Investors addicted to the drug of stimulus

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4 mins. to read

It really is a crazy world! For stock market investors, global equity indices are ebbing and flowing as expectations change in relation to new rounds of stimulus by the world’s central banks. Growth seems to have been forgotten and now we need the heroine induced high of central bank intervention. But we all know that abuse produces highs and extreme lows and one day the addict has to detox! By God it’s difficult for stock market investors to wean themselves off stimulus!  

Just to put things into context, the amount of central bank intervention over the last 3-4 years has already been staggering. The following is a summary of the US, European and Chinese intervention over the period since the financial crisis of 2008 erupted. Of course, there has, in addition, been an unprecedented period of low interest rates in addition to this.

The US Federal Reserve has expanded its balance sheet from around $800 billion to $2.8 trillion since 2007 as a result of two doses of quantitative easing (QE 1 and 2), where US government Treasury bonds are bought to force down yields and provide additional liquidity for institutions to buy alternative assets. The Fed announced an extension last week of the $267 billion “Operation Twist” programme to buy long dated bonds in exchange for shorter dated ones, helping to reduce long term interest rates and bring down borrowing costs for Americans.

The Bank of England has spent £325 billion on quantitative easing, with talk of £50 billion or more very soon to try and kick start Britain’s stuttering economy. Good news for mortgages, terrible news for pensioners buying annuities!

The Eurozone has committed €1 trillion to the European Financial Stability Facility (EFSF) and the European Central Bank (ECB) started buying government and private debt securities in May 2010, reaching over €220 billion by early 2012.

In December 2011, the ECB started the biggest infusion of credit into the European banking system in the euro’s 13 year history. Under its Long Term Refinancing Operations (LTROs) it loaned €489 billion to 523 banks for an period of three years or more at a rate of just one percent. Previous  refinancing operations matured in periods well under a year. €325 billion was taken by Greek, Irish and Italian banks. As well as reducing a potential bank credit crunch in Europe, the ECB hoped that the extra liquidity to be used to buy sovereign debt and reduce the pressure on government bonds in the weaker economies including Greece. On 29 February 2012, the ECB held a second auction, providing 800 Eurozone banks with further €529.5 billion in low interest loans. 

Plus, let us not forget the 4 trillion yuan ($587 billion) that the Chinese government spent on stimulus in 2008/2009 with money pouring into infrastructure and cheap loans to businesses.

Last weeks meeting of the Eurozone finance ministers was aimed at resolving the European debt crisis once and for all, but it was the usual fudge with the main point of disagreement between Germany and the others being the potential issue of eurobonds.

If Eurobond’s were to be used, debt issued by individual eurozone countries would be aggregated, so in effect Germany would support the weaker countries and underwrite their debt. This would bring down the unsustainable interest rates being expected by bond investors to raise new capital for Italy, Spain and others. It can be argued that without Eurobonds, weaker countries will experience unpalatable levels of austerity and recessionary conditions for years to come. Unfortunately this approach is unacceptable for German voters used to fiscal responsibility. Italy and Spain are pushing Germany to adopt the bonds, but Chancellor Angela Merkel is resisting for now, given the potential backlash from angry voters.

Germany is reluctant to reverse the principle that Eurozone members should live with the consequences of their spending habits, poor tax collection and hence huge debts.  The counter argument that it would be collectively good for the Eurozone to have lower interest rates to stimulate growth and drive demand for German goods seems to be falling on deaf ears. Germany, Finland and Austria believe that any collectivization of debt will lead errant countries to continue their spend thrift habits rather than tightening belts and taking the pain. In other words it sends the wrong signal to the “credit card” economies of Europe who have spent hard and worried about the consequences later gorging on cheap European credit.

The cost conscious economies of Europe want any further bail outs or centralized approach tied to agreement of central control of budgets. Lets face it if German tax payers are taking the strain, they want the Mediterranean mind set changed. This is pretty unpalatable for the French, Italians and others. All may become clearer at another meeting of European leaders at the end of this month to force through a longer term strategy. That is a big maybe!

At the end of the day some certainty needs to return to markets to stop the constant selling of equities into so called safe havens such as US Treasury’s and the dollar. Stimulus may be the short term shot in the arm to pump up equity performance but the eurozone crisis needs to be sorted out and whether that is possible given the political landscape in Europe is very much debatable. The BRIC emerging market economies came to the rescue in the last few years to prop up global growth, but all the signs are that their rate of growth is slowing and that leaves the onus on Europe, the US and Japan to get their house in order. But do they have the tools at their disposal to boost growth? That seems unlikely in the short term at least, without leaving a horrible legacy for future generations in terms of debt…

Contrarian Investor UK

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