The sky has not fallen yet, but if you believe Societe Generale’s Prince of Doom and Gloom Albert Edwards, it will be falling soon, and you just have to take a peek at the Middle Kingdom to see it happening in real time.
In his Global Strategy Weekly of November 19th, Edwards notes: “Equity investors continue to attach a high degree of confidence to policymakers ability to control economic and financial market events. That this should be the case in the aftermath of the spectacular 2008 collapse in the global economy remains a mystery to me. I suppose investors feel that policymakers prevented another Great Depression and perhaps, on that low benchmark, some small measure of success was achieved! But if, as I believe, we are set for another deep economic and market downturn, the ensuing loss of confidence in policymakers will mark a huge shift in sentiment. This will only deepen the downturn and make any attempt at economic revival even harder to pull off. Events in China in recent months have been following exactly that template.”
Albert Edwards: It begins with loss of confidence
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The SG report begins by suggesting that the reason the government of China has been unable to reinvigorate the Chinese economy is a serious loss of confidence in the authorities following the debacle with the Chinese equity bubble. He notes that while the supply of credit is readily available, the demand for it has largely disappeared.
Edwards then delivers the punchline: “Exactly the same outcome will soon be heading westwards.”
From QE to direct foreign exchange intervention – currency wars are coming!
According to Albert Edwards, while QE has been framed in a “pretentious theoretic framework” as a long-term a portfolio balance approach strategy, the real effect has been to push interest rates so low that people are forced out of cash into financial assets, which supports consumption through wealth effects.
He says: “Lets not beat around the monetary bush, one of the main aims of QE is to drive down ones currency to gain a competitive advantage without overtly doing so. But, that mask is now lifting, with the ECBs. Draghi openly stating that a weaker euro was one of its main targets in adopting its QE program.”
As the QE game progresses, instead of pretending to nit be targeting the exchange rate and pursuing domestic money printing (which of course distorts domestic asset prices, increases inequality and only indirectly weakens the exchange rate), the next step will be direct FX intervention or an out and out currency war. Edwards points out that China has already been pursuing this strategy for most of the past decade.
He argues that the BoJ will eventually see the obvious that Japan’s recovery has stalled and that real inflation is clearly not moving up. Then if Japanese central bankers conclude they are running out of domestic financial assets to purchase, they will do what Ben Bernanke and other well-known economists have suggested as a possibility, they will buy start buying up foreign assets to directly target a lower yen.
As Edwards notes “The next logical stage in the global currency war will be direct FX intervention!”