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Unfounded fears on China boost markets
The worst-case scenario on China has failed to play out, cheering markets.
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[img=620x0]http://www.afr.com/content/dam/images/g/j/4/9/2/s/image.related.afrArticleLead.620x350.gk44wh.png/1444366864143.jpg[/img]Some of the credit for restoring investor confidence must also go to Beijing. Reuters
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by Karen Maley
Global equity markets have spent the past week partying hard, in what appears a deliberate bid to discredit doomsayers who warned of October's potential perils.
Two key factors are responsible for reawakening the market's appetite for risk.
The first came with the release of deeply disappointing US employment figures, which showed that non-farm payrolls rose by only 142,000 in September, or about two-thirds of what economists were expecting.
Investors quickly decided that the poor jobs figures would make the US central bank even more wary about raising interest rates – and that, indeed, there was no longer any need to worry about a rate hike until next March.
This sent US bond yields tumbling, while the US dollar - which has been strengthening, particularly against embattled emerging market currencies, eased back. At the same time, the US share market shrugged off its September to stage a convincing rebound, while the oil price climbed back above $US50 a barrel.
Investors were also cheered by last week's release of the minutes of the US central bank's September policy meeting which indicated that key officials wanted to see more signs of inflationary pressures before raising interest rates.
But some of the credit for restoring investor confidence must also go to Beijing. For months, global markets have been weighed down by fears of a sharp slowdown in the world's second largest economy could trigger a global recession.
Slowing Chinese growth has already resulted in a collapse in commodity prices, which has eroded the export earnings of emerging countries such as Brazil, Russia, South Africa, Indonesia and Malaysia that are heavily reliant on raw material sales.
FEARS ABOUT CHINA NOT REALISED
Investors were also anxious that Beijing's surprise decision in August to devalue the yuan would hurt other countries in the region – such as Taiwan and South Korea – because it makes Chinese-made goods cheaper in global markets. Some worried that China would continue to push its currency lower in a bid to boost exports and to discourage hefty capital outflows, and that this could ignite a new and damaging currency war.
But these fears eased this week, after new figures showed China's foreign currency reserves fell by just over $US40 billion in September – well below the record $US94 billion plunge the previous month. Analysts argued that capital outflows from China appear to be slowing, which reduces the pressure on Beijing to push the yuan sharply lower.
As a mood of optimism spread through the markets, investors began to suspect that fears about slowing Chinese growth had been pushed too far. This set the stage for a major recovery in share prices in emerging markets, which some commentators saw as being reminiscent of strong surge in markets in the final three months of 1998.
Seventeen years ago, emerging markets were again grabbing the headlines as a virulent financial and economic crisis spread through the Asian region. The crisis reached its climax in September 1998, with the failure of the US hedge fund, Long-Term Capital Management, which suffered losses of close to $US4.5 billion as a result of its high-risk trading strategies.
In order to prevent a major market meltdown, the US central bank stepped in and organised a bailout for the embattled hedge fund, which then led to a surge in US share prices.
However, not all analysts are convinced that global equity markets are poised for a strong rally.
They note that the outlook for the global economy is continuing to darken, with the International Monetary Fund this week downgrading its forecast for global growth this year to 3.1 per cent. It also warned that most emerging economies face a tougher external environment as their borrowing costs are rising, while the economic slowdown now under way in China has weighed on commodity prices and reduced Chinese demand for their products.
EMERGING ECONOMIES' DEBTS LEAVE THEM VULNERABLE
The Washington-based fund also warned that the huge build-up in debt in many emerging countries has left them vulnerable to rising US interest rates, and any future economic downturn.
Some analysts warn that the latest market rally could be short-lived, particularly if the oil price again comes under pressure.
They also warn that investors may again start fretting about the slowing Chinese economy now that the US earnings-reporting season is under way.
Although the world's largest sportswear maker, Nike, reported that its Chinese sales jumped by nearly one-third in the three months to the end of August, other US companies have not been as fortunate.
The fast food restaurant operator Yum Brands saw its stock tumble after it reported that "unexpected headwinds" had led to disappointing Chinese sales.
Meanwhile the US cosmetic company Nu Skin saw its share price come under pressure after it reported disappointing third quarter results because of China.
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Is the world addicted to debt?
http://www.aljazeera.com/programmes/coun...56315.html
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The problem of having plenty
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[img=620x0]http://www.afr.com/content/dam/images/g/k/a/s/8/d/image.related.afrArticleLead.620x350.gk756p.png/1444980697556.jpg[/img]There is too much fast-moving money rushing in and out of financial assets, a legacy of years of central bank largesse.
