Europe’s economy is in more trouble than ever.
There’s rebellion in the ranks of the French government. And German business confidence is dropping.
It’s one thing acting tough when Greece or Portugal are suffering. It’s quite another when the ‘core’ of the eurozone is in the doldrums too.
Naturally, stocks rose at this turn of events. You see, the worse things get, the more pressure there is on the European Central Bank to print money.
And comments from Mario Draghi, the European Central Bank (ECB) boss, at the central bankers’ big get-together in Jackson Hole suggest he’s close to breaking point.
Draghi gives the green light to eurozone money-printing
Draghi and the ECB were the stars of the show at Jackson Hole. He noted that eurozone inflation was crumbling. He said that the ECB could use “all the available instruments” to combat deflation.
Analysts reckon that means he’s acknowledging that quantitative easing (QE) is more than likely to be necessary. In short, the ECB would print money and use it to buy eurozone government bonds, in order to prop up the region’s banking sector, and to encourage more risk-taking by lenders and investors.
Of course, any hint of more money-printing always cheers the market, and European stocks reacted well to the news.
But US stocks have also continued to do well. That’s even although some people thought that Federal Reserve boss Janet Yellen’s Jackson Hole speech was a little more hawkish (ie supportive of rate rises) than her previous utterances.
So what’s going on? And what does it mean for your money?
How eurozone QE could help US and UK central bankers
The Anglo-Saxon economies have suffered a lot during the financial crisis. But compared to the eurozone, they’ve had it lightly.
QE has made the difference. Printing money has done two main things. Firstly, it bailed out the banks. It has allowed them to take the slow, painful route to repairing their balance sheets, rather than the fast and very painful route (ie, bankruptcy).
Secondly, it has kept the US dollar and the pound weak. That’s helped to boost competitiveness in both countries. In fact, Britain’s labour costs are now lower than Spain’s, according to data from Eurostat reported in the FT.
Economies in both the US and the UK have now rallied to the point where there’s talk of higher inflation and interest rates.
Europe, meanwhile, tried to sweep a lot of its banks’ problems under the carpet. Limited action by the ECB has kept them on life support, but it has held up the balance sheet repair process.
To add insult to injury, after the initial panic was over, the euro appreciated strongly against currencies that were being weakened by QE. As a result, the euro is too strong for the vast majority of countries who use it.
The ECB knows this, and it’s been trying to talk the euro down (pretty successfully in recent months). And this is one reason why eurozone money printing might end up boosting stocks around the world, not just in Europe.
You see, if the ECB launches QE – and we expect it will – then the euro will no longer be the world’s ‘strong’ currency. Throw in the fact that Japan is also trying to weaken the yen, and it looks like that mantle will be passed back to the US dollar.
All else being equal, a stronger currency is deflationary. So this suggests that money printing by Europe could take pressure off the US – and perhaps the UK – to raise interest rates.
Anglo-Saxon governments don’t want higher interest rates
The other thing to be aware of is that governments everywhere still carry huge amounts of debt that they need to deal with at some point. It’s been easy to forget this because there hasn’t been a huge panic so far. But as recent figures show, the UK’s debt situation in particular, is still as grim as ever.
An interesting piece from the team at fund manager M&G put this into context the other day. While both the US and the eurozone have managed to cut their budget deficits (as a proportion of GDP) quite drastically since 2010, Britain’s efforts have stalled in the last two years.
The only way to get out of this in a moderately painless manner is through ‘financial repression’. You keep interest rates down, and allow inflation to rise. This way you pay off a good chunk of your debts via inflation, rather than by defaulting outright.
The reason why both Mark Carney at the Bank of England and Yellen at the Fed want wages to start rising strongly before they raise interest rates, is because they want to maintain low ‘real’ interest rates. They want to be ‘behind the curve’. A sustained period of inflation at 3-4%, say, would be just what the doctor ordered.
So we could see interest rates staying lower than markets expect for some time. And in the longer run, we could see a lot more inflation than we’ve been used to as well.
In terms of investing, I’d rather stick with countries that are actively looking to do more QE and still have relatively inexpensive stock markets – such as Europe or Japan – than the US.
However, the FTSE 100 doesn’t look a terrible bet either – it offers exposure to half-decent dividend stocks, the mining sector (which should benefit from a more inflationary world) and to the US dollar.
• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
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On this day in history
On this day in 1768, Captain James Cook set off from Plymouth on his way to Tahiti and the fabled land of Terra Australis Incognita.