If you haven't yet really paid full attention to the G20 announcement from this past Saturday (June 5, 2010) you really should because it was a potential game-changer.
After a horrible Friday (June 4) reaction ostensibly to a relatively poor jobs report, for the first time in a year the S&P 500 happens to be sitting below both the 200 day moving average and the 50 week moving average. It now seems probable that the rally over the past year was an ordinary bear market rally—albeit a long one fueled by the trillions of dollars in stimulus and thin-air injections—is over and done.
While I admit that the jobs report was not exactly stellar, it was not bad enough in my view to cause the stock market reaction we saw. Instead, I ascribe some of the move to leaked rumors about the upcoming G20 announcement due to be released the next morning.
The G20 Shocker
G20 drops support for fiscal stimulus
June 5 2010
Finance ministers from the world’s leading economies ripped up their support for fiscal stimulus on Saturday, recognising that financial market concerns over sovereign debt had forced a much greater focus on deficit reduction.
Wow.
That's an enormous departure from past policy and creates an enormous gap between major countries, primarily the US, UK and Japan on one side and everybody else on the other.
Consider that the US and the UK are currently running deficits well north of 10% of GDP and are politically committed 100% to continued stimulus as the means to stoke domestic demand. But along comes the rest of the world saying that they are now committed to living within their budgetary means.
Worse, these converts to fiscal sanity have even thrown in the towel on the very idea that stimulus works:
The communiqué of the meeting made it clear that the G20 no longer thought that expansionary fiscal policy was sustainable or effective in fostering an economic recovery because investors were no longer confident about some countries' public finances. "The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability," the communiqué stated.
"Those countries with serious fiscal challenges need to accelerate the pace of consolidation," it added. "We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions".
Doubting the value of expansionary fiscal policy is the same as saying, "Keynesianism doesn't work!" I welcome their belated discovery, but am also shocked by it. Is it possible for economic sanity to break out across the world?
This is a profound event and it cannot be overstated in its importance. How did the US react? Well, Geithner was disappointed that Europe and the rest of the G20- seemed to be bailing out on bailouts saying he had, "concerns about growth as Europe makes needed policy adjustments threaten to undercut the momentum of the recovery".
That's politico-speak for "Guys, you're going to ruin the party! Things are just picking up...you can't take the punchbowl away now!! Hey c'mon...guys....guys? ... Hello?"
Here's another angle on the story:
ECB Advocates Tightening as U.S. Urges Domestic Demand Growth
June 6 (Bloomberg) -- European Central Bank President Jean-Claude Trichet and Treasury Secretary Timothy F. Geithner diverged on prescriptions to sustain growth, with Europe set to tighten budgets and the U.S. seeking stronger domestic demand.
The impact of narrower budget gaps "on growth could not be considered negative because it would improve confidence," Trichet told reporters yesterday after meeting with Group of 20 finance chiefs in Busan, South Korea. The need for such action is clear in "old industrialized economies," he said.
Trichet has even gone out of his way to offer the novel theory that narrower budget gaps could be viewed as a good thing, something that is certain to land on deaf ears in the US.
Beggar Thy Neighbor
In the 1930s, during the depression, the practice of competitive currency devaluation as a means of lifting exports was known as the "beggar thy neighbor" policy.
Each country would seek to devalue its own currency because that would make its exports seem cheaper to the rest of the world and thereby lift their domestic industry and job growth.
So we keep our eyes peeled for any and all efforts to systematically weaken a currency to help our exports. Here's one:
"I see good news from the current euro-dollar rate," French Prime Minister Francois Fillon told reporters in Paris June 4. President Nicolas Sarkozy "and I have been saying for years that the euro-dollar rate didn’t reflect reality and was penalizing our exports," he said.
In the U.S., the Obama administration is aiming to double exports during the next five years. Geithner warned that other countries can’t rely on the U.S. consumer to propel the global economy.
(Source)
Well, Timothy Geithner is going to find it extremely hard to double US exports in the face of a surging dollar and a weakening euro. Knowing this, he warned the G20 that the "US consumer can no longer absorb global exports." The rhetorical tension in this statement belies what is certain to be enormous political tension lurking just out of sight.
Where Mr. Trichet is extremely happy to bring a weaker euro to his countrymen and colleagues, the US is going to find that the policy makes things much harder on its export markets and corporate earnings.