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by Patrick Commins
The major problem for the global economy is there's an excess of just about everything. You name it, there's too much of it: too much debt, too much iron ore, too much oil, too many factories. And to top it all off, there's too much money washing around the globe looking for a productive home.
Let's call it the "plenty problem", and it's a growing one.
Take debt. The sub-prime crisis was a story of too much borrowing mixed with negligent lending, followed by a spectacular housing bust and global financial crisis. Yet global debt has increased since then, from $US142 trillion ($194 trillion) at the end of 2007 to $US199 trillion in the middle of last year, according to McKinsey research, which looks to have the most recent numbers on the topic.
Here in Australia, household debt to gross domestic product in Australia has pushed to a record high of 133 per cent, despite the fact that economic growth is sub-trend and wages after inflation are going backwards. Australian household debt to income is also at a peak.
It's why households are reluctant to open – and quick to close – their wallets.
DON'T JUST LOOK AT DEMAND
"What we are seeing all around the world is capacity surges and if you experience one in your industry and you've borrowed during the boom period, you're in trouble," Mark Burgess, who ran the Future Fund during 2012 and 2013, told a panel discussion during the week.
"This is a theme all investors have to manage. Whether it's a house or an apartment in Melbourne, don't just look at the demand side; think about how the market is going to respond on the supply side. It's supply that will kill your investment rather than some other factor."
It certainly rings true in the commodities complex, where supply has swamped dwindling demand. There is overcapacity in iron ore and miners continue to ramp up production. The US shale oil revolution created a wave of new crude supply that halved the global price in short order.
The likes of BHP and Rio will swear until they are blue in the face that they didn't over-invest in expanding their output, but the fact is that BHP's annual profits went from $13.8 billion in the 2014 financial year to $1.9 billion in the next – the big miner's lowest profit since 2003.
Meanwhile, China's factories this week recorded their 43rd straight month of year-on-year deflation. That means Chinese manufacturers in aggregate haven't enjoyed higher prices for their goods since early 2012.
"An environment where there is plenty of everything means we are in an investment spending vacuum," explains Tracey McNaughton, head of investment strategy at UBS Asset Management in Australia.
New investment creates jobs, which leads to more spending, which in turn inspires further investment and the virtuous circle is complete. But that circle is now working in reverse, depressing prices and profitability of businesses around the world.
PRICING POWER
So for investors, the obvious question is what is there not enough of? Or, at least, where is supply and demand more evenly matched? Surely that is where the money will be made in the coming few years.
It's easier said than done, but it's a useful starting point.
Specialist fund manager Cooper Investors, in its latest newsletter, identifies the global dairy market as one where the market is moving away from overcapacity as supply reduces and prices (which have fallen heavily over the past two years) stabilise and start to improve "in the medium term". Growing incomes in developing economies should underpin increased demand for milk products.
The Melbourne-based boutique is invested in MG Unit Trust, which provides economic exposure to Murray Goulbourn, an unlisted public company and a dairy co-operative of more than 2500 supplier-owners, mostly in Victoria.
The team at Cooper also highlights the attractiveness of the aged care industry, underpinned by growing demand from Australia's ageing population. Their picks are Regis Healthcare and Summerset Group.
PRICING POWER
For Bruno Paulson, who runs the Global Brands fund for Morgan Stanley Investment Management, the answer to the plenty problem is immediate (and satisfyingly alliterative): pricing power. Businesses with the ability to raise prices to offset the deflationary pulse of excess supply are the best positioned to reward shareholders.
"In a disinflationary and slow-growth world, being able to grow steadily either through volumes or through pricing power is valuable," Paulson says.
Paulson, visiting from London, says he won't go near banks and miners, describing both industries as populated by highly leveraged, highly cyclical price takers. He is unimpressed with our big supermarket owners: "[Food retailing] is not an attractive industry; it's very low margin and very capital intensive if you capitalise the leases, as you should."
Instead, Paulson identifies ratings agency Moody's and Visa as two businesses with "very, very strong market positions".
"Moody's has some of the best pricing power around, [the company raises prices] 4 to 5 per cent a year, even through the financial crisis," he says.
FAST MONEY
The final facet of the plenty problem is this: there is too much fast-moving money rushing in and out of financial assets, a legacy of years of central bank largesse. Desperate for return and with few or no opportunities, that fast money gets overexcited then ultimately disappointed by lumbering economic and profit growth.
"There is a lot of liquidity built up in the system which then creates a lot of overcrowded trades, which unwind quickly and violently and then crunch prices – before central banks step in again," McNaughton says.
