Monday, 01 August, 2016
The great fiscal fair of 2016 has begun. The world’s governments are seizing on the flimsy excuse of Brexit to prime pump their economies, hoping to stretch the ageing global cycle for a little longer.
Japan’s Shinzo Abe has kicked off the first round with a "shock and awe" fiscal package ostensibly worth $270bn, though the South Koreans nipped ahead of him with a $17bn raft of measures.
Britain cannot be far behind as Philip Hammond prepares his first post-austerity Budget this autumn, while France’s Francois Hollande and Italy’s Matteo Renzi have seized on Brexit to run a coach and horses through the eurozone’s fiscal rules. Brexit is manna from heaven.
Brussels hardly dares to raise a squeak, knowing that revolutionaries – the Front National and Beppe Grillo’s Five Star movement – are knocking at the doors of power. Fiscal austerity is over in Europe.
The details of the Japanese plan will be fleshed out next week. The infrastructure measures will include a push for the Maglev magnetic levitation train, which has already attained speeds of 600 km/h on a stretch rail beneath Mount Fuji.
Mr Abe’s plan amounts to 5.6pc of GDP, though the actual figure will be less once double counting is stripped out. This is far bigger than sums floated earlier by officials and would pack twice the punch of Japan’s stimulus after the Lehman crisis. He has already postponed plans for a rise in the consumption tax until 2019. All pretence at fiscal rectitude has been abandoned.
This "precautionary" stimulus has a loose parallel with the events of 1998 following the Asian financial crisis, when the US Federal Reserve and others slashed interest rates.
The global authorities overdid it – easy to say in hindsight – setting off the final explosive phase of the dotcom bubble on Wall Street, with similar excesses on Germany’s Neuer Markt. This time the policy mix is subtly different. Fiscal spending is the spearhead, backed by easy money.
Japan is taking advantage of the new global orthodoxy. The International Monetary Fund – once the voice of fiscal restraint – wants "growth-friendly" spending to soak up chronic slack in the world economy, mostly on infrastructure schemes with the highest multiplier effect. "There is an urgent need for G-20 countries to step up their efforts to turn growth around," it said last week.
US fixed public investment is the lowest in 60 years, much like Europe and JapanCREDIT: JP MORGAN
Fixed public investment in the US has fallen to a 60-year low of 2.8pc of GDP, even though Kennedy Airport is crumbling and New York’s gas mains date back 120 years or more. Almost fifty of the city’s bridges are rated "fracture critical" and prone to collapse.
Public investment has fallen to 2.6pc in the eurozone, and has been negative in Germany for much of the last fifteen years, though the Kiel Canal is falling into the water and the country’s railways still rely on 19th Century signalling in places. In Japan it has fallen from 9.7pc to 3.9pc over the last two decades.
None of this makes sense when there is so much excess capital in the world and $11 trillion of sovereign debt is trading at negative yields, allowing governments to borrow for twenty or thirty years for almost nothing. Debt ratios are higher, but debt service costs in the US have dropped to just 1.2pc of GDP from 3pc in the early 1990s.
Governments can borrow for almost nothing, for as long as they want CREDIT: JP MORGAN
Mislav Matejka and Emmanuel Cau from JP Morgan has created a series of "fiscal baskets" for investors. "We believe that it is prudent to begin adding to stocks that could benefit from a potential increase in fiscal spend and from infrastructure projects," they said.
They like Haynes, Atkins, Balfour Beatty, Costain, and Kier Group, among others, in the UK; Siemens, ThyssenKrupp, Thales, Alstom, and Dong Energy in Europe; General Electric, Steel Dynamics, and Texas Instruments in the US; and Tokyo Steel, and Osaka Gas in Japan.
The beauty of fiscal stimulus is that it goes directly into the veins of the real economy. There is by now near universal agreement that reliance on zero rates and quantitative easing merely to drive up asset prices have reached their limits, rewarding the owners of capital with precious little trickle-down to the working poor. The politics are poisonous.
Some of Mr Abe’s spending will go on child-care and homes for the elderly. You could question whether a country with public debts near 250pc of GDP can afford to borrow yet more to fund social welfare, but debt is a mirage in a world of helicopter money.
The Bank of Japan is monetising the entire budget deficit, buying $76bn of bonds each month. Former Fed chief Ben Bernanke floated the idea of a “money-financed fiscal programme” earlier this month in Tokyo but some would say that is exactly what they are already doing.
The Bank of Japan’s balance sheet is already 92pc of GDP, and rising very fast CREDIT:JAPAN MACRO ADVISERS
The BoJ’s balance sheet has reached 92pc of GDP. It owns 38pc of the Japanese government bond market, rising to 60pc by 2019. Whether such central bank adventurism is a free lunch remains to be seen. There is no sign yet of an inflationary ‘pay-back’, the moment when the chickens come home to roost. Japan can borrow for fifteen years at minus 0.05pc.
My own view – not yet with full conviction – is that global growth will accelerate in the second half. The Fed’s retreat from four rate rises this year has been a powerful tonic for emerging markets, while there is still enough fiscal stimulus in the pipeline to keep China’s mini-boom going for a few more months.
You can see the largesse in the global money supply figures. Simon Ward from Henderson Global Investors says his key measure – six-month real M1 money – is rising at a rate of 10.5pc, the fastest since the post-Lehman stimulus. It is a torrid pace even if you adjust for the declining velocity of money. The figure for China is an explosive 45pc (six-months annualized).
Sooner or later, this surge of liquidity will lead to flickerings of inflation in the US, and then to the time-honoured inflationary take-off as the labour market tightens, at which point the markets will react and the global asset rally will short-circuit.
The Atlanta Fed’s measure of ‘sticky price’ inflation picks up the underlying pressures. It is rising CREDIT: ATLANTA FED
The Atlanta Fed’s gauge of ‘sticky price inflation’ for the US is running at 2.8pc. Wage growth has picked up to 2.6pc. Employers are having more trouble finding workers than at the peak of the last two booms. We are not at the danger line yet, but we are getting closer.
Brexit was always a hoax for world markets. The financial cycle will end as it always has in peacetime over the last century: when the Fed tightens. "We suspect that an abrupt reassessment of the outlook for US monetary policy remains the key risk," says Capital Economics. Precisely.
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