Billionaire George Soros is known as the man who broke the Bank of England.
He was smart enough to bet against the pound when it was tied to the deutschemark as part of the European Exchange Rate Mechanism in 1992.
But you may not know that Soros had a partner – a chap called Stanley Druckenmiller. Druckenmiller is a billionaire too, and a widely-respected hedge fund manager, who produced average annual returns of 30% from 1986 to 2010.
And he now reckons we’re facing disaster.
Actions have consequences – even central banks’ actions
One argument you often see being made by pundits today – particularly those who have a ‘secular stagnation’ view of the world – is that there’s nothing to lose by conducting extreme monetary policy. Given the risks involved in a deflationary world, it can’t hurt to fight it in any way possible.
Unfortunately, this is just Frederic Bastiat’s parable of the broken window writ large. In summary: a shopkeeper’s window gets smashed. A crowd of economists – I assume that’s what they are – argue that it’s great news for the glazier, forgetting that the shopkeeper could have spent the money on something more useful.
The reality is that every action carries costs. And recently, as Henny Sender in the FT notes, a report from Swiss Re has tried to put a number on that cost as far as artificially repressing interest rates goes. The re-insurance giant reckons that US savers have lost $470bn in interest rate income – “and that is net of lower debt costs”.
Now, Swiss Re is not an entirely neutral party. As part of the insurance industry, falling interest rates and overpriced bonds are a problem because it essentially has to own government debt in order to match its long-term liabilities.
But the point stands – everything has consequences, and you can’t expect to keep interest rates at current levels without distorting the market in some way.
At a talk given in January – but only really picked up on now – Stanley Druckenmiller explained that he thinks that central bankers’ actions have put the economy in a very dangerous position.
In short, he reckons that interest rates are too low. As a result, we’re seeing a replay of the mid-2000s – when interest rates were too low given economic growth, and as a result, the bubble in US subprime property was inflated. And when it blew up, it triggered the global financial crisis.
He notes that a similar thing is happening today. Even although the US economy is growing, interest rates are lower than they’ve ever been. It’s hard to argue that current conditions justify that level of emergency intervention.
“If you look… at the real root cause behind the financial crisis, we’re doubling down. Our monetary policy is so much more reckless and so much more aggressively pushing… people… out the risk curve”, notes Druckenmiller.
“When you have zero money for so long, the marginal benefits you get through consumption greatly diminish, but there’s one thing which doesn’t diminish, which is unintended consequences.”
The danger of keeping monetary policy so low for so long is that people make bad investments. They invest because they feel they have to, rather than because they think the potential returns are genuinely attractive. They’ll buy anything that promises a half-decent income, rather than looking for value and low-risk.
He points out various signs of over-valuation in the US market in particular. Around 80% of new companies listing make no profits. That’s a proportion only seen before during the tech bubble in 1999. And 71% of the corporate debt issued in the last two years has been ‘B’ rated. That compares to just under 30% in 2006/07.
In other words, poor quality companies are finding it easier and easier to raise money, whether through equity or debt. What’s the likely outcome of that?
“I think it could end very badly.”
What Druckenmiller is investing in now
However, what’s interesting is that Druckenmiller more recently has said that “I’m not all that excited by the US, but I do have large exposure in Japan and Europe.”
So he might not approve of money printing particularly, but he’s not so disapproving that he won’t take advantage of it when it happens – and nor should you. We’d have some money in both countries, as they are more likely to benefit from ongoing quantitative easing than the rather overvalued-looking US.
Meanwhile, if you haven’t already checked out my colleague Tim Price’s nightmare scenario for markets, you can learn more about it here.