McNaughton reckons there have been four such "tantrums" since the original example in May and June 2013 when investors reacted violently to news that the United States Federal Reserve would begin to taper its bond-buying program. The most recent was the general freak-out over China in August. Depressingly, she expects this environment to continue for a number of years.
The plenty problem looks here to stay.
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Why central banks should try prick housing bubbles
A recent conclave spent drinking through the BIS's legendary wine cellar has not led to policy consensus, but we do now know enough to start pricking bubbles, writes the Royal Bank of Scotland chairman Howard Davies
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[img=620x0]http://www.afr.com/content/dam/images/g/i/o/p/k/o/image.related.afrArticleLead.620x350.gkd5fy.png/1445292747166.jpg[/img]Glenn Stevens with Fed chair Janet Yellen. Like central bankers around the world they are grappling with whether their institutions can reliably prick bubbles. Getty Images
by Howard Davies
Very soon after the magnitude of the 2008 financial crisis became clear, a lively debate began about whether central banks and regulators could – and should – have done more to head it off. The traditional view, notably shared by former US Federal Reserve Chairman Alan Greenspan, is that any attempt to prick financial bubbles in advance is doomed to failure. The most central banks can do is to clean up the mess.
Bubble-pricking may indeed choke off growth unnecessarily – and at high social cost. But there is a counter-argument. Economists at the Bank for International Settlements (BIS) have maintained that the costs of the crisis were so large, and the clean up so long, that we should surely now look for ways to act pre-emptively when we again see a dangerous build-up of liquidity and credit.
Hence the fierce (albeit arcane and polite) dispute between the two sides at the International Monetary Fund's recent meeting in Lima, Peru. For the literary-minded, it was reminiscent of Jonathan Swift's Gulliver's Travels. Gulliver finds himself caught in a war between two tribes, one of which believes that a boiled egg should always be opened at the narrow end, while the other is fervent in its view that a spoon fits better into the bigger, rounded end.
It is fair to say that the debate has moved on a little since 2008. Most important, macroprudential regulation has been added to policymakers' toolkit: simply put, it makes sense to vary banks' capital requirements according to the financial cycle.
When credit expansion is rapid, it may be appropriate to increase banks' capital requirements as a hedge against the heightened risk of a subsequent contraction. This increase would be above what microprudential supervision – assessing the risks to individual institutions – might dictate. In this way, the new Basel rules allow for requiring banks to maintain a so-called countercyclical buffer of extra capital.
But if the idea of the countercyclical buffer is now generally accepted, what of the "nuclear option" to prick a bubble: Is it justifiable to increase interest rates in response to a credit boom, even though the inflation rate might still be below target? And should central banks be given a specific financial-stability objective, separate from an inflation target?
Jaime Caruana, the General Manager of the BIS, and a former Governor of the Bank of Spain, answers yes to both questions. In Lima, he argued that the so-called "separation principle," whereby monetary and financial stability are addressed differently and tasked to separate agencies, no longer makes sense.
The two sets of policies are, of course, bound to interact; but Caruana argues that it is wrong to say that we know too little about financial instability to be able to act in a preemptive way. We know as much about bubbles as we do about inflation, Caruana argues, and central banks' need to move interest rates for reasons other than the short-term control of consumer-price trends should be explicitly recognised.
At the Lima meeting, the traditionalist counterview came from Benoît Cœuré of the European Central Bank. A central bank, he argued, needs a very simple mandate that allows it to explain its actions clearly and be held accountable for them. So let central banks stick to the separation principle, "which makes our life simple. We do not want a complicated set of objectives."
For Cœuré, trying to maintain financial stability is in the "too difficult" box. Even macroprudential regulation is of dubious value: supervisors should confine themselves to overseeing individual institutions, leaving macro-level policy to the grownups.
Nemat Shafik, a deputy governor of the Bank of England, tried to position herself between these opposing positions. She proposed relying on three lines of defenseagainst financial instability.
Microprudential regulation, she argued, is the first line of defense: if all banks are lending prudently, the chances of collective excesses are lower. But the second line of defense is macroprudential manipulation of capital requirements, to be applied across the board or to selected market segments, such as mortgages. And, if all else fails to achieve financial stability, central banks could change interest rates. Because British law assigns capital regulation and interest-rate policy to two separate committees – with different members – within the Bank of England, the Shafik strategy would require some clever political and bureaucratic maneuvering.
