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Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Deflation spectre still hovers as Fed’s big day begins. Quelle surprise, baby boomers no better off than their parents, and their kids are even worse off. Germany’s boom, Ireland’s exit, and Iceland’s default


Deflation spectre still hovers as Fed’s big day begins

To be fair, the Fed’s big day actually started yesterday. But as far as the media is concerned, later today (this evening in the UK) is a big moment. The FOMC meeting lasts for two days of course, and today it will announce its latest monetary policy decision. And economists from Washington to Jakarta will be waiting with bated breath to hear the outcome.

The general feeling is that today the Fed will reveal tapering of QE. You may recall that when the Fed began upping interest rates in the mid-1990s, the foundations were laid for the Asia crisis. Or if you want to be pedantic, the foundation itself was laid sometime earlier. It is just that the Fed tightening policy led to money flowing out of Asia, we had runs on currencies, Alan Greenspan busily bestrode the world stage, and to the triumphant sound of a bugle, the IMF galloped over the hill like the US cavalry, but in this case created havoc in the region it was supposed to be helping.

So will it be like this again?

It may be, but frankly the idea that the Fed will taper QE soon has been so well telegraphed, that if the markets have not priced in the effects already, we would have to conclude the idea of the wisdom of crowds is well and truly dead.

There is another issue, however. Even if the Fed does go in for a spot of tapering – remember it is currently forking out $85 billion a month on bond purchases – it does not appear to think that such a development is in any way an example of monetary policy tightening.

There is more than one reason for this. For one thing, no one expects QE to be put on hold altogether; they’re expecting that there will be just a bit less of it. As such if the Fed does announce tapering, it will be akin to a very fast car that has been accelerating from the moment it was switched on accelerating at a slightly slower rate.

For another thing, the Fed reckons it has come up with a cunning plan to make QE less necessary. And what is this cunning plan? Is it as cunning as Professor Fox from the University of Oxford? Well, actually it is a kind of US style forward guidance. The Fed reckons that by laying down the conditions that will precipitate a rate increase in advance, it does not need so much QE. Baldrick would have been proud of such logic.

As an aside, it does appear that central bankers genuinely think that forward guidance is charging the economic recovery – even Alan Greenspan stopped short of such hubris.

The fact is, however, that inflation in the US, and indeed in Europe, is about as threatening as a stick with stoppers on the end. Data out yesterday revealed that US inflation was 1.2 per cent in November, from 1.0 per cent the month before. It is odd, isn’t it? Where is the hyperinflation we were told QE will create? It appears that hyperinflation is a kind of dog that miaows (geddit?).

In the eurozone, inflation in November was a blistering 0.9 per cent. In fact the annual inflation rate shot up from the month before when it was 0.7 per cent. Still month on month prices were minus 0.1 per cent. As you know the head of Germany’s central bank reckons QE is like a Faustian pact, and that hyperinflation will follow as surely as night follows day. And here’s your evidence: German inflation was 1.6 per cent in November, while in Greece it was minus 2.9 per cent. And that is hyperinflation, in much the same way as two plus two equals six.

The point though, is that given the level of inflation, central banks in the US, the UK and the eurozone will not exactly be in a hurry to tighten monetary policy.

The Fed may or may not taper QE, but thanks to its wizardry called forward guidance, this does not mean it thinks it is tightening monetary policy; rather, by its definition, monetary policy is set to be as loose as a pair of trousers after Christmas dinner.

Quelle surprise, baby boomers no better off than their parents, and their kids are even worse off

This is how the IFS put it: “Since the Second World War, successive cohorts have experienced higher incomes and higher living standards than the previous generation, as they have benefited from rising national income.”

But it said: “This has stalled over the last decade. Working-age adults do not currently have higher incomes (after adjusting for inflation) than their predecessors born 10 years earlier had at the same age.”

And here is the interesting bit. “Those born in the 1960s and 1970s did have higher incomes during early adulthood than their predecessors. But this additional income at younger ages relative to earlier generations was all spent: they have not saved any more past income than their predecessors had by the same stage in life.”

Does that mean the 1960s and 1970s generation need to knock up a memo to their parents, and if they are no longer with us, communicate via a séance, saying “Err yes, you were right, we were spending too much after all.”?

But never fear, mummy and daddy may come to the rescue after all. The IFS put it this way: “If people’s expectations are correct, then receipts of inheritances will be far higher among those born in the 1960s and the 1970s than among those born earlier. 28 per cent of those born in the early 1940s have received or expect to receive an inheritance, compared with 70 per cent of those born in the late 1970s.”

Steve Wilkie, managing director of retirement specialist Responsible Life, is not impressed with these expectations of inheritance. “As gambles go,” he said, “it’s a risky one.” He added: “The reality is that care costs will eat up most of their elderly parents’ wealth long before they can leave it to them. Just yesterday MPs debated a Bill that could force elderly people to pay as much as £150k towards their own care.”

Still, spare a thought for the baby boomers’ kids. According to the IFS, individuals born in the 1970s are taking longer than their predecessors to get on the housing ladder, and their home ownership rate has stalled over the last few years at around two-thirds – far below the four-fifths rate at which it peaked for those born in the 1940s and 1950s.

Just remember, however, that there is a good underlying reason for this. The golden age of growth was the 25 years after World War 2. Given this, does it not make sense that the younger generation don’t have it quite so good? As for funding their retirement, the best way to achieve this is via an economy that is growing.

Germany’s boom, Ireland’s exit, and Iceland’s default

The latest ZEW index tracking economic sentiment rose to 62 in November, which was the highest reading since 2006. The current conditions index was not quite so good, but even so pointed to 3 per cent growth. All in all then, it’s not bad.

Alas, Capital Economics reckons that while Germany’s recovery is having a spill-over benefit on the rest of the eurozone, the resulting growth rate in the region will be insufficient to see the region grow out of its debt crisis.

Meanwhile, heading north, Iceland is writing off debts. The government has revealed plans to allow households to write-off debts worth the equivalent of 9 per cent of GDP by 2017. The write-off will be funded mainly by taxes on those nasty Icelandic banks, but this does mean that creditors of banks that failed in 2007/08 will be forking out much of the bill.

Fitch doesn’t like it, and threatened to downgrade Iceland’s credit rating. But then credit agencies tend not to like it when anyone defaults. There is also a danger that the resulting stimulus may exert an inflationary effect on the Icelandic economy.

James Howat, European economist at Capital Economics, pointed out, however, that: “Iceland’s policies are being financed by hitting external creditors. Constrained by Single Market rules and political pressure from their core creditors, peripheral economies [of the eurozone] would struggle to do the same.”

Meanwhile, Ireland has exited its bail-out programme, which was instigated three years ago amidst predictions of doom. Ireland’s government has managed to implement 16.4 billion euros worth of cuts.

Even so, government debt is still 125 per cent of GDP. Its budget deficit this year is expected to be around 5 per cent and unemployment is at 12.6 per cent. If Ireland is the ‘poster country’ of austerity, one dreads to think about what the ‘peeling wallpaper’ countries are like.

 

 

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


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