record in April and Volkswagen AG, Europe’s largest automaker, said June 12 that “very weak” global car markets aren’t yet recovering.
Sixteen days earlier Krugman had warned that inflation worries were overstated and exaggerated in an earlier op-ed:
First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.
So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.
The first story is just wrong. The second could be right, but isn’t.
Indeed, one only has to read the financial news recently to realise that stock markets worldwide have been beating a hasty retreat when investors suddenly realise that fundamentally, nothing has changed at the economic level. The American stimulus package has yet to kick in fully (legislation was passed just four short months ago) and believe it or not Geithner has yet to finalise his PPIP (public-private investment program) for saving the US banks from insolvency. Indeed some news reports have been suggesting that he may even be quietly backing off those plans.
Personally I do not think Geithner would disown something the entire Obama adminstration have been frenetically working behind the scenes to piece together the past few months. More likely he fears the potentially negative impact announcing his plans would have on the stock markets and doesn’t want to be blamed if such actually occurred. The media has a dislikable penchant for post hoc fallacies so perhaps his actions are understandable.
In any case, news in the past few days have been indicative of a pause or even a reversal of the green-shoot gains of the past few months:
As trading got underway in Europe, Germany’s DAX was down 2 percent, Britain’s FTSE 100 fell 1.7 percent and France’s CAC-40 lost 1.9 percent. U.S. stock futures pointed to losses Monday on Wall Street with Dow futures down 94, or 1.1 percent, at 8,696.
Earlier in Asia, Japan’s Nikkei 225 stock average lost 96.15 points, or 1 percent, to 10,039.67. On Friday, the index finished above the psychologically important 10,000-point level for the first time since October 7, 2008.
Hong Kong’s Hang Seng slipped 390.72, or 2.1 percent, to 18,498.96 and South Korea’s ended 1.1 percent down at 1,412.42.
The question which should be on everyone’s lips is: Why have investors been so optimistic the past few months if the fundamentals of the economy remain weak? The answer lies in what central banks around the world, especially in the US, have been doing for the past few months:
Throwing vast quantities of cash at the markets has certainly rescued banking systems from total meltdowns and created a new boom in stock markets, particularly those in emerging markets such as China, and in commodities.
However, it looks ever less likely that fundamental problems are being resolved and a new day of reckoning may be getting closer.
Indeed, every market is now factoring in a steep and early earnings rebound. Some of this may happen as there is still an overhang of capacity in many industries from cars to electronics to airlines. China’s stimulus is being driven by massive increases in bank lending, mostly to state enterprises. This does not augur well for the profits of the borrowers, let alone the banks which at some point will have to absorb big increases in non-performing loans.
None of this is to suggest that the global market rally cannot go on for a while longer. Monetary stimulus is still the order of the day and commodity-driven emerging markets (and Australia) can continue to be buoyed by raw material prices. But asset price gains unrelated to real economy and profits improvements will ultimately prove temporary.
Thus the market bounce is not driven by irrational enthusiasm but by the weight of money. But it does leave unanswered the question of where to invest should the outcome of all this be a repeat of the mid-1970s era of stagflation. Or a sudden market realization that the real economy’s recovery will be a long and painful event and that once the central banks take away turn off the liquidity tap the world will still have a long way to adjusting those old imbalances and resuming a reasonable rate of growth.
Voila! There you have it. The green-shoots were spurred on largely by unusually interventionist actions by central banks; the very same actions were condemned by Austrian school adherents and supply-siders for possibly sparking inflation in the future. Those worries appear to be quite unfounded.