It may be only February, but it already feels like a whole year’s worth of market action has been compressed into the first two months of 2015.
As recently as mid-December, Thomas Jordan, chairman of the governing board of the Swiss National Bank (SNB), told investors that the bank “remains committed to purchasing unlimited quantities of foreign currency to enforce the minimum exchange rate with the utmost determination”.
Not even a month later, the SNB’s promise to hold the Swiss franc down against the euro was gone – along with several foreign-currency brokers.
Front running in the eurozone
Then we had the European Central Bank’s long-awaited launch of its quantitative easing (QE) programme: Mario Draghi’s purchase of €60bn worth of bonds each month, beginning in March. Being helpfully pre-advised of the strategy, banks weren’t slow to take advantage.
By early February, five-year government bonds issued by Germany, Austria, Holland, Sweden and Denmark were all trading with yields below zero – creating a peculiar world where holders of bonds would technically be paying for the privilege of holding them, at least if they planned to hold until maturity.
(What’s called ‘front running’ in the City – exploiting knowledge of customers’ orders by sneaking in ahead of them – is normally illegal. This cosy relationship between our central and commercial banks evidently must be something else.)
Then we heard, via China’s National Bureau of Statistics, that the country’s economy grew by 7.4% during 2014. That may sound impressive by comparison with eurozone growth (or lack of it), but it still amounted to the slowest Chinese growth rate for 24 years. And since the Chinese figures are probably exaggerated anyway, this is cause for concern.
But the biggest reason for investors to be wary came via the McKinsey Global Institute, which has just published a blockbuster report on the global debt markets. You might have thought that after the global financial crisis and the worst recession since World War II, heavily indebted economies would have started to deleverage and pay down their debts. Far from it.
Since 2007, global debt has actually grown by $57trn. Almost half of that is accounted for by government borrowing. The rest is down to companies and households. Awkwardly for China, just as its economy has started to slow its own debt burden has quadrupled, rising from $7trn in 2007 to $28trn last year.
No country for fiscal conservatives
There’s a good line from the Coen brothers’ 2007 film No Country for Old Men that gets the point across. “It’s a mess, ain’t it, sheriff?” remarks his deputy, surveying a landscape littered with dead bodies after a drug deal gone bad. Tommy Lee Jones’ grizzled sheriff replies sourly, “If it ain’t, it’ll do ’til the mess gets here.” The mess is already here.
The Austrian economist Ludwig von Mises, in his magnum opus Human Action, warned of the excesses of a bubble in credit: “The credit boom is built on the sands of banknotes and deposits. It must collapse… If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders.”
If you accept that most of our problems stem from an absurd over-issuance of debt going back at least four decades, you must accept, in turn, that there are only three “remedies”. One is to generate sufficient economic growth to service that debt.
As McKinsey archly suggests: “we find it unlikely that economies with total non-financial debt equivalent to three to four times GDP will grow their way out of excessive debt”. To put it more bluntly, the “growth” remedy is implausible, if not outright impossible.
The second remedy is default. While the system has survived the relatively trivial defaults of tiny countries such as Iceland and Cyprus, a default by a major economy – within the context of a debt-based global monetary system – is akin to Armageddon. So let’s park that option.
The third way – inflation
By a process of elimination, and with the precedent of thousands of years of history, we get to remedy number three. The time-honoured way that indebted governments have always sought to handle their out-of-control borrowings – inflation. So it’s massively ironic that the eurozone seems to be tipping ever closer to outright deflation.
Since ingrained deflation is certainly the death knell to heavily indebted states, we can be sure that the inflationary impulse (via ever-more aggressive money printing) will be revisited by Europe’s governments and central banks – regardless of the outcome of the latest Greece-inspired spat.
At some point, there has to be a risk that the whole system breaks apart. As things stand, banks (and central banks) seem to be goading investors to hoard their money under the mattress – making the prospect of a bank run ever more likely.
What should investors do? Diversify. Invest in only the soundest, most defensive stocks. Hold real assets, such as precious metals. And avoid most bond markets like the plague.
• Tim Price is director of investment at PFP Wealth Management. He also writes The Price Report newsletter.
Category: Market updates