But the worst of it is that where the US is seeking to stimulate domestic demand at any cost, the rest of the G20 is seeking to repair their domestic budgets. This will create enormous difficulties for the US to continue on its own path of $1.5 trillion deficits.
After all, who will continue to buy US debt when European budgets are being run on a much more sound and sustainable basis? This is not yet clear and if it turns out that the US cannot fund its deficits, then the US will be forced into austerity by circumstances.
From The Outside In
For now, the world financial markets seem to complacently accept that the US represents the safest and most liquid market in the world. Well, the liquid part may still be true, but the safest part just took a big hit with the G20 now offering the first glimpse of fiscal sanity we've yet seen during this crisis (or in decades).
Where the G20 has now seen that false growth spurred by growing government indebtedness is both fake and temporary, the US has yet to arrive at that same conclusion. This means that the US will be continuing on a reckless path of monetary printing and deficit spending while a large portion of the rest of the world bites the bullet and begins to live within its means.
This means that the US markets are no longer the safest. There's a problem here and I only wonder how long it will be before the bond and dollar markets wake up to that fact. It may be a while, but eventually they will and it will be a sight to behold.
Which means that the whole concept of "from the outside in" is in play. The trouble began in Greece, progressed to the center of Europe, and will someday arrive in the US markets. It is virtually unavoidable at this point and the G20 announcement moves up the probable date.
Gold
My view of the dollar is that it is the worst currency out there…except for all the rest.
Not to be boring or anything, but gold performed beautifully during Friday's 300+ point Dow rout. Instead of viewing this as a vote for gold, I viewed this as a vote against fiat currencies. There is real fear out there right now that all of the various fiat measuring sticks are not as desirable to hold as compared to gold.
Certainly there was a bit of market fear playing into the price, but I suspect there's more than a little concern over either the euro or the dollar as legitimate stores of wealth. The former because it might break apart and the latter because the US has said it will print up as many as needed to keep domestic demand artificially elevated.
Note that gold, a monetary metal, went up on Friday but that silver, an industrial commodity, went down. This is what we might expect from a low growth environment that could lead to additional monetary uncertainty. The industrial metal goes down, the monetary metal goes up.
As an aside, my two-thirds to one-third split between gold and silver has always been partly a hedge; gold will perform well if the monetary system breaks down and silver will perform well if the economy takes off like a rocket (mainly due to severe depletion issues and the fact that silver has no substitutes for several critical applications). While silver still has some utility to me as a potential future monetary metal, I see that as further off and less certain than the story for gold.
Conclusion
Believe me, I have my eye firmly on the potential for another serious stock market rout. Yes, there was some slightly poor data that came out about the employment situation, but it was not nearly disparaging enough to explain the stock market decline we saw on Friday.
Instead, it would seem that we're still in the midst of liquidity difficulties, something I've been talking about ever since the resumption of the currency swaps in early May. My crash alert hat is on, and I worry that we'll end up testing and then breaking the prior stock market lows by the end of the year.
And now my concern is being compounded by the newfound call for austerity that just emerged from the G20 meeting. In truth, I was quite surprised when the announcement came out early this week. I was not even close to suspecting that widespread austerity was even being discussed let alone considered. This is why I pay special attention to the late Friday/early Saturday news releases.
This move represents a very serious gap between the US economic and monetary policy and that of the rest of the developed world. Such departures are what inflection points are made of. I consider this news to be 'game changing' and will be following the effects closely.
For now I might speculate that stocks will do especially poorly with the news that much of the G20 is essentially throwing in the towel on the growth story. The extent to which the US resists joining this austerity parade is the extent to which pressure will grow on the US treasury and dollar markets. However, we might not detect the pressure on the dollar via a decline in the US dollar index as it's merely a comparison to other paper currencies. Instead we'll see that pressure reflected in the price of gold, and possibly other commodities, although that's not as likely.
For now, the pressure continues to build and I will be fascinated to see how the US responds to this dramatic change in the G20 policy. My guess is "badly" by which I mean the US policy-makers will continue to behave as if the US can operate in splendid isolation and continue to rack up trillion dollar deficits until forced to stop by the bond market.
And so the pressure will continue to build.
