Investing in a global economy where growth remains fragile
It is easy to succumb to .glum views, but good firms will get through the turbulence, as they always do
Things are looking up: maybe not, as the US market is overvalued
The Republicans had no option but to approve the raising of the US debt ceiling, and they’ll have no option the next time either. The stand-off between the Republicans and Democrats on the issue was a smokescreen and had more to do with deep dissatisfaction by Republicans with Obamacare, the costly healthcare insurance programme introduced by President Barack Obama.
Everyone knows that the US is running a sizeable budget deficit which, along with quantitative easing, is designed to offset the contraction in consumer spending and bank deleveraging following the global credit crisis shock in 2008. The US budget deficit means that the rise in US debt has been totally predictable.
What we do know about the global economy is that growth has positively surprised in 2013. Japan has returned to growth after a 23-year slump, Europe has surprised on the upside and China’s slowdown appears not to have derailed its economy.
Growth is still below average and is fragile. Indeed, many argue that the growth is not real. Take away quantitative easing in Japan, the US, the UK and the euro zone and GDP would likely decline again making the debt load even more dangerous for many major economies.
Looking at the US in isolation, the Federal Reserve may continue to struggle to ease back on quantitative easing. Growth simply is not strong enough. The Fed now has a mind-boggling $3.7 trillion of assets (and growing) on its balance sheet bought with printed money. This has hugely assisted the US banking system to deleverage.
It can try and sell these assets back to the market over time, but that will surely mean at higher bond yields (lower bond prices) which would hurt when debt levels are so high – and rising.
In a best-case scenario, the US and global economy is strong enough down the line to allow the Fed to let the bonds on its balance sheet mature (in effect, taking the money back out of circulation). That is clearly what the Fed is hoping. The situation in the UK and Europe is somewhat similar, while Japan is in an even more precarious position; the yen will surely resume its decline sooner or later.
Given the debt load that is saddled on the major economies, central banks and governments simply cannot allow deflation as it would lead to insolvency for entire economies and banking systems.
The clear and future danger must, therefore, be inflation. In the developed world, because of the lack of consumer demand (as they deleverage) and lack of investment by corporates (due to waning consumer demand), there is little sign of inflation – yet.
Growth however is picking up and with the greatest amount of liquidity available to the banking system ever witnessed (ie the extra $3.7 trillion lent to them by the Federal Reserve), it is a brave person who would bet against eventual inflation. The real pessimists expect hyperinflation!