Industrial quantities of research, analysis, and debate have been devoted to the causes of the 2008 crisis and its consequences; so it seems odd that senior central bankers are still so sharply divided on the central issue of financial stability. All those days spent in secret conclave in Basel, drinking through the BIS's legendary wine cellar, have apparently led to no consensus.
My view is that Caruana had the best of the arguments in Lima, and Cœuré the worst. Sticking to a simple objective in the interests of a quiet life, even if you know it to be imperfect, is an inelegant posture at best. We need our central bankers to make complex decisions and to be able to balance potentially conflicting objectives. We accept that they will not always be right. However, it is surely incumbent on them to learn from the biggest financial meltdown of the last 80 years, rather than to press on, regardless, with policy approaches that so signally failed.
Howard Davies, the first chairman of the United Kingdom's Financial Services Authority (1997-2003), is Chairman of the Royal Bank of Scotland. He was Director of the London School of Economics (2003-11) and served as Deputy Governor of the Bank of England and Director-General of the Confederation of British Industry.
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'Global economy is in serious trouble': Larry Summers
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[img=620x0]http://www.afr.com/content/dam/images/g/i/3/0/a/l/image.related.afrArticleLead.620x350.gkf7w9.png/1445464127834.jpg[/img]"We are flying at close to stall speed," Mr Summers said in Washington. Matthew Lloyd
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by John Kehoe
Four of the world's eminent economists hit the speaking circuit in the United States on Wednesday, offering widely diverging views on US interest rates, China's economic health and slumping commodity prices, in assessments that underline the uncertainty shrouding the outlook.
The economist who President Barack Obama originally wanted to lead the Federal Reserve instead of Janet Yellen, Larry Summers, was the most bearish.
Dr Summers, a former US Treasury Secretary to president Bill Clinton, urged the Fed not to "hit the brakes" by raising interest rates any time soon, arguing the US and world economies were too weak to cope with higher borrowing costs.
"The global economy is in serious trouble as emerging markets have basically taken a major turn down."
"We are flying at close to stall speed," Dr Summers said in Washington at the Center for American Progress business and economic policy conference.
Former treasurer Wayne Swan was among those listening in the audience.
Across town at the Peterson Institute for International Economics no more than an hour later, the International Monetary Fund's recently departed chief economist, Olivier Blanchard, was more sanguine.
The US-based Frenchman said the risks to the global economy were a "little bit lower" than six months ago.
"I have become convinced that the risk of a major decrease in growth in the short term in China is very, very small," Dr Blanchard said.
The recent stock market correction and slowing growth in China, combined with a mooted increase in US interest rates before the end of the year, have been two of the top risks identified by skittish investors in recent months.
Tumbling commodity prices have also hurt exporters from Russia to Brazil, and advanced economies including Australia and Canada.
Appearing alongside Dr Blanchard on Wednesday, IMF financial counsellor José Viñals said global financial stability was "not yet assured" because of the rising risks in emerging market economies, including slower growth and high corporate debt levels in China, Turkey, Thailand, Brazil and Indonesia.
He said low commodity prices, such as for oil and iron ore, were probably the "new normal".
The IMF this month downgraded its 2015 global growth forecast to 3.1 per cent, in what would be the weakest expansion since the depths of the global financial crisis in 2009.
The IMF calculates there is a $US3 trillion credit excess among businesses in developing economies, based on credit-to-GDP compared to long run trends.
The fund is conscious that an increase in US interest rates and rising American dollar could render those firms financially distressed as they struggle to repay unhedged US-dollar borrowing.
Fed chair Janet Yellen said last month she expects to raise interest rates before the end of the year. However, an ostensible slowing in the US economy has bond traders betting there is only about a 30 per cent chance of a December rate increase. The odds of a Fed tightening at its meeting next week are virtually zero.
Former Fed chair Ben Bernanke was tight-lipped on what the Fed should do when pressed at an event in New York on Wednesday morning.
"I don't want to second guess Janet," Dr Bernanke reportedly said.
He has previously backed the Fed's decision not to raise rates in September.
Mr Summers, who Congress blocked from becoming Fed chairman, said US demand was too brittle, lamenting that growth was unlikely to exceed 2 per cent in annual terms in the second half of this year.
He said the government should take advantage of record low borrowing costs to upgrade roads, bridges and airports, to stimulate jobs and economic demand in the short term and add to the economy's long-term growth potential.
"The federal infrastructure investment was negative last year," Dr Summers said. "That is crazy."
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On track for biggest year ever in global M&A
DateOctober 25, 2015
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Stephen Cauchi
Business reporter
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Already, just in the 10 months to October, 2015 is the second-biggest merger and acquisition year in history.
