In the second of three interviews (part 1 here), Hugh Hendry tells MoneyWeek's Merryn Somerset Webb why central banks will go even further than anyone expects to keep the global economy afloat. Hendry notes, "there’s so much debt that if you reprice debt, the economy slows down. We saw that I think in 2012, after the taper tantrum and ten-year bond use went over 3%. What happened next? The economy slowed down. If anything I would be a buyer of U.S. Treasuries."
Key excerpts (full transcript here)
Let’s move on to looking at markets more specifically.
Hendry: This is almost unparalleled in being the most exciting moment for global macro today. And I predicate that upon making an analogy with the Central Bank coordinated policy intervention, in the foreign exchange markets, after the Plaza Accord in, I believe, 1985. There was a profound unease at the current account and particularly the trade deficit that America was running up, especially against the Japanese, which was deemed to be contentious. The real economy is composed of slow-moving prices, wages are slow and the notion of having to wait for productivity improvements and wage price negotiations to work their course, via the U.S. corporate landscape in Japan, such as those deficits would be resolved successfully and become less politically contentious. It was just too long. Politicians just don’t have that time and so they jumped into the world of macro. Macro’s all about fast-moving prices. Foreign exchange is fast. Stock markets prices are fast.
So the notion then was that the Yen and the Deutschmark would appreciate. Now for hedge funds that was amazing. This is the period of the alchemy of finance, as George Soros has celebrated in very successful financial adventures. They just run the biggest long positions. No one stopped to say “Well, the Deutschmark’s getting expensive.” It didn’t really enter into the vernacular of trading in that market. It was macro, there was a policy impulse, a sponsorship by the world’s monetary authorities and you were trending and you had to have that position.
By and large it succeeded. So what I would said to you today is that the policy response can’t be found in foreign exchange markets. It’s been muted somewhat by the “Beggar thy neighbour” way that everyone can pursue the same policy. So currencies, up until very lately, haven’t really moved that much. Instead the drama is unfolding in the stock market.
I would say to you that policymakers are so absolutely beside themselves with regard to how structural these deflationary forces are, and that they recognise that they really have very little to offer once policy rates are at zero, the zero lower band, that they have to stave this crisis off. They cannot have deflation today.
I believe they are now responding to the fast-moving circuit of the stock market and clearly America’s demonstrated something. That policy response underwrote a very virtuous cycle of higher asset prices.
You’re telling us that QE worked.
Hugh: It’s all about to which degree does it work? Now if you wish to take the other side and say “QE doesn’t work.” It worked by redistributing but it doesn’t create wealth, clearly.
What it aims to do, is redistribute economic growth from one part of the global system to another. So as the U.S. has come to the forefront in the last five years, China’s found its growth rate has, from this perpetual notion of 10% GDP expansion, is now 7%, and everyone’s scratching their head and has great doubts that 7% can be maintained.
Europe needs high equity prices and high animal spirits and then you’ll get people feeling more confident about the collateral
It may not work, but presently the perception is that it will work and those asset prices are trending and you should participate. Then within Europe, such is the political timeframe and the stakes are so enormous, that is has to work now and we have the French elections, national elections are in 2017. Europe has been slow to this game of quantitative easing. As a result they are clearly behind the curve.
So economies from France to Italy and others have been unsuccessful in bringing these deficits below 3%, which of course, then imposes further austerity measures which are toxic in the political/social space, and we’re seeing radicalization of policy.
It may be contentious to say, but if the French election was held today, I would worry that Marine Le Pen’s party would win. That’s not to say, necessarily, to cast aspersions on that side it’s just to say that I think the thrust of her policy would be to take France out of the Euro.
The people who very angry about QE – who disapprove of it. They would say the moral imperative is not to do QE, but you suggested that for you the moral imperative in Europe is to do proper QE.
Hugh: Well, desperate times breed desperate measures and the fatal policy errors are I believe, all in the past. Economies across the world were allowed to take on so much debt, and taking on debt, you’re borrowing from the future. You’re borrowing consumption to spend it today. So we overinflated the GDP growth rate. There’s no surprise to me when people are disappointed by today’s growth rate. Because it’s like “I ate your sandwich yesterday.” It’s not there. So I don’t see this as a clean solution.
I see this is a grubby solution, but it’s closer to being a solution than anything else that I conceive of. With QE, again, I say I think we barely scratched the surface in terms of what will happen. I think it will spread into central banks essentially having to endorse higher government budget deficits to sponsor public work projects or favourably to sponsor tax cuts. I think that is in the future, because we have not resolved that deficiency of demand. Which, of course, is a function of having over-borrowed from the future to spend yesterday.
I think Dylan Grice was the great architect of the notion that you can define the upper bound to today’s interest rates by trying to determine society’s capability to meet those interest rates at higher and higher levels. What you find is we cannot live with a Paul Volcker putting interest rates at 15%. It doesn’t work. There’s so much debt that if you reprice debt, the economy slows down. We saw that I think in 2012, after the taper tantrum and ten-year bond use went over 3%. What happened next? The economy slowed down. If anything I would be a buyer of U.S. Treasuries and I’ll come back to that.
Well, we are long on 30-year Treasury bond use and this year we have, I think, been among a select group of macro-investors who have actually made money being long U.S. Treasuries. It’s been a very popular trade being short. It’s particularly relevant since the Jackson Hole Central Bank soiree in late August. That there seems to have to come out of it, some tolerance that the dollar would rise.
Typically that’s the fiefdom of the Treasury and not the Central Bank. But I’ll let that pass. The dollar has been on a tear ever since that meeting. My take on that is that I think America looks at it and increasingly feels confident, rightly or wrongly. I’d err on the side of caution. But when it looks to the global theatre, it’s desperately concerned about China, desperately concerned about the Europe. So the last five years were, if you will, it redistributed global growth and by “redistribution” bear in mind, I’m saying that quantitative easing as pursued by the Federal Reserve had the explicit policy aim of ensuring that the dollar would not rise.
The dollar always rises when there’s a deflationary crisis in the marketplace. The dollar index was trading at 80 pre- the events of late 2008. It briefly flared and then you had . . . Immediately you had quantitative easing and it sat at 80 for five years. That’s about America being determined that dollars earned in America create jobs and prosperity in America.
Whereas in the last 10-15 years the mercantilist axis of Europe, and of course, China has meant that those dollars were exported via the trade deficit to elsewhere. That just couldn’t be allowed to happen. That hasn’t happened, which is to say that again, boosted by shale oil, of course, the trade deficit has been falling.
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