it comes out in a few weeks) will almost certainly mean an adjustment in asset prices around the world. That adjustment is going to lead to the increased volatility that I was talking about last week, and that volatility is going to lead to a flight to a safe-haven currency, which the world sees as the US dollar. The potential is growing for a real correction leading to outright recession in a period when inflation is receding.
The stock market is down only 5% from its high, and the last two times the Fed has exited QE the market dropped roughly 20% over three months. Even Jim Bullard, who only a few weeks ago was writing about dealing with the risk of inflation and normalizing interest rates sooner than the expected June 2015 FOMC meeting, said in a speech last week that “We could go on pause on the taper at this juncture and wait and see how the data shakes out into December.” When a “hawk” like Bullard (who represents the normally monetarist St. Louis Federal Reserve) started talking about postponing the end of QE, the markets responded with a massive upward move. Talk about your whipsaw communication.
I am pretty sure that Yellen and team are not all that pleased with the corner into which they are now painted. While $15 billion a month is not all that significant in the grand scheme of things – and I think the market, on reflection, will understand that – it has been enough to get the rockets roaring.
The Federal Reserve is in danger of losing the narrative. And the pressure on them to do something will grow if we continue to see the dollar rise and inflation fall. If the markets respond as they have to the end of past QEs, will the Fed once again feel that it needs to respond with yet another round of QE to forestall a drop in asset prices?
Ambrose Evans-Pritchard argued this week that the world economy is so damaged that it may need permanent QE:
Combined tightening by the United States and China has done its worst. Global liquidity is evaporating.
What looked liked a gentle tap on the brakes by the two monetary superpowers has proved too much for a fragile world economy, still locked in “secular stagnation”. The latest investor survey by Bank of America shows that fund managers no longer believe the European Central Bank will step into the breach with quantitative easing of its own, at least on a worthwhile scale.
Markets are suddenly prey to the disturbing thought that the five-and-a-half year expansion since the Lehman crisis may already be over, before Europe has regained its prior level of output. That is the chief reason why the price of Brent crude has crashed by 25pc since June. It is why yields on 10-year US Treasuries have fallen to 1.96pc, and why German Bunds are pricing in perma-slump at historic lows of 0.81pc this week.
We will find out soon whether or not this a replay of 1937 when the authorities drained stimulus too early, and set off the second leg of the Great Depression.
While I believe that central banks should not focus on asset prices but instead on ensuring overall stable monetary prices, the reality is that markets have responded quite positively to quantitative easing. I along with many others argued that the withdrawal process from QE was never going to be easy. As Minsky taught us, the longer the central banks try to maintain a period of stability, the greater the problems of instability will be at the end of the process.
I’m not certain where I read it, but someone suggested that the world economy should be checked into the Betty Ford clinic to learn to withdraw from the massive overdose of quantitative easing that various central banks have foisted upon it.
Recessions are by definition deflationary. Two things we learned from This Time is Different by Rogoff and Reinhart are that economies are more fragile and volatile than we knew and recessions are more frequent after a credit crisis.
When we enter the next recession (and there is always another recession), the Flat Debt Society will be screaming for more stimulus, more quantitative easing, and more debt. Count on it. Their prescription for dealing with the problems arising from debt is similar to telling an alcoholic to drink more whiskey. They deny that debt can be a problem. Their theories prove it. They even have books and papers by noted academics to show that there is no such thing as too much debt, at least as long as you can print money. Currency wars be damned.
We’re entering a period of renewed global volatility. Adjust your portfolios and hedges accordingly.
Chicago, Athens (Texas), Boston, Geneva, Atlanta, and New York
I’m back on the road. Tomorrow is jam-packed with meetings and ends with a late-night discussion with Woody Brock here in Dallas. Tuesday I go to Chicago for a speech, fly back very early to a meeting with Kyle Bass and friends at his Barefoot Ranch in Athens, Texas, and then fly out to Boston to spend the weekend with Niall Ferguson and some of his friends at his annual briefing. I am sure I will be happily surfing mental stimulus overload that week. I fly from Boston to Geneva for a few days and then more or less directly to Atlanta for a day (board meeting), before heading back to Dallas. I will also be going to New York in the middle of November.