Those elusive "animal spirits" may be returning, at least globally, with 2015 shaping up to be the biggest year ever for global merger and acquisition activity.
Already, in the 10 months to October, 2015 is the second-biggest merger and acquisition year in history, behind 2007. If the trends continue it will be the biggest, Citi says.
"Global deals announced so far this year amount to $US3.1 trillion ... the biggest if we annualise year-to-date activity," Citi said in a paper.
So far, global deals were up 38 per cent over the same period in 2014, it said.
"We see it as a logical catch-up. Cheap borrowing rates, modest global economic growth and reasonable chief executive confidence should continue to boost activity into 2016, providing further impetus for this global bull market."
However, the rise has not been equally spread throughout the world. "The pick-up has been strongest in the US and the UK," the paper said. "These are also the only major markets where M&A activity this year has exceeded the 2007 peak."
Citi attributed the rise in M&A to a number of factors.
"Record low interest rates make debt financing cheap and cash hoards dilutive. The economics of debt-financed M&A look compelling," it said. "Additional support for M&A activity comes from ongoing, though not especially strong, economic growth.
More forgiving of bidders
"Another common explanation for the current M&A upturn is that the market is becoming more forgiving of the bidders. That makes it easier for ambitious chief executives to get deals approved by previously wary boards."
So far, the strong rise did not appear to be a bubble or a reason for caution, Citi said.
More than $US3 trillion ($4.1 trillion) of M&A "seems like a sign of frothiness," Citi said. But in fact, "it is not yet especially frothy, amounting to 6 to 7 per cent of global market cap, compared to 8 to 10 per cent at previous peaks.
"We are not especially worried. We see this strong deal activity as a logical catch-up between lagging M&A activity and strong global equity markets.
"We are also reassured by the fact that M&A is not overly concentrated in one or two hot sectors globally. This has been the case in previous peaks – telecoms in 1999, financials in 2007. Just as mature bull markets tend to narrow into a few trades, so does global M&A. This is not the case, at least for now."
Among the world's regions, emerging markets in Asia were up 37 per cent compared to 2014, central Eastern Europe, Middle East and Asia were up 54 per cent, Latin America was down 51 per cent, continental Europe was 12 per cent lower and Japanese activity was 4 per cent lower.
"Japan and continental Europe have been lagging. We see the biggest scope for catch-up in Europe," Citi said.
Australia 'disappointing'
The paper did not mention M&A activity in Australia. A King and Wood Mallesons briefing in July noted that while global M&A was frenetic, activity in Australia was "disappointing". Bank of America Merrill Lynch, however, said that in Australian dollar terms M&A activity in Australia was "strong".
Recently, Australian M&A has picked up, especially in the energy sector. Drillsearch will merge with Beach Energy, Woodside tried to merge with Oil Search, and this week Santos rejected a takeover bid from overseas fund manager Scepter Partners.
The biggest deal in 2015 was between Dutch brewer Anheuser-Busch InBev and its South African rival SAB Miller, worth $US120 billion.
Anglo-Dutch oil and gas giant Shell and British rival BG formed the second-biggest deal, worth $US80 billion.
US food giants Heinz and Kraft formed the third-biggest deal, at $US62 billion.
As for sector M&A activity, financial companies have led the way, Citi said, making up 18 per cent of deals. Of these, real estate accounted for half.
Healthcare and consumer were the next-biggest sectors, accounting for 16 per cent and 14 per cent respectively. Utilities had the smallest share of M&A activity.
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Investors give little chance the Federal Reserve will translate its tough talk into action
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[img=620x0]http://www.afr.com/content/dam/images/g/k/a/g/k/d/image.related.afrArticleLead.620x350.gklbrv.png/1446067109087.jpg[/img]Investors realised a combination of subdued inflation and the strong $US meant there was little chance the Federal Reserve would translate its tough talk into action. AP
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by Karen Maley
The US share market yo-yoed overnight as investors initially took fright at the aggressive language coming from the US Federal Reserve, before deciding that there's little chance that the central bank would follow through with its threatened interest rate rise.
As widely expected, the Fed kept its key interest rate unchanged at close to zero, where it has been since late 2008. But markets were alarmed that in the carefully worded statement issued at the end of the two-day meeting, Fed officials specifically mentioned the possibility of a rate rise at their December meeting.
"In determining whether it will be appropriate to raise the target [interest rate] at its next meeting, the [Fed] will assess progress—both realised and expected—toward its objectives of maximum employment and 2 per cent inflation," the statement said.
