January 31, 2013 | By Scott Minerd
At last week’s World Economic Forum in Davos, I witnessed a crystallization of the view that the financial crisis is officially over and a period of economic expansion lies ahead. The sentiment was so euphoric, in fact, that contrarians could interpret it as a concerning signal. Despite the bullish sentiment coming out of investors and policymakers at this point, significant structural problems persist in the world’s advanced economies. Global quantitative easing programs carried out by central banks over the last half decade have covered up a litany of short- and long-term economic ills, without addressing their underlying causes.
In the immediate-term, currency wars appear to be an ongoing risk. Germany is concerned with maintaining its export competitiveness, given Prime Minister of Japan Shinzo Abe’s stated intention to further depress the yen. Down the road, monetary authorities will have to address their strategies for reversing the vast accommodation that has been carried out since 2007. Before the central banks can contemplate tightening liquidity conditions, however, they will have to cease making large scale asset purchases. This is unlikely to occur in the near future, as these policies seem to have provided a window of continued economic expansion, which may last for two or more years. The investment take away from all this is that those who are still worrying about the financial crisis are probably too late, and those worried about a bubble in credit markets are too early.
The continued balance sheet expansion in certain major global central banks has resulted in a depreciation of these countries’ currencies over the past few months. Since last June, the trade-weighted Japanese yen, British pound, and U.S. dollar have depreciated 15.1%, 2.6%, and 2.0%, respectively. By contrast, the euro has appreciated 5.8% against its major trading partners’ currencies, corresponding with a contraction of 5.6% in the European Central Bank’s (ECB) balance sheet during the same time. The contraction in the ECB’s balance sheet was caused by European banks returning their loans from the central bank as a result of improving economic sentiment in the eurozone. Nevertheless, economic fundamentals in the eurozone remain weak, and most peripheral nations are still in recessions. The competitive devaluation in other major economies may push the value of the euro to growth-inhibitive levels, exacerbating the eurozone’s problems.
CHANGE IN CENTRAL BANK ASSETS VS. CHANGE IN TRADE-WEIGHTED EXCHANGE RATES (JUNE 2012 – PRESENT)
Source: J.P. Morgan, Bloomberg, Guggenheim Investments. Data as of 1/29/2012. Note: The trade-weighted exchange rate is calculated by J.P. Morgan.
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