This weekend I flew to Houston to be with Worth Wray and his new bride, Adrienne. It was a lovely wedding, and the bride was beautiful. One of the interesting episodes had nothing to do with the wedding but rather with my taxi driver. He’s an engaging fellow from Ethiopia who is been in the States for years, and the first time he drove for me I took his card and have called on him for four trips. We have gotten to know each other, and this time around he began to express his frustrations over the response to Ebola.
The world ignores Africa. Just a little help would save so many lives, but we don’t even get the basics. And they ignore what we have learned about Ebola. The doctors and other healthcare workers in Africa know how to take care of these patients and keep from getting the disease themselves. But nobody wants to pay attention to what we have learned.
Sadly, last night I learned that the situation is even worse than he thought. Presbyterian Hospital in Dallas is one of the finest institutions in Texas, but their initial procedures for dealing with their first Ebola patient were simply incompetent. The details will eventually come out, and Presbyterian is doing the right things now, but our entire healthcare system is simply unprepared to deal with what should have been a very foreseeable crisis. While I don’t think that Ebola in its current form will be a serious risk to developed-world countries, it does expose some major flaws in our system.
Replace the FDA
But the worst flaw is in our drug regulatory process. Only a few months ago the FDA (Food and Drug Administration) was doing everything it could to slow down the development of new drugs for Ebola. Now that there are a few cases of Ebola in the US and we have a general news panic, it seems they can’t encourage drug development fast enough. Nothing changed except the politics.
A few people in the US contract Ebola and suddenly the FDA allows companies to pull out all the stops. My side bet is that we will have a cure for Ebola in the not-too-distant future.
The serious tragedy here is that millions of people die every year from all sorts of diseases that are on the verge of being cured. There are very hopeful new technologies in the labs, but the FDA is preventing them from getting to you. When I say millions of people that is NOT an exaggeration. But those diseases haven’t caused a political firestorm. We need to change that. We need to create a firestorm to force change on the most deadly bureaucracy in America.
There are hundreds of life-saving drugs and other therapies that are being kept from you and me because bureaucrats are using 19th-century science to try to deal with technologies developed in the 21st century. They are more interested in protecting their personal fiefdoms and reputations than in saving lives. Gods forbid we have a drug that might cause a problem, so they sacrifice progress and our collective health – indeed our very lives – on the altar of self-interested bureaucratic expediency. Oh, they couch it in all sorts of high-sounding words, but the results are the same. You and I are prevented from making good choices about our own healthcare and saving the lives of our loved ones.
The FDA does not need to be reformed; it needs to be replaced. We need as a country to create a commission to design a 21st-century Drug Regulatory Authority and then turn over the regulatory process to this new authority. If any of the current structure fits in the new system, then fine. Otherwise, close it down.
As an economist, I would point out that we are leading the world in biotechnology research, but we’re going to see that research create jobs elsewhere if we don’t figure out how to develop the cures and procedures in this country. We need to slash the cost of drug development by 90%. If we do that, we will see the number of new drugs and procedures increase by orders of magnitude.
Pat Cox and I are watching companies that have the ability to cure scores of some of the most debilitating diseases known to mankind, but they are frustrated at every level by the FDA. And the technologies that are on the drawing board are even more mind-blowing. We simply have to get our heads around this situation and make the needed changes.
I’ve talked with a number of other people around the country and am quite serious about trying to form a group to launch an initiative to replace the FDA with sensible 21st-century regulation. It will take some money and time to build an organization. If you have either, drop me a note and let me know, and I will get in touch with you.
It is time to hit the send button. I am excited about all the meetings and people I will get to see in the next 12 days, but the travel schedule is going to be a little rough. Nothing I haven’t done before, and it will totally be worth it. You have a great week!
Your seeing deflation everywhere analyst,
John Mauldin