Top Fed officials appeared more sanguine about the outlook for the US economy, with the statement pointing to the "solid" growth in consumer spending and business investment, and the continued improvement in housing. And they appeared to brush off the latest disappointing US unemployment figures, saying that the jobs market had improved this year.
What's more, Fed officials also saw market conditions as more conducive to a rate rise. The statement removed the reference to market turbulence and global developments that had caused them to shy away from a rate rise in September, although Fed officials did note that they were "monitoring" what was happening abroad.
But it didn't take long for investors to realise that combination of subdued inflation and the strong US dollar meant there was little chance the US central bank will translate its tough talk into action.
In the latest statement, Fed officials repeated their oft-repeated line that interest rates won't rise until they became "reasonably confident" that inflation will move back to its 2 per cent target over the medium term.
But investors believe the downward pressure on US inflation is likely to continue, given that commodity prices are continuing to fall while the strong US dollar is pushing down the price of goods imported into the United States.
And the stronger greenback is itself acting as a brake on US economic activity. As Steve Schwarzman, founder of the giant funds management firm Blackstone Group, noted earlier this month, "with the dollar up anywhere from 10 per cent to 25 per cent, we've effectively experienced a Fed rate hike without actually having one."
At a time when central banks in Europe and Japan are following extremely stimulatory monetary policies with the aim of driving their currencies lower, investors are betting that the Fed will be loathe to put even more upward pressure on the US dollar by raising US interest rates.
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Preference for inflation over deflation a frayed argument
Adam Creighton
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Economics Correspondent
Sydney
[b]“Deflation means impoverishment to labour and to enterprise by leading entrepreneurs to restrict production ... it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier,” wrote John Maynard Keynes in his seminal 1923 tract on money.[/b]
News Australia’s consumer price index — which measures the prices of the goods and services that people want to buy, except homes, a niche product apparently — rose only 0.3 per cent over the three months to September elicited disappointment this week.
It was a sign of economic weakness, apparently, that the Reserve Bank should offset with stimulatory rate cuts.
Keynes’ brilliance has entrenched a preference for inflation over deflation. Falling prices are thought to choke business investment and fuel lay-offs, while inflation does the opposite but saps the value of rich people’s wealth.
But even if Keynes was right in the 1920s, the premises of his arguments have frayed.
Indeed, this century’s rentiers, far from being euthanised, have been doing handsomely out of central bank efforts to fight deflation by pumping new money into the financial system. In the two years to 2015, the world’s richest 1 per cent have seen their share of global wealth increase from 46 per cent to 50 per cent. That can’t all be due to extra effort.
If the bulk of rentiers’ assets were fixed in nominal terms in the 1920s, they aren’t now. Property, stocks and art are among the favoured repositories — real assets whose values are ultimately immune to erosion by inflation. Inflation would be more likely to disappoint the workers, whose real wages have stagnated. According to Labor MP Andrew Leigh, in the US at least household income has stood still since 1989. In any case, the much lauded inverse relationship between inflation and unemployment has broken down.
If anything, in the past 40 years it’s been broadly positive. Contrast the 1970s and 1980s with the 1990s and the current situation of ultra-low inflation and modest or falling unemployment.
Entrepreneurs aren’t as fussed about the direction of the aggregate price level, either.
In Keynes’ time, new businesses might worry about having to pay back loans if deflation were about to set in. Today, risky ventures increasingly do not require the vast financial inputs that fuelled the emerging manufacturing empires of the early 20th century. The innovative frontier this century has been dominated by businesses such as Uber and Airbnb, and emerging fintech companies, which typically require little in the way of debt finance. The biggest profits are increasingly flowing to the best ideas rather than heavy-duty machinery.
Finally, the world is no longer “impoverished”, at least in rich countries. Life may still have been nasty, brutish and short in Keynes’ 1920s Europe. Now, it’s quite nice, at least in a material sense. The unemployed are looked after. Society is teaming with paid “carers”, antibiotics, and household appliances that have eviscerated early 20th-century drudgery.
The unconvinced will point to the supposed unfolding economic disaster in Japan, which has been flirting with deflation for 15 years. Despite perceptions, Japan’s growth between 2000 and 2014 has been reasonable; once it is adjusted for a shrinking population, it has outgrown Europe for much of that period.
Moreover, Japan’s unemployment rate has averaged 4.5 per cent, compared with about 6.5 per cent in the US and 9.5 per cent in Europe, which have “benefited” from consumer price inflation.
