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Will Removal Of Stimulus Lead To Another 'lost Decade'?

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As G20 finance ministers met in London yesterday to discuss how and when they will withdraw the expensive medication that has kept the global economy functioning, it is worth pausing for a moment to consider what this means for equities.

There is little to worry about in the short term. It is highly unlikely the G20 members will suddenly end their huge stimulus packages because that would threaten the fragile economic recovery. Indeed, Alistair Darling, the chancellor, warned this week that the world could be dragged into a double-dip recession if governments stopped stimulating their economies. This is why stock market bulls believe the summer rally will continue.

But at some point the G20 and others will need to restore their rapidly deteriorating finances and the fiscal and monetary tightening implied is likely to have serious implications for equities. At best the stock market could be facing years of range bound trading. At worst another lost decade. It is sobering to think that the FTSE 100 was trading at 6,332 10 years ago - 23 per cent above last night's close.

A report by Morgan Stanley this week, highlighted the poor state of government finances in the European Union following the worst postwar global recession. Citing European Commission projections, the bank forecast budget deficit and gross government debt across the 15-strong group of eurozone countries would reach 7.4 per cent and 82 per cent of GDP respectively in 2010. To put those figures into perspective, the European Stability and Growth Pact limits budget deficits to 3 per cent of GDP and gross debt to 60 per cent of GDP. To correct these imbalances would require a combination of spending cuts, privatisation and tax rises. A tepid economic recovery would not be enough to repair finances, the bank's strategists said.

Clearly, there will be many stock market losers from higher taxes and spending cuts. For example, lower government spending would hit construction, bus and rail and drug and healthcare companies. Higher taxes would hit retailers and other consumer-facing companies.

Governments will also look to sell their large stakes in banks such as RBS and Lloyds as quickly as possible and this will create a stock overhang. This process has already begun. The Swiss government recently sold its 9 per cent holding in UBS for a $1.1bn profit. On top of that, the stock market will have to contend with a huge supply of government bonds and the prospect of lower trend growth in the future.

But what really concerns Morgan Stanley and others is the combination of fiscal tightening and further deleveraging by consumers and banks. It is this cocktail that will condemn the stock market to years of range bound trading. "Post the rebound rally, we expect some sort of trading range for years to come because of the structural problems of the financial sector, household deleveraging as well as the poor state of government finances," Morgan Stanley said. "We expect MSCI Europe to be in a broad trading range for years to come, between 600 and 1200 (Latest value 1046)."

Of course, the stock market rally could continue for a while longer given that significant spending cuts are not expected in the next year and the US Federal Reserve is expected to keep rates on hold at least until the second half of 2010. But for some observers, the reluctance to implement exit strategies from policies such as quantitative easing and increase interest rates is just making things worse. In a recent note, Bob Janjuah, RBS's chief strategist, said the emergency fiscal and monetary support put in place after the collapse of Lehman Brothers had tricked the markets into believing all was well but was just creating another bubble that would make the events of the past two years seem like a walk in the park. "Think of unemployment, inflation and bond yield up in the teens and then ask yourself how you will feel," he said.

So, enjoy the rally while it lasts because it looks like the hangover will be painful.



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Or here's another option to cutting spending, raising taxes, and monetary tightening.

The EU could abandon it's totally arbitrary 3% deficit and 40% debt as a percentage of GDP 'targets' and thus abandon the twin policies of consumer spending/consumer credit expansion, and inflation targetting which has typified the feelgood late 90's and noughties.

The UK could do the same with it's golden rules and it's 2% inflation targetting, which Merv conveniently no longer seems to care about as he struggles :lol: to maintain IR's at a zero rate bound.

Now all this would assume that the UK and EU private sectors go a bit japanese, and therefore that we get a period of deflation or stagflation and a private sector which net saves. This wouldn't so much result in a lost decade but a decade which would see the current extraordinary fiscal and monetary policies become, well, the norm.

I'll tell you what my in opinion this would mean for house prices.

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This is not stimulation, it is a stunt, a short term, debt fuelled ramp. Almost entirely politically motivated. When the bill needs to be paid either directly, through cuts or through inflation how much will THAT cost?

Where's the investment? All I see is propping up the balance sheets of FAILED companies, inveterate gamblers and property tarts.

The central bank and the government couldn't work out the figures were all wrong in the first place, have they got an assessment of the cost and the effects of all this - not a chance in hell that these muppets have, they can't get a single fan chart right based on their prime notional remit - inflation, which itself is so distorted it is next to useless. This whole situation would be so funny if it were not so serious we are dealing with sub-morons and liars running an economic gameshow.

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We need a recovery with growth probably in the 5%-6% range for several years to "repair" the damage and fix the banks. However that isn't possible because it would require a huge debt spend which can't be afforded.

The system has to be cleansed and the debt mountain tackled.

There are no easy solutions.

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..../As the QE policy plays out, at the back of Mr King’s mind must be the fear that Britain sees a repeat of Japan’s lost decade. Moreover, any loss of faith by international investors in the UK would quickly show up in a collapse in sterling or a big jump in gilt yields.

Sterling has dropped 5 per cent against the dollar since August 1 on rising worries about the UK economy, which is recovering more slowly than the rest of the industrialised world.

George Magnus, senior economic adviser at UBS, says: “Clearly, it could all go horribly wrong. We have entered unknown territory and so far the jury is out, particularly as the important money supply figures are still not good. It may take longer to work than first envisaged.â€



QE has led to the major banks (RBS and Lloyds) continuing to tighten credit and why not? The risks are too high given current levels of debt and rising unemployment. Brown's attempt to push more debt onto a population drowning it it already was always doomed to failure and the banks do not want to add to the bad loans already in existence with more to come as jobs are lost. The trap has sprung and going Japanese is inevitable.


BTW--anyone know why the "indent" feature on this website has never worked since the "Big Chnage?"

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The EU could abandon it's totally arbitrary 3% deficit and 40% debt as a percentage of GDP 'targets' and thus abandon the twin policies of consumer spending/consumer credit expansion

I thought they were limits, not targets, and therefore nothing to do with credit expansion.

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