The Next Central Banking Fix is Coming to an Economy Near You

The fallout from Brexit continues as global stock markets saw more selling overnight. The Euro Stoxx 50 index closed down 2.8%, while the FTSE 100 fell 2.55%. In the US, the Dow fell 1.50%, the S&P 1.8%, while the NASDAQ sank 2.4%.

The major concern is the European banking sector. Bank stocks are crashing. In London overnight, Barclays and RBS were both halted from trading after crashing 11.5% and 14.2% respectively.

The European bank stock index crashed to its lowest level since November 2011, after falling another 7.8% overnight.

European banks are poorly capitalised and still carrying lots of bad debt. They haven’t cleaned up their balance sheets since the 2008 crisis. Brexit is just the shock needed to spark fresh fears about balance sheet health.

While in better shape, UK banks are suffering from a number of factors. British bonds (gilts) fell below 1% for the first time in history overnight. This is despite S&P cutting the government’s credit rating from AAA to AA.

The drop in bond yields signals a coming UK recession or slowdown, which is not good for banks. On top of that, Brexit raises all sorts of concerns about what the UK financial system will look like a few years from now.

The pound continued its fall against the US dollar, down another 3.3%. The Aussie fell 1.8%; the selling was the result of general risk aversion across global markets.

Yesterday, I mentioned that China would not like the strength of the US dollar resulting from Brexit. Sure enough, their central bank moved to resist this strength. Remember, the yuan is loosely pegged to the US dollar, so it rises along with the greenback. The Wall Street Journal reports:

The Chinese yuan fell to its weakest level against the U.S. dollar since late 2010, after China’s central bank cut its daily-fix value for the currency by the biggest margin since a one-time devaluation in August 2015.

The sharp move in the yuan fixing was a reaction to volatility in currency markets following the U.K.’s Thursday decision to leave the European Union, and especially to a surge in the U.S. dollar Friday as haven currencies jumped.

Gold did well again overnight, as it continues to take on the characteristics of a global non-fiat currency. It’s trading around US$1,325 an ounce. That’s still cheap in my view, given the state of the global economy and where government bond yields are.


Speaking of gold, Alan Greenspan has been talking it up on Bloomberg. Although I can’t say I agree with the former Fed Chief, who, incidentally, did more to damage the global economy and set it on its current path than anyone else.

Anyway, in the interview Greenspan said there was going to be a crisis. That’s hardly a revelation, given we could be in the early stages of one now, but Greenspan’s solution is a little nostalgic.

If we went back on the gold standard and we adhered to the actual structure of the gold standard as it [existed] prior to 1913, we’d be fine. Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the United States, and that was a golden period of the gold standard.  I’m known as a gold bug and everyone laughs at me, but why do central banks own gold now.

I get his point. The financial system would be far safer if gold represented the world’s monetary base, not US Treasury’s or other sovereign bonds with unlimited supply.

But the problem with harking back to a classical gold standard is that it represents the fixing of gold to sovereign currencies. And who would decide what the price of the fix should be?

It’s not like governments would leave it to the markets and deliver gold bugs a windfall. Gold would need to trade at least around US$10,000 an ounce if it became official money again.

And even if that were to happen, how long would the fix last? The problem with any ‘fix’ is that it can’t last. Prices are all relative. They need to constantly move against each other to reflect shifts in demand and supply.

So fixing the price of gold against other currencies would work for a while, but it would cause problems down the track. Gold would get the blame, and we’d move on to some other harebrained scheme.

Don’t get me wrong, I’m a fan of gold. Subscribers to Crisis & Opportunity know this well. We’ve got six gold stocks in the portfolio and they’re all up strongly. But I’m not a fan of a return to the classical gold standard. Gold certainly has a role to play in the modern financial system. But I think it’s more effective in an unofficial, rather than official, role.

By the way, gold in Aussie dollars breached $1,800 an ounce overnight. It is doing its job and protecting portfolios in a time of crisis.

How big a crisis is this? Judging by the performance of global banking stocks, it’s a pretty big deal. And judging by the complacent attitude in the business media, it’s…a pretty big deal. Here’s the Financial Review patting our banks on the back…

Australia’s big four bank stocks stand out like knights in shining armour in a world left dazed and confused by Britain’s vote to leave the European Union.

After several months being pounded in the heat of the election campaign events are starting to turn in the bank’s favour, including the fading prospect of a Labor Party victory on Saturday.

The first and most obvious positive development for the banks is the Brexit vote because it provides a valuable reminder of the strength of the Australian financial system and their attractiveness in terms of profits and dividend yield.

If all the banks have to look forward to is a Coalition victory, then God help them…

Profits are strong, yes. But profitability is falling and that’s all that matters for share price performance. The Big Four banks are all trading back down on or near the lows from January and February. Another bad day or two and they will break these supports levels and fall heavily.

What many don’t realise is that Australian banks benefit from a global ‘risk-on’ trade but suffer from ‘risk-off’. That is, our banks find it easy to raise debt cheaply when things seem fine and dandy. But when the mood turns, European and Japanese capital isn’t so sure, and the cost of debt rises.

This is why our banks are trading near multi-year lows. If those lows don’t hold, you’re looking at big falls ahead for the sector.

The question is, how far away is the central banking cavalry from trying to engineer a confidence-enhancing (if short term) rally? Not long is my guess.


Greg Canavan,
For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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