Myth #1: The Fed is not printing money
Perhaps this should come under the heading ‘lie’ rather than ‘myth.’ Retreating behind a fog of semantics – ‘quantitative easing’ (QE) and ‘large scale asset purchases’ - Fed Chairman Ben Bernanke, like his counterpart Mervyn King at the Bank of England, has denied that the QE essentially amounts to money printing, but he is being economical with the truth. In QE, the central bank purchases financial assets – usually government bonds - from the private sector by creating new money. If the purchase is from a bank the central bank merely credits the reserve account of the bank in question. If it is from a non-bank the central bank credits the account of the seller’s bank, which in turn credits the deposit account of the seller. Money has been created out of nothing. It is an electronic transaction and while it is not physically printing bank notes, it amounts to the same thing. Asset purchases from banks increase the monetary base, while asset purchases from non-banks increase both the monetary base and broad money. The most dangerous type of QE is that which appears directly linked to financing large budget deficits. The Bank of England’s ‘QE1’ took out a whole year’s gilt issuance and was associated with an apparently inexplicably high inflation rate for the last year and Mervyn King’s repeated assurances that this was a temporary phenomenon related to sterling and VAT began to ring hollow. The Fed’s QE2 is also effectively taking out the whole supply of bond issuance and is arguably a more dangerous iteration of QE1, which was as much about addressing dysfunction in individual markets (‘credit easing’) as pumping up the money supply. When the central bank finances government borrowing, and the long run solvency of that government is in question (as it is in the US and the UK), then this is a very slippery slope. If the US economy does not respond to QE2, and if unemployment starts to rise again, the Fed will lobby for a ‘money financed tax cut’ – a terrifying proposition whereby the Fed will print money to finance a large tax cut – this is as close as you can get to a ‘helicopter drop.’
Myth#2: We are in a depression-like environment similar to the 1930s
While the ‘Great Recession’ of 2008/09 was the most severe in post-war times comparisons with the 1930s are a bad analogy propagated by discredited economists trying to peddle spurious books masquerading as academic research on depression economics. It is almost as disingenuous as comparing Saddam Hussein to Adolf Hitler. In the Great Depression US GDP fell by 27%, while in the Great Recession it fell by 4%. Real GDP has recovered to with 1% of its previous peak, while nominal GDP is already 1.7% above its previous peak. It would be more accurate to say that we have emerged slowly from a balance sheet recession and that deleveraging of private and public balance sheets will remain a headwind for some time, while monetary policy remains extremely accommodative.
Myth#3: Deflation is a bigger threat than inflation
Policymakers and politicians alike are terrified of deflation and have over-stated the risks. Policymakers because they fear they may lose control of real interest rates and politicians because deflation effectively represents a tax cut, rather than a (stealth) tax increase (inflation). Deflation is often a wonderful thing, which empowers the consumer by boosting real incomes and hence boosts economic growth. For example the glut of fine wine on the market has driven down prices of some Bordeaux and burgundy. Do I wait for prices to fall further? Hell, no. The term ‘deflationary boom’ is not an oxymoron. It also rewards savers and those who have behaved responsibly, while it tends to hurt those who have behaved recklessly. A generation of US intervention has rewarded reckless lending and borrowing and has ratcheted up moral hazard after each and every bail out, raising the stakes even higher every time. The risks are very much skewed to inflation being the end game because the Fed does not acknowledge let alone recognize that it is the problem. The Fed is a myopic institution guilty of the worst kind of group think: it is focused on core inflation, the most backward of lagging indicators, and it now has a very low tolerance of even trend like growth given its mandate for maximum employment. It is totally oblivious to the unintended consequences of its actions. Core inflation today is a reflection of how bad the economy was two years ago. Meanwhile asset bubbles are emerging all over the place, commodity prices are on a tear and precious metals prices have almost gone vertical. Bernanke wants to get the inflation rate up by 1% point to 2% point by printing money – how’s he going to do that? That’s like trying to cook an egg with a blow torch.
