Short holidays, this year, for the markets. The stress test European Unions and Japanese fiscal and monetary measures will keep us busy in the next few days and at the end of next week we will know whether the weak figure in June or the strong one in July was anomalous on American employment. The stress tests have been weakened as their destabilizing capacity has been understood and they will probably give softened results compared to what had been emerging, but they will still be important for understanding the strategy of the regulators and the fate of the individual banks and their securities.
As for Japanese measures, we will see on stage a new important episode of the experimentation of a joint fiscal-monetary action against stagnation. In America this joint line was followed only in the first three years following the crisis, after which it returned to an exclusively monetary action. In Europe, the joint line was followed for only one year and then, as is well known, they threw themselves into fiscal austerity, leaving the ECB alone in supporting the eurozone economy.
At the end of August, as usual, policy makers and economists from all over the world will gather under the mountains of Jackson Hole to discuss strategy. It is here that the Quantitative Easing policy was launched and formalized in the past years and it is here that this year we could see something new discussed ranging from the radicalization of monetary measures to the restoration of joint monetary and fiscal action, which in some versions it will tend to approach helicopter money.
There are many expectations this year about Jackson Hole, but it is possible that in the end they will be disappointed. In fact, there will be a stone guest, the new American president, whose name will not yet be known. The new American Congress will then be absent, which will have the task of deciding fiscal policy in the first and last instance. In return, there will be confusion and uncertainty which in these years of weak recovery have grown not only on the measures to be taken, but on the very analysis of the world situation.
There are, simplifying and making a somewhat arbitrary choice, four theories on the world.
La before purchasing, is that of the Fed. The Great Recession has certainly changed things and made the recovery particularly slow, but the fundamental laws of economics, those taught in universities from the XNUMXs onwards, have not changed. The Phillips curve still works and the phasing out of the number of unemployed will eventually lead to wage inflation, necessitating a cycle of rate hikes. Of course, the Fed are people of the world and this line has been watered down over time and made almost unrecognizable, so as to lead some to accuse the Fed of preaching hikes without actually wanting them. In the background, however, the Phillips curve still stands out sharply and clearly in the Fed's vision and induces it, if not to implement, at least to predict (as in yesterday's press release) the opportunity for future increases. The Fed, in other words, is expansive tactically, but remains subtly worried above all about a possible future excess demand that could become difficult to control. What would happen if wage pressure were then joined by a renewed willingness of the banks to grant loans, something already visible in America?
La second theory, that of Secular stagnation, argues instead that excess demand is not really the case because the problem lies, if anything, in its weakness. There's little question, Summers says, why populations are aging and why inequality is rising. These two factors lead to more saving and excess saving causes a structural fall in interest rates. The Fed is therefore right to keep rates low, but this is not enough. We need to stimulate demand through fiscal policy and not by lowering taxes but by increasing public spending.
La third theory argues that there is no shortage of demand but oversupply. The enthusiasm of the past decades has bequeathed us too many steel and car factories, too many mines, too many oil wells, too many banks in Europe, too much electricity, too many semiconductor and electronic product factories. The deflationary pressure of this excess production capacity is combined with that exerted by technological innovation. This pressure raises real rates, increases the propensity to save and reduces the propensity to invest. As Steven Ricchiuto, Mizuho's chief economist, argues, the problem could worsen in the near future due to unrealistic expectations on corporate earnings by investors. Faced with a growing difficulty in raising margins, firms may resort to layoffs again, thus exacerbating deflationary pressure. The only remedy in this situation is a reduction in investor expectations or, in practice, a lower stock exchange.
Una fourth theory see indebt excess that the world carries with it the origin of problems and therefore the point to attack to solve them. This is supported by a range of positions ranging from Rogoff to the Bank for International Settlements and which are in any case influential above all in Europe. This school considers as a priority not only and not so much the consolidation of public finances, but above all that of the banks, which in a forthcoming crisis could infect the whole system. In general, discouraging the use of debt and encouraging the use of equity should be a priority. Unlike the other schools, which are more attentive to the short term, this school argues that paying some short-term prices in terms of debt restructuring and controlled defaults can bring benefits in the medium term and in any case less damage when the time comes for the next crisis.
However the discussions in Jackson Hole turn out, their impact will be felt starting next year. Until the American elections everything remains entrusted to the automatic pilot of monetary policies, with the sole exception of Japan. In this context, we may see a modest consolidation of equity increases in the coming weeks, but not a trend reversal.
As has been noted, we are in a strange phase of looking for capital gains on bonds and looking for returns on stocks. We recommend not to overdo it in both cases. To have capital gains on bonds you need to move to distant maturities and take largely asymmetrical risks (limited gain if it goes well, substantial losses if it goes badly). To look for returns on shares, one must go, especially in America, to high multiples, neglecting many cheap cyclicals. L'Europe, land of cyclicals, is at this point preferable to America.
