Reinhart to Fed: don’t taper!
One of the world’s leading experts on debt cycles, Professor Carmen Reinhart, recently warned of a substantial policy mistake if the US Federal Reserve begins to “taper” its asset purchase program.
Reinhart cited the stubborn disrepair of US household and fiscal balance sheets, and headwinds to growth.
In an interview with the Euromoney magazine, Reinhart warns: “We have a great degree of deleveraging to endure in the US, and the issues around the world, particularly in Europe, are far from resolved.”
Reinhart co-authored research with Kenneth Roggof, former IMF Chief Economist, which concluded that if the public debt to GDP ratio exceeds 90 per cent, there would be a close correlation with slowing long term growth and potential default.
“There is a consensus that the Fed should continue to focus on growth and employment as its target, and it does not have a history of pricking bubbles. I don’t see why this should have changed.”
Reinhart’s comments, combined with the appointment from early 2014 of Janet Yellen as Chairman of the US Federal Reserve, indicate a rather “dovish” attitude to macroeconomic policy.
In turn this should assist Australia’s price-taking export industries.
Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Kenneth Beer
:
I’m not an economist but I think i have worked what is going on out!
US “quantitative easing” is increasing money supply by the US central bank buying US bonds from investors (US banks) with US dollars it has recently printed. The intent is to reduce US interest rates and improve US economic growth. That’s US monetary policy.
In FY 2013, the US federal government in its budget estimated that the deficit would be $973 billion. The US federal government deficit is financed by issuing US bonds to investors (US banks, foreign governments, etc). That’s US fiscal policy.
The US central bank is buying US bonds at the rate of about $1,000 billion a year so the net supply of US bonds in the market is about constant. In theory it seems the US central bank and federal government could keep doing this forever. I suppose what will stop them is an increase in inflation pushing interest rates up and/or a decrease in the US dollar causing foreign US bond holders to demand higher interest rates to compensate for the currency risk.
It makes me a very nervous investor
Roger Montgomery
:
I’m with you Kenneth. Yellen will need to take her foot off the accelerator in a carefully considered but timely fashion
Joe Rich
:
Thanks Roger, makes sense.
Should anticipated inflation figures be incorporated into the Required Rate of Return? – E.g. usually RRR = [Risk Free Rate + Risk Premium]. Should inflation rate be subtracted from the risk free rate to reflect the fact that a ‘risk free’ 4% may actually equate to 1% (or 0%) when looked at on a real, rather than nominal basis?
Roger Montgomery
:
Check out the chapter on that subject in Value.able…
Dragon Tucic
:
Hi Joe,
I think you are right on the money. It would be great to see Roger elaborate more on this topic or conundrum.
“True genius resides in the capacity for evaluation of uncertain, hazardous, and conflicting information.”
Winston Churchill
Joe Rich
:
Hi Roger,
Any thoughts on how to invest when central banks around the world are printing money like crazy?
How does this affect the ‘Risk Free Rate’, that is used to determine the ‘Required Rate of Return’?
On one hand, using your valuation method, a lot of equities look expensive at the moment, and a diligent approach would have investors only buy when significant discounts to intrinsic value are present.
On the other hand, if investors leave their money in cash, they risk value being corroded by a sudden spike in inflation that is inevitable if central banks keep printing money.
What to do…
Joe
Roger Montgomery
:
…the experts seems to suggest party while the punch bowl is out. The problem is knowing when it will be pulled. At this stage we don’t see any train wrecks but for the fact that value seems thin on the ground which makes the market susceptible to periodic sell offs. This shouldn’t rattle the longer term business owner though.
Roger Montgomery
:
Business able to raise prices with inflation must be the answer Joe.