The Federal Reserve's attempt to pump more inflation into the US economy by pushing up asset prices looks as though it might backfire.
Ben Bernanke has already admitted that he's relying on 'the wealth effect' to help consumer confidence. The argument goes that if stock prices are higher, people feel richer, so they spend more money.
This is a pretty tenuous argument to begin with. House prices have a far bigger 'wealth effect' and right now, plunging property prices are making the typical American feel very poor indeed.
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But it looks as though his attempts to drive up stocks might be scuppered too. Why? Because at the same time as the US is trying to loosen monetary policy, much of the rest of the world is tightening it right up.
What happened to the bubbles QE was going to inflate?
Asian stocks took a bit of a hit this morning. China's Shanghai Composite Index hit a one-month low. Oil and copper have eased back too. What happened to all the bubbles that were going to be pumped up by quantitative easing (QE)?
Well, the situation in Europe is certainly keeping investors on their toes. Ireland at the point of writing, at least still hasn't put its hand out for the bail-out that every other European leader so desperately wants it to take.
The aim is to find a way for Ireland to save face by making clear it's a banking bail-out, rather than a sovereign bail-out, although it amounts to the same thing. However, markets seem to be assuming that some solution will be forthcoming. Ireland's cost of debt has fallen from the record highs hit last year. No doubt we'll see some sort of fudged resolution after the 'Ecofin' meeting of EU finance ministers in Brussels today and tomorrow.
The real worry for this morning is that, even as the Fed tries to loosen monetary policy further, Asia the world's new growth machine is trying to tighten it up. South Korea raised interest rates this morning, for the second time this year. Consumer price index (CPI) inflation hit 4.1% in October, a 20-month high, and above the Bank of Korea's target of 2% to 4%. "The central bank made clear that they will keep raising interest rates. The crisis is over and monetary policy is now set for normalisation," one economist told Bloomberg. The country is also looking at capital controls to prevent too much 'hot' money from flooding into the economy.
Meanwhile, Australia's central bank has also signalled that it's happy with rates carrying on higher. It seems that economies in less fragile parts of the world aren't content to sit on their hands as cheap money from the US flows their way. "While inflation still isn't a major concern for the Western world, it really is coming to the forefront in emerging markets," Ivan Leung of JPMorgan Private Bank tells Bloomberg.
Special FREE report from MoneyWeek magazine: Don't be fooled - house prices will fall again!
- Why UK property prices are set to collapse by 30%
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The West can't rely on cheap imports any more
But the Western world can't relax either. Emerging and Asian economies have been exporting deflation around the globe for many years. It was one of the major factors that enabled Western central banks to keep interest rates low and cheerfully ignore the resulting rampant asset price inflation. But with raw material costs surging, we can't rely on cheap goods from overseas any longer.
One Bloomberg headline this morning reads: "Gap, Wal-Mart clothing costs rise on 'terrifying' cotton prices." It looks as though US retailers may have to pay "Chinese suppliers as much as 30% more for clothes as surging cotton prices boost costs."
Jessica Lo of China Market Research Group spells it out: "American consumers better get used to rising prices on the shelves China's manufacturers are getting squeezed not only by rising cotton costs but also soaring real estate and labour costs."
Of course, the trouble with these sorts of rising prices is that they aren't at all helpful. If companies pass the costs on to consumers, then all that happens is that people buy less. If companies choose to absorb the costs and get locked in a price war with rivals, then corporate profit margins take a hit. Either that, or companies cut costs elsewhere to compensate, which often results in higher unemployment.
The UK is already clearly suffering the effects. The latest figures on inflation over here show that CPI once again came in above expectations. Economists had predicted a 3.1% annual rise for October, the same as September instead inflation came in at 3.2%. It's just the latest in a long run of "unexpected" surprises.
And if you look at the breakdown of all the items included in the CPI, not a single item actually fell in price compared to this time last year. Even clothing and footwear costs were up 0.7% on last year, for example, after years of falling reliably every month.
Protect yourself from stagflation
What does it mean? Well, it's going to become ever harder for the Bank of England to resist raising interest rates for one thing. But it's also going to squeeze consumer income at a time when threats of higher taxes are hanging over us all.
In short, commodity price inflation at a time when unemployment is relatively high, is stagflationary. Your wages don't rise to accommodate your cost of living, which is a grim situation to be in.
In terms of protecting your wealth, we still think the best bets are the sorts of companies that have a good chance of passing costs onto consumers big dominant firms that sell products that we need to buy, even during tough times as well as hopefully hiking dividends to match. You can read more about how to cope with the impact of QE and the backlash against it in the here: Quantitative easing: What Bernanke's billions mean for you. If you're not already a subscriber, subscribe to MoneyWeek magazine.
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John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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