Central banks frustration with low inflation is also odd. Owing mainly to excessive issuance of paper money, the German mark went from 4.2 to the US dollar in 1914, to 65 in 1920, and 7600 in 1922. In August 1923, the hapless Von Havenstein, governor of the Reichsbank, having already provided unlimited sums to the German government and even private German businesses, boasted to parliament he had the infrastructure to increase all Germany’s money supply by 60 per cent in a day. Over the next four months, the mark was blown to smithereens: from 620,000 to 630 billion — yes billion — against the US dollar. In the same year, Keynes was writing his monetary tract, Germany provided a timeless lesson in how, in a fiat money system, inflation is always a policy option and one that can spiral out of control, even in the most technologically advanced nation.
The sense of targeting an aggregate national price level is becoming less meaningful as online commerce enables consumers to import larger shares of their goods from abroad. And prices, and even wages, are much more flexible than in the 1920s, when unions were better able to exact inflation-matching pay rises and the technology to change prices rapidly didn’t exist.
Central banks’ ability to control the price level may have been exaggerated. While the heavy hand of high interest rates can crush growth and inflation, as Paul Volcker and Bernie Fraser demonstrated in the US and Australia, fine tuning the level appears a little farcical. Central banks don’t control the speed with which money circulates nor, despite perception, have they much control over the quantity of money. Banks create money. When they grant a loan, they credit both the asset and liability side of their balance sheet — a process that has precisely nothing to do with the policy of the central bank, indeed any third party.
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In line with the script... nothing unexpected as reflected by mkt performances
Global investors take courage from central bank back-up
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[img=620x0]http://www.afr.com/content/dam/images/g/i/r/x/t/e/image.related.afrArticleLead.620x350.gknxuj.png/1446367636309.jpg[/img]Central banks have shown they are ready to support economies if need be. Phil Carrick
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by Karen Maley
Possibly the best sign that financial markets have regained their mojo is Chris Corrigan's daring ambush of Brookfield Infrastructure's takeover bid for the ports and rail group Asciano.
In a dazzling sharemarket raid last week – the largest in Australia's corporate history – the Corrigan-chaired Qube Logistics, along with its two new North American partners, picked up almost 20 cent of Asciano to block the $8.9 billion bid for the company by Brookfield Infrastructure.
More broadly, this reawakened appetite for risk-taking ensured that global sharemarkets enjoyed a glorious October, after two miserable months in August and September. In the US, the Dow Jones Industrial Index soared 8.5 per cent in October, its biggest monthly gain in four years, while Japan's Nikkei and the Euro Stoxx index of the top 50 European stocks recorded gains of almost 10 per cent.
Global central banks deserve much of the credit for this market rebound. In the space of 10 days, the US Federal Reserve, the European Central Bank and the Bank of Japan all signalled their willingness to support economic activity.
Now that investors have become increasingly confident central banks have their back, they're prepared to take some risks again. Last week, they poured an estimated $US15 billion ($21 billion) into equity funds and a further $US3.9 billion into junk bond funds.
But that's not to say investors are embracing risk indiscriminately. On the contrary, they are being very picky in how they deploy their funds.
Most of the gains over the past month have come from the giant listed companies, including big moves from Apple, Alphabet – the parent company of Google – and Amazon.com.
TOUGH PUNISHMENT
And investors have dealt out tough punishment to companies – particularly small and mid-cap stocks – that have failed to reach their profit targets.
Last week in Britain, engineer Meggitt's share price fell by more than 25 per cent after it warned that profit this financial year would be "meaningfully below forecasts". The sell-off pushed the FTSE 100 stock to a three-year low.
And the music-streaming service Deezer postponed last week its initial public offering, as investors worried that the Paris-based company could struggle to compete against larger and richer rivals, including Sweden's Spotify and Apple Music.
One factor driving global sharemarkets higher is the surge in takeover activity. Altogether, $US544 billion worth of mergers and acquisitions were announced in October, bringing 2015's total so far to almost $US4 trillion, Dealogic said.
But this figure does not include the possible blockbuster merger between US drug maker Pfizer and the Ireland-based Allergan, which is likely to be worth more than $US125 billion. If this deal proceeds, October will become the biggest month for corporate deal making in history.
And this frenzied corporate activity is unlikely to end any time soon. EY's Global Capital Confidence Barometer survey released last week shows 59 per cent of executives expect their companies to actively pursue acquisitions in the next 12 months, the highest level in six years.
GROWING OPTIMISM
In part, this enthusiasm for deal-making reflects a growing optimism on the part of corporate leaders. The survey found that 83 per cent said global conditions were improving, compared with only 53 per cent a year ago.
