http://themacrotourist.com/images/Azure/IMFFed.png

In what has to be one of the stupidest moves I have seen in a long time, yesterday IMF Head Christine Lagarde told the Fed to hold off raising rates until the first half of 2016. One of my twitter guys joked that the IMF is used to telling highly indebted sovereigns what to do with their economies. All kidding aside, this was such a brain dead move I can’t figure what Lagarde was thinking. I have to believe it wasn’t a mistake. You don’t get to be the head of the IMF making off handed remarks. So I am assuming Lagarde purposely applied this pressure. But why?

You might be wondering why I think this comment is a big deal. Isn’t the US economy starting to struggle a little? Doesn’t it make sense for the US to hold off raising rates? Isn’t Lagarde’s comment logical?

The problem is that by telling the Fed what to do, Lagarde has actually increased the chances of the exact opposite occurring. The Fed is an organization that barely answers to its own government (they were designed to be independent, not vulnerable to political pressure – whether that design works or not is another question). The last thing the Fed wants is to appear to be taking orders from the IMF. When Lagarde made such a specific comment about when the Fed would raise rates, she increased the chances the Fed would in fact do the opposite, just to prove they are not at the beck and call of the IMF.

The appropriate venue for Lagarde to express this opinion is privately. I have to assume she did this, and the reason she went public is she did not receive the response she was hoping for. The only reason I can fathom for her ill conceived remarks is the Fed members were wholly unresponsive to her concerns. Although she understands her comments will probably be unproductive in achieving her goal, she is framing the picture to firmly place the blame for the coming economic calamity in the Fed’s lap. I just don’t see how her comments achieve anything productive.


She must be desperate

Lagarde’s willingness to take this disagreement public indicates the seriousness of the situation. My guess is the rest of the global economy is bitterly struggling with the American’s reduction in the rate they are creating liquidity. Let’s face it, the US dollar is still the world’s reserve currency. As the Federal Reserve stopped QE, and started to prepare the markets for the first hike in years, liquidity has been slowly withdrawn throughout the global financial system.

During the heyday of the American QE programs the rest of the world struggled with the tsunami of liquidity that was unleashed. Countries like Brazil accused the US of engaging in a currency war. Now that the tide has gone out, these same countries that were at one point complaining of too much liquidity from the Fed, are desperately clamouring for breath as the oxygen is being removed.

To a large degree Lagarde’s comments reflect the direness of global financial markets. The system cannot handle the Central Bank of the world’s reserve currency having the relatively tightest monetary policy out there. In our over-indebted messed up world, liquidity needs to be continually administered into the system. The IMF Head’s ill conceived comment about the timing of the next Fed rate hike is desperate plea for the Americans to not shut off that liquidity.

Unfortunately it will not work. It’s not like the Americans don’t understand the consequences of their policies. Although there are a couple of Fed Presidents who have showed a willingness to consider global financial conditions in making policy (Fischer recently addressed this very topic in a speech in Toronto), at the end of the day, the Federal Reserve is mandated to conduct policy for the benefit of the American economy, not the world economy. Yes, the world economy eventually affects the US, but the Federal Reserve will not tune for global financial conditions.

The John Connally school of banking is still very much alive and well in the United States. “It is our dollar, but it is your problem” applies both ways – up and down.

And herein lies the real problem. The privilege of having the reserve currency comes with some great benefits, but also some terrible responsibilities. My suspicion is this disagreement with the IMF is just the start of a new round of conflict that ultimately causes the rest of the global financial markets to question the idea of the US dollar being the world’s reserve currency.


More towel throwing

Apart from that bonehead remark from Lagarde, the other interesting part of yesterday’s IMF announcements is the downgrading of their forecasts for the American economy. I have been looking for more of the economic optimists to throw in the towel, and this was a rather high profile capitulation. From the WSJ:

WASHINGTON—The International Monetary Fund Thursday slashed its forecasts for U.S. economic growth, calling for the Federal Reserve to hold off its first rate increase in nearly a decade until 2016.

In its annual review of the U.S. economy, the IMF said a series of negative shocks, including a strong dollar and bad weather, had sapped momentum for job creation and expansion, forcing the fund to downgrade its growth expectations to 2.5% for the year. Its last estimate in April was for a 3.1% expansion.

There are still lots of holdouts who are hopeful the American economy will rebound strongly from the winter/spring stall (almost every FOMC committee member for example). As every day passes without an economic uptick, these optimists will be forced to confront the disappointing reality that the hoped for economic acceleration is MIA.


Taking a stab on the long side of the gold/S&P 500 spread

When the Fed first started QE in the depths of the 2008 credit crisis, the market was convinced it wouldn’t work. Investors piled into gold thinking a new inflationary quagmire was about to be unleashed. When newly elected President Obama suggested it might be a good time to buy stocks, he was laughed at as a naive President who didn’t understand the severity of the situation. Here is Obama’s comment from March 3, 2009:

What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.

For the next couple of years, as the Fed desperately expanded their balance sheet in an attempt to offset the credit destruction, the market drove gold up at a much faster rate than stocks. Although stocks rallied, gold rallied even more. The market was petrified of the Fed’s policy and clamoured for some insurance for the anticipated inflationary explosion.

But a funny thing happened. Inflation never showed up. After three years of calling for the Fed’s balance sheet expansion to cause inflation, the market gave up. Investors abandoned gold faster than Lindsay Lohan at a court ordered community service “just say no to drugs” Sunday school picnic. And they flocked into stocks. Big time. All of a sudden, Obama’s call to buy stocks looked wise, and investors became full fledged converts of the “QE causes stocks to rise” instead of “QE causes inflation” camp.

This change in attitude caused the gold/equities ratio to retrace the entire move of the previous 3 years.

http://themacrotourist.com/images/Azure/GLDSPXLTJun0415.png

But here we are; investors, Central Banks and corporate equity buy backs having pushed stocks to asinine valuations, all the while, gold has slumped badly. There is no one worried about QE causing inflation. No one. Well, that might not be completely true – I am pretty sure Peter Schiff and Michael Pento are hanging tough with their inflation call, but apart from the crazy gold bugs, no one is worried about inflation.

I am not sure if we are about to get a deflationary swoon first, or whether we will just suddenly get inflation when we expect it least, but I think that gold relative to equities is a good buy down here.

Have a look at the short term chart. It is hanging tough:

http://themacrotourist.com/images/Azure/GLDSPXJun0415.png

I know gold might suffer if the Fed continues with their tightening, but I suspect equities will suffer even more. I am buying the spread in here. I suspect if Obama was honest he would have to admit that profit and earnings ratios are at a point where stocks are a good sale if you have a long term perspective. And given Central Banks’ willingness to fix everything with a printing press, I think you need to own a real asset. This is a pretty lonely call, but that can sometimes be the best kind.

Thanks for reading,

Kevin Muir

the MacroTourist