Central Banks are Nothing More than Illusionists

It’s all about interest rates… the perceived risk-free return is what every other asset class is measured against.

This week, the US Federal Reserve — surprise, surprise — signalled US rates would not be going up anytime soon. Markets rallied. The Australian Financial Review reports (17 March 2016):

Federal Reserve officials held off from raising borrowing costs and scaled back forecasts for how high interest rates will rise this year, citing the potential impact from weaker global growth and financial-market turmoil on the US economy.

The US was never in a position to bear raising rates. As I’ve stated previously, the Fed’s rate hike in December last year was a ‘one and done’ exercise.

After talking about raising rates — I will, just watch me, I’m going to, I mean it — Yellen had to do something…or risk being labelled ‘all show and no go’. Put up or shut up. So Janet ‘put up’ rates and bought herself some time, but not credibility…at least not in my eyes, anyway.

The freeze on US rates sent the Australian dollar shooting up. Aussie interest rates look very attractive…at least to outsiders getting diddly squat on their money.

Who would have thought a month or two ago we’d be at $US0.76? Not me.

The RBA will be giving serious consideration about what to do with domestic rates. A strong currency decreases our international competitiveness.

With Europe, Japan and China all looking for ways to keep their currencies competitive, we cannot afford to be left behind.

The combination of slowing global demand and a stronger currency increases the odds of the RBA taking our rates lower. The timing is still uncertain, but if we see the recent bounce in global share markets give way to another bout of panicked selling (resulting from further deteriorating economic conditions), this could force the RBA’s hand.

Europe’s latest triple shot of stimulus — taking interest rates deeper into negative territory, increasing its monthly bond buying by another 20 billion euros per month (in addition to buying corporate bonds), and incentivising banks to lend — is a sign of how bad things are on The Old Continent.

Economic growth in Euroland is non-existent. Super (or stupid) Mario’s previous stimulus attempts have delivered nothing of lasting value…unless of course you are an investment banker. The highly indebted socialist model is a ball and chain around Europe’s economic ankle.

Be prepared for the European refugee crisis to escalate as the weather starts to warm up. This issue is going to create even deeper divisions within Europe. The anti-immigrant, right-wing Alternative for Germany party polled quite strongly in Germany’s recent local council elections.

Mainstream parties must be getting a little more sweat on the brow these days.

Anti-immigration, anti-austerity, anti-establishment, anti-anything that changes the status quo is resonating with a growing number of disenfranchised people.

Social mood is turning negative. When households feel squeezed, attitudes become insular. Beggar thy neighbour. It’s all about me.

It has taken a while, but people are finally starting to understand why Trump is gaining so much traction…people are peed off with the insiders. They want an outsider, or at least a political outsider, to do their bidding. One who tells them who to blame for all their woes. ‘It wasn’t you being encouraged to and wanting to live beyond your means that got you into this mess, NO, it was the (insert your race and religion here) who are cause of your hardships.’

And the chorus goes up, ‘Yeah, those people there…they’re the problem’. If we just get rid of the (insert your race and religion here), and protect our jobs from those cheap Asian imports, all will be OK.

If Walmart is closing stores because not enough people are buying those cheap Asian imports, do you think they’ll suddenly rush to the stores demanding higher priced locally manufactured goods?

Logic has no place in this debate. It is all about base emotions.

The problem is the established parties offer no real solutions either. The ECB’s latest stimulus plan simply lines the pockets of the bankers. The autocrats enrich themselves and the favoured few, but in the end it does sweet nothing for the economy.

Japanese Prime Minister Shinzo Abe was elected on the grand promise of ending two decades of deflation. The greatest stimulus plan in history (as a percentage of GDP) was launched three years ago with much fanfare. The economic elite went into raptures. What has it produced?

The Bank of Japan (BoJ) finances the Japanese Government’s deficits. The BoJ supports the share market, the yen is much lower…and the economy is still in a funk. All in all, the BoJ has achieved what all other central banking stimulus plans have — wealth for the insiders…and bugger all for the rest.

Little wonder people are becoming more cynical.

The wealth divide is staring people in the face and they do not like it.

A summer of discontent in the northern hemisphere — Trump stirring the pot in the US, China dealing with a slowing economy, Europe’s refugee dilemma, the Middle East continuing to be the Middle East, Japan going even further into voodoo economics and Britain’s decision to stay or leave the EU — have the potential to make the global social mood even darker.

A pessimistic overhang is the last thing a struggling economy needs.

In this environment, negative interest rates are about the dumbest thing you can do. It only encourages people to stockpile cash. Hence the increase in the sale of personal safes in Japan.

Forcing people to sit on cash is no way to stimulate an economy.

Share markets are being elevated by artificial means. Central banks are nothing more than illusionists. Conjuring up a so-called recovery with their tawdry magic act of QE and suppressed interest rates.

In my opinion the latest tick up in markets is a ‘buy the dip’ programmed recovery.

The deeper the social malaise becomes in the northern hemisphere, the more the disconnect between the real economy and fake share market becomes.

Like the wealth divide, people will decide they don’t like what they see. And another wave of panicked selling in global share markets will await us.

What we’ve seen is pretty much another week of grinding our way towards the realisation of just how dire the global economy really is. Markets are being bribed to ignore the signals from the economy, but the illusion is soon to be followed by disillusion.

When that happens, investors are going to wish their money vanishing into thin air was an act of magic.

Sadly, it will all be too real.

Vern Gowdie,

Editor, Markets and Money

Vern Gowdie 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 five financial planning firms in Australia. He 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. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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