The ‘race to debase’ is on and the majority of nations are now involved in competitive currency devaluations. For instance, in addition to America, Euro zone and Switzerland, even Japan has now affirmed that it wants to weaken its currency.
The world’s major economies are struggling and their private-sector is deleveraging (paying off debt). If history is any guide, this deflationary process is likely to continue for several years.
On Thursday, the Federal Reserve initiated QE3 and this prompted a big rally in risky assets. As you know, we were expecting Mr. Bernanke to unleash ‘stimulus’ but even we were taken aback by the extent of the easing.
The world’s economy is passing through a low growth environment and this is in stark contrast to the first half of the last decade, when we had a global boom. Today, Europe is on the brink of recession, the US economy is growing at only 2% per year and it appears as though China is facing a major slowdown.
Europe’s debt problems are driving the world’s financial markets and investors are trying to figure out whether the single currency will survive. Furthermore, the mainstream media is currently awash with scary forecasts about the impending collapse of the Euro and many pundits are now predicting a Greek or Spanish default.
The world’s most influential central bank wants to inflate American asset prices; thus it is conceivable that the ongoing rally on Wall Street will continue for several months. Look. The Federal Reserve has made it clear that it will keep rates on hold until at least December 2014 and it is also buying US Treasuries across the entire yield curve.
The economies of the developed world are sluggish, unemployment is a real menace and debts are out of control (Figure 1). Nonetheless, the world’s stock and commodity markets are defying all logic and advancing in the face of adverse economic conditions.
You may recall that only a few months ago, the investment community was worried about Europe and many were questioning the survival of the single currency. During that period, investors were dumping all sorts of risky assets and capital was flowing towards the world’s reserve currency and the most liquid government bond market.
Even though the vast majority of the world’s stock markets are in a primary downtrend, it is astonishing that Wall Street has not changed its optimistic tune! For example, Goldman Sachs is still calling for a strong Q4 2011 GDP print and other houses are also urging investors to ‘buy-the-dips’.
The global economy is slowing down, most of Europe is in recession and the US is also on the verge of a contraction. Nonetheless, the ‘risk on’ trade has raged over the past month and somehow, the market seems to be oblivious to the real economy.