Mergers and takeovers also offer companies a convenient way to drive down costs in a low-growth world. The EY survey shows slightly more than one-fifth of executives said reducing costs and improving margins had been elevated on the boardroom agenda in the past six months.
At the same time, the EY survey shows business chiefs are still extremely careful about what deals they consummate, with 73 per cent reporting they had either failed to complete or cancelled a planned acquisition in the past 12 months. Heated competition from other buyers was the main reason for walking away from deals.
Of course, it remains to be seen whether investors' risk-taking appetite is strong enough to withstand a possible US interest rate hike in December, and certainly the US central bank rattled investors last week when it indicated a December rate rise was still on the table.
At this stage, a sizeable section of the market is discounting the risk of a rate rise, believing the US central bank is unlikely to hike rates at a time when economic activity remains patchy and inflation remains well below its target.
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The factor keeping stockmarkets afloat
Without higher interest rates, or evidence that big economies are slipping into outright recession, share prices are unlikely to collapse.
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[img=620x0]http://www.afr.com/content/dam/images/g/i/l/z/a/d/image.related.afrArticleLead.620x350.gkoixy.png/1446440713130.jpg[/img]Markets are unlikely to collapse. Jessica Shapiro
by The Economist
This was supposed to be the year when monetary policy started to get back to normal. Seven years after Lehman Brothers collapsed, central banks were expected to edge away from a policy of near-zero interest rates. But now, with the year almost over, the Federal Reserve has yet to push up rates while other rich-world central banks are focused more on easing than on tightening.
Sweden's Riksbank extended its quantitative easing (QE) program on October 28. Mario Draghi, the president of the European Central Bank, has indicated that further easing may come in December, probably by adjusting the pace, scale or type of asset purchases in its QE regime.
The picture in the emerging markets is more mixed. Capital Economics calculates that, on balance, slightly more emerging central banks have been tightening than cutting. But China cut interest rates on October 23, the sixth reduction in the last year. India unveiled a half-percentage-point rate cut in late September.
The attitude of central banks reflects their worries about economic growth. The IMF just lowered its global growth forecast to 3.1 per cent for 2015, with cuts applying to both advanced and developing economies. Inflation is also low in Europe, North America and Asia, giving central banks more freedom to be supportive.
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REGAINING GROUND
The benign interest-rate outlook is one reason why equities have recovered from the wobbles they suffered in August and September. As of October 28, the S&P 500 index had regained nearly all the ground lost in the previous two months. Futures markets indicate that investors do not expect the first Fed hike until next year, although that may change after the Fed's open market committee removed a previous reference to global economic risks in its October statement.
The other main reason why markets have rallied is a more sanguine view of the Chinese economy. Official figures for third-quarter gross domestic product showed growth of 6.9 per cent and, although some have doubts about the data, it was noticeable that the IMF did not downgrade its forecast for Chinese growth in its latest global outlook.
But the optimism should not be taken too far. Other market indicators still suggest investors are worried about sluggish growth and deflation. Bloomberg's commodity index is down by more than a quarter over the past 12 months. The yield on the 10-year Treasury bond is hovering around 2 per cent, not a level that suggests investors expect normal levels of economic growth to return any time soon.
American companies are also struggling to maintain the robust profit growth they have shown since 2009. While third-quarter profits for S&P 500 companies are marginally ahead of expectations (as is usually the case), they are still likely to be 4 per cent lower than they were a year ago; sales will probably fall by 3 per cent.
It is simply hard to keep pushing up profits when global GDP growth is subdued. The number of American companies citing a slowing global economy as affecting their profits and revenues is more than 50 per cent higher than a year ago, according to Thomson Reuters. The news is no better in Europe, where third-quarter profits are expected to be down 5.4 per cent on the year, with revenues dropping 7.9 per cent.
So the equity markets are caught in something of an awkward equilibrium. Positive economic news will make the outlook for profits more rosy but will also mean that the Fed is more likely to push up rates. And bad economic news may mean a respite from monetary tightening but is still bad news.
This explains the rather bumpy ride that stockmarkets have had in 2015. The lack of profit growth makes it hard for markets to surge ahead (the MSCI world index is back around its end-2014 level). But without higher interest rates, or evidence that big economies are slipping into outright recession, share prices are unlikely to collapse.
Equities may be following the path of government bonds, which have been stuck in a narrow trading range for a while. Central banks may have helped stockmarkets in an era of low growth by making other assets less attractive; the result was a positive shift in share valuations. But slow growth hasn't gone away. For equity investors, it was better to travel hopefully than to arrive.
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