Bully in the playground
Lula and the Carnival

There is a lot of chatter around about the need by the Federal Reserve in the United States and the Bank of England here to expand its Quantitative Easing operations. This a type of economic policy that Central Banks undertake when they have run out of other ideas and interest rates have fallen to near zero. In theory it is a good plan. The Central Bank buys securities from Commercial Banks in exchange for cash. The Commercial Banks, flush with cash, then lend that to you and me. We take the borrowed money and invest in businesses and generally spend. This boosts the economy in the same way as a set of jump leads helps a car with a flat battery.

All well and good I hear you say. Someone lends me money, I buy something and the economy improves. That is the theory. Well what happens if you and me have soooo much debt already that we really don’t want to borrow any more. As you get older you realise that you do not need so many new things to survive. You manage with the things that you have. Do you need 3D televisions when you are 60? We as a population are aging fast and so we do not need as much new “stuff” as when we were younger. So we prefer to try and pay some debt back, especially when the job outlook is poor and the Government is telling us they are going to cut back so even public sector jobs will be hard to come by. What happens then? Going back to the car analogy the battery is so flat that we might get the car started but it will stall again very quickly.
Now what? The Central Bank has to change the perceptions of the public. This is what all the noise and chatter is about in the newspapers. The Central Bank has to persuade you and me to stop paying off debt and borrow more.
Is that likely? If you are convinced that inflation is coming ( a rather large IF!) you will borrow money to buy things NOW because you will have to pay more for them in the future. But if you are retired and living on a pension you are more likely to be worried that inflation will ruin your pension and so you save even more. Forget buying more stuff, you want to save to survive.
This is why the Bank of England has to become the BULLY IN THE PLAYGROUND. It has no choice. THERE WILL BE MORE QE, A LOT MORE. The Bank of England will try to force us to spend more money. Hence, Governor Bean on the radio the other day encouraging pensioners to spend their Capital. Not sure that is either wise or acting prudently.
THE END GAME HERE IS INFLATION IS COMING – DON’T FIGHT THE BULLY. The real issue is when? Watch this space!

LULA and the Carnival

Think of Brazil and your thoughts turn to sandy beaches, attractive young people, carnival and rather a lot of forest. The country is exciting and vibrant – a cocktail of the exotic. In finance too there is a buzz in the air. The country has weathered the global financial crisis well. The Brazilian Breal has been soaring, economic Growth is around 8% per annum and they are hosting the Olympic games in 2016. According to Bloomberg which tracks the interest rates of over 50 countries, the interest rates in Brazil are the fourth highest after Lebanon, Pakistan and Venezuela.
This optimism attracts the so-called Carry Trade investors. These investors borrow in a currency with low interest rates and invest in a country with high interest rates to pick up the difference. Hence the attraction of so-called Lula Bonds (Brazilian Real denominated bonds named after their colourful President) that currently yield around 11.7%.
There is a snag of course. The currency has to remain stable for the idea to work. This time around the rally in world stock markets and asset prices generally has benefitted Brazil. The Real has risen (witness the chart below against Sterling).

However, in the world of finance there is no such thing as a free lunch. Higher yields are higher risk. When the sentiment turns against Brazil for whatever reason the correction will be sharp and dramatic. This is the way of markets – slow to rise and quick to fall. Enjoy the high rate of interest – If things go wrong I hope that you get your money back!

Beggar thy neighbour

On the subject of Brazil, the Finance Minister was on the wires this week complaining about everyone else!
Apparently he thinks that there is a plan amongst the struggling economies of the world to export all their problems. Well if he thinks that the Brazilians need to be worried about sending our English football team over there I can reassure him now! On the other hand we do have a few other problems and I think that he has a point. The UK, via the Bank of England (those folks again!), has made no secret of their desire for a lower currency. It might not help in the long run but short term it makes our exports more competitive and makes London Real Estate look really cheap. This all goes to help the economy and it really needs that help at the moment. We are EXPORTING DEFLATION elsewhere.
This means that successful countries like Brazil, Switzerland and Australia all have rapidly rising currencies as we try to send our deflation there. This will have consequences. At some stage their economies become so uncompetitive internationally that it leads to a recession. This then leads those countries to pursue lower rates and expansionary fiscal policies to maintain growth domestically. That way the whole world ends up with economic stimulus. At different times mind you, but this is the only outcome possible.
ALL THIS WILL LEAD TO MORE CURRENCY AND INTEREST RATE VOLATILITY. Asset prices will continue to be very choppy for the foreseeable future while we work off the problems. This is not a good time for the “Buy and Hold” type of investing
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Until next time….