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Why Politicians Aren't Going To Save The Global Economy

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Poor Stephen Roach.

It seems that the hard times may have arrived for the global economy. But Morgan Stanley's global economist, once the biggest bear in mainstream economics, doesn't even get to say: “I told you so.”

Clearly tired of waiting for the crash, his May 1st investment missive began: “It seems like eternity since I was last optimistic on the world economy.” He went on to describe why he had become cautiously optimistic on the outlook for the global economy.

Less than three weeks later, the FTSE 100 has fallen 6%, the Dow Jones is down 4% from its peak and the Nikkei 225 down 7%. The dollar is diving and fear of inflation is rampant.

Talk about bad timing...

It’s hard not to feel sorry for Stephen Roach. After all, it’s oft-declared that a bear market can’t truly get underway until the last bear has turned bullish - so perhaps his misfortune was inevitable.

So what prompted the change of heart? Well, you can read his whole piece here – Is the world economy really on the mend? (http://www.moneyweek.com/file/12368) – but in essence he argues that the good news is that the G7 and the IMF have realised that they need to deal with the US trade deficit, and central banks have realised they can’t keep flooding the world with cheap money.

A combination of a falling dollar, and gradually rising interest rates are evidence that the “global economy finally seems to be taking its medicine.”

Mr Roach’s heart is in the right place. He recognises that the US trade deficit is a serious problem, and that central banks have been way too lax with monetary policy. His only real mistake is to trust in the ability of politicians and governments to do anything other than make a bad situation worse.

Anatole Kaletsky, writing in The Times, has a completely different view from Mr Roach - but still expects the government, in the form of the Fed, to sort everything out.

The trade deficit has nothing to do with the weakness of the dollar, he declares.

Why not? Easy, he says. “The US trade deficit has been consistently denounced as ‘unsustainable’ since 1980, yet it has been sustained since then without any trouble and without… diminishing the dollar’s long-term value at all.”

The idea that a situation must be permanently sustainable simply because it has been ongoing for the past 26 years is a peculiar one. The British Empire lasted a lot longer than 26 years, but it eventually collapsed. And the gold standard lasted a lot longer than the British Empire, but it too eventually made way for the dollar standard we currently have.

(Though that may be a temporary blip, if you believe The Daily Reckoning’s Justice Litle. We published Justice’s piece on how gold could replace the dollar yesterday, but if you missed it, click here: How the dollar's collapse will lead to a new gold standard (http://www.moneyweek.com/file/12641))

Let’s leave that to one side for now. So what is to blame for the fragile state of stock markets?

Mr Kaletsky pins the blame squarely on Federal Reserve chief Ben Bernanke and the way he has confused and unnerved Wall Street by first giving the impression that interest rates were definitely on hold, and then gradually back-pedalling from that position.

But never mind. Mr Kaletsky is “convinced that the Fed will eventually pass this test…and that the dollar will re-establish itself as the most trusted currency in the world.”

This is a remarkably optimistic outlook, to say the least. Central bankers don’t have magic wands – not even Mr Bernanke.

The truth is, as Dr Marc Faber points out, the Fed chief can’t win, regardless what he does. If Mr Bernanke hikes rates aggressively to target inflation, it will burst the already hissing US housing bubble and “have a lethal impact on US consumers”.

This is not a palatable option. So the Fed is more likely to “err on the side of inflation more often than not”, says financial commentator David Fuller.

This will mean a “generally soft US dollar”. That’s good news for gold, “which could easily rally by a multiple of its current price over the next twenty years.”

He also remains bullish on the resource sector and emerging markets - though he plans to wait until "the anticipated medium-term correction has gone far enough for many people to suspect that we are in a bear market." In other words, hold off investing until everyone else thinks stocks are going to keep falling - and then start buying.

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  • 301 Brexit, House prices and Summer 2020

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      • down 5% +
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