Myth#4: Gold is a bubble
This is a myth propagated by those who never owned it or have tried to short it and had their arses handed to them. Usually these are people with a poor grasp of economic history, and who don’t understand the profound implications of the changing monetary landscape. Gold was a terrible investment in the 1980s and 1990s because central banks adopted ‘fight inflation first’ monetary policies with high real interest rates. Now they are fighting the phantom threat of deflation with negative real interest rates. In an environment of still high inflation and hence very high nominal interest rates gold was a cripplingly expensive asset to own. The credibility of inflation targeting regimes in the 1990s – more by accident and good luck than anything else – also did gold no favours. Then UK Chancellor of the Exchequer Gordon Brown sold 400 tons of gold almost at the lows, a howler which has cost the UK tax payer about $15bn (10 billion pounds). The behavior of the gold price is a rational response to central bankers’ attempts to debase fiat money by printing ever greater quantities of it – and billion dollar bailouts have become trillion dollar bailouts – why not quadrillion dollar bailouts? Arguably Volcker gave our fiat money a stay of execution in 1979, but maybe we could be getting close to the end game. When the fiat money panic happens it will just arrive out of the blue regardless of the macroeconomic backdrop. It will be analogous to a flock of birds: one flies off an dthen an instant later the whole flock follows. Gold generally hasn’t outperformed the rest of the commodity complex, but if and when it does this will set alarm bells ringing. As would official tirades against holding gold, or worse still outright bans on holding it.
Myth#5: The US Treasury market is not a bubble
Deflationists argue that treasuries are good value here, and if the US is going down the Japan route then they are. But the market is already pricing in a bleak scenario, arguably with 2-3% nominal growth that would hardly be acceptable in Washington. So policymakers would not just sit idly by and allow unemployment to rise – they would do something – and probably something pretty radical like a money financed tax cut discussed above. It is important to understand that while the Fed may not be able to boost real growth for long it can boost nominal growth and inflation. The UK’s experience with a more unadulterated QE than the Fed’s is that it tends to have a larger impact on inflation that real growth
Myth#6: The ECB is clueless
This is an accusation you here over this side of the pond in America, even in private from Fed insiders who argue that the ECB ‘just doesn’t get it.’ The reality is that it is not the ECB who are clueless it is their accusers…and in particular those ignoramuses who argue that the ECB should do more do boost growth in the euro area in general and in the periphery in particular. In fact the ECB has done an incredible job in managing the euro area business to cycle and meet its inflation mandate of ‘close to but slightly below 2%.’ Since the inception of the euro inflation has averaged 1.9%. The ECB has a single mandate – for inflation - and is hardly responsible for Europe’s fiscal and structural policy failings. In addition, the Fed and the ECB have an almost diametrically opposed view of the virtues of quantitative easing and an entirely different philosophical approach (reflecting their respective nemesis of depression/deflation and hyperinflation.) ECB policymakers are privately aghast at what they regard as US policymakers’ impatience, particularly because growth is rarely vigorous coming out of a balance sheet recession and there is nothing monetary policy can do about it. Excessive policy activism just creates uncertainty and instability. Moreover the ECB pins the blame for the recent recession on overly lax (US) monetary policy which fuelled credit booms and created asset bubbles followed by inevitable busts and deleveraging. Therefore further monetary policy activism will just stoke up more asset bubbles in the future. I must say I would agree with these sentiments. It is the Fed which is clueless not the ECB.
Myth#7: The euro is viable
The euro is unlikely to survive in its current form indefinitely because it was built on shaky foundations. Entry into the euro was determined by political, rather than economic, considerations; there was insufficient sustained nominal and real convergence, and there was insufficient ‘political union.’ Around the time of the euro’s launch many wise heads warned that the single currency would not be viable without political union, and the EC’s federalist ambitions really reached the high water mark in 1992 with the signing of the Maastricht Treaty, and have since receded. Within EMU, countries have too much discretion over fiscal, structural and regulatory policies, and the enforcement mechanism – the stability and growth pact (SGP) – is toothless and lacks credibility – there was no political will to implement sanctions. There was too much focus on fiscal policy variables and not enough on structural issues. For example in the early EMU years Germany embarked on a Draconian cost cutting program to regain competitiveness while at the same time very low interest rates fuelled protracted housing booms in countries like Spain and Ireland, which led to destabilizing structural imbalances – external deficits and inflation. The response to the 2010 sovereign debt crisis has been multi-pronged: multi-lateral support package for Greece, introduction of the European Financial Stability Fund (EFSF), aggressive fiscal consolidation in the ‘PIGS’ and proposals to reform and strengthening of the SGP. These are all welcome steps but are unlikely to be sufficient. The proposals to strengthen the SGP are too woolly and vague, and there is absolutely no appetite for a US-style transfer union. Debt dynamics are very problematic for the PIGS because there is no devaluation safety valve in their currencies are overvalued (reflected in huge current account deficits and low FDI coverage). Aggressive fiscal tightening will additional crimp nominal GDP growth, the denominator of debt/GDP and nominal GDP growth rates are about flat. Greece is in a hopeless position: debt to GDP will stabilize at 150% at best, where it is estimated that Greece needs to run a primary surplus of at least 6% of GDP (only 3% planned, and Turkey had to run a 6% primary surplus for many years with much lower debt). Moreover Greece has no merchandise export base…imports are 3-4 times exports and so cannot support this level of debt. In 2012 Europe will have to choose between voluntary/involuntary debt restructuring or permanently large transfers to Greece (which will cause resentment). Given the dim prospects for political union/economic government the euro is unlikely to survive in its current form and the breakdown is likely to be very traumatic. We could end up with ‘euro-mark’ II a more stable currency comprised of northern European countries. The notion of a euro-mark for the north and ‘esperanto’ for the south is unlikely to be workable.
