John Butler's Blog

Is reserve currency status an economic blessing or a curse? The answer might seem obvious, as reserve currencies have been shown to confer lower borrowing costs on their issuers. But what of the borrower who, enticed by low interest rates, borrows more than they can pay back?

While neo-Keynesians may realise that their policies are failing, what they are now contemplating is an even more radical programme of outright debt monetisation, wealth confiscation and vastly expanded central planning. Investors must take appropriate actions to protect themselves now, before such policies are implemented.

Former GE CEO Jack Welch recently ignited a firestorm over his ‘tweet’ that the US September labour market data appeared to have been manipulated for political reasons.

Economic data the world over indicate that a global economic slowdown is well underway. Central banks have already responded with fresh stimulus, as anticipated by financial markets. But just as the economic recovery of 2009-2011 was largely artificial and, thus, disappointing in key respects, so the unfolding slowdown is going to result in a few nasty surprises.

Negative interest rates will result in a preference for physical cash and checks rather than bank deposits, actions that will destabilise banks’ funding base and impair their ability to make loans. Now what do you think that will do to the economy? What effect will it have on global trade, given the dollar’s central position as the pre-eminent reserve currency? Well, probably not what the Fed supposedly intends, but pathology is pathology.

As with many of his classmates, Jack arrived at his commencement day ceremony with a sense of forboding. Notwithstanding an honours degree in business studies, with a concentration in marketing, he had yet to land a job. Sure, there were some jobs out there, as the career office had advertised all year, but there was next to nothing in marketing.

As with much of the euro area, the US is in a debt trap. All the politicking in DC does not change this economic fact. The federal debt is going to be devalued. Yet even now, amid a new economic slowdown, US consumer price inflation is set to remain positive following a large spike in global food prices.

In what might be the most underreported financial story of the year, US banking regulators recently circulated a memorandum for comment, including proposed adjustments to current regulatory capital risk-weightings for various assets.

For the third time since 2008, financial markets are pricing in a deflationary rather than inflationary future. The reasons for this are understandable. There is now strong evidence that global economic activity is slowing. The euro-area banking and sovereign debt crisis is worsening.

With the euro-area crisis and associated uncertainty escalating rapidly of late, safe-haven assets are outperforming, with the notable exception of gold. Why are high-quality government bonds rallying to new highs, while gold sinks to a six-month low? A key explanation is surprisingly simple if technical: Government bonds are Tier1 capital assets, gold is not (yet).