Myth#8: Property bubble will cause China to collapse
China has a frothy property market which the authorities are struggling to control with various measures. Is it a bubble that is about to burst with widespread systemic implications, which could cause China to implode? Hardly; this is just Anglo-Saxon wishful thinking. First of all the Chinese authorities have the resources to deal with the fall-out from the bursting of any ‘bubble’ – over $2.5 trillion of reserves and a strong fiscal position – while the banking system is in good shape: loan to deposit ratio is under 70% and NPLs are just 1.2% compared to around 20% a decade ago. Moreover China is hardly unique in the region and arguably China is less afflicted than some other countries like India, Hong Kong and Singapore. Of course property bubbles are much more of a problem in the major cities than in aggregate; but it is worse in New Delhi, Hong Kong and Singapore than it is in Shanghai. At the aggregate level there is no bubble. In the last five years property prices Nationwide have risen by around 80% while disposable incomes have risen by around 65% - hardly a disastrous collapse in affordability. Moreover mortgage debt is very low (12% of household deposits), and the mortgage market has only been in existence for 12 years. Property has proven to be an attractive investment relative to equities and cash, and typically properties are acquired without being rented out. As elsewhere in the region the underlying reason is low/negative real interest rates, which are not going to disappear any time soon. The key to understanding the China growth story is the relentless migration from the rural areas to the cities, which has much further to go. Just over 100 million have migrated in the last 20 years and there are 300 million more to go over the next 15 years. Given that urban workers produce 4-5 times as much as rural workers these relentless flow will keep trend growth elevated at least in the high single digits for the foreseeable future. Those focusing on the alleged property bubble really are barking up the wrong tree.
Myth#9: Property bubble will cause Australia to collapse
It is the same story in Australia where high house price income ratios have led to dire warnings of an imminent collapse in house prices with US-style implications for the Australian economy. As in China these Jeremiahs are missing the big picture and barking up the wrong tree. Whereas in China the most important growth driver is urbanization in Australia it is the semi-permanent increase in the terms-of-trade which isn’t going to reverse very much unless China collapses, which it isn’t. The terms-of-trade is a massive tail wine for the Australian economy. Even if the terms-of-trade stays where it is it will provide a big tailwind for many years to come. As a result household income growth is running at an annual rate of about 8% and property prices have falt-lined for about a year now. The RBA will be happy if CPI inflation averages 3.5% over the next 10 years, and the AUD will probably reach $1.20 a year from now, but as always run a trailing stop given that the Aussie banks are highly dependent on foreign funding (which will dry up in extreme risk aversion).
Myth#10: Hungary is a basket case
When it comes to lazy analysis Hungary has to take the cake. Perhaps influenced by ‘loose cannon’ remarks by Hungarian officials some so called analysts continue to treat Hungary as a Greek-style basket case including the ratings agencies. If they had bothered to look at the data they would have seen that Hungary has had a nearly 10% of GDP fiscal adjustment, taking the cyclically adjusted primary balance from -7% to +2.5% over the last four years, and its current account has moved from a 7% of GDP deficit to a 1% of GDP surplus. Greece could only dream of doing this. The Greeks don’t produce anything, whereas the Hungarians have a high powered dynamic FDI-driven, super-competitive export sector; e.g. Audi engine plants using workers who are nearly as productive as their German counterparts for a fraction of the wages. In essence markets are assuming that Hungary quickly reverts to its old habits under Fidesz…like the fat guy who loses 100 pounds then puts it straight back on again. Hungarian PM Orban is not interested in frittering away the hard won fiscal consolidation achieved by his opponents. And when the chips are down the Hungarians are more like the Latvians than the Greeks. The Latvians who have been occupied by a hostile power in most of their history accepted 35% wage cuts. The Soviet invasion of Hungary in 1956 has not been forgotten and the Hungarians are hardy souls who know how to hunker down in a crisis. While the future for the PIGs in the e-z is bleak, the prognosis for Hungary is extremely bright.
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