Financial

Milei shows central bankers how to do it right

Argentina’s President Javier Milei, whom we praised in our article in February this year for his sober views and realpolitik, is showing his clout. Since he has been in office (exactly one year), applying radical measures, he has brought inflation in Argentina sharply down. At the beginning of his term of office, monthly inflation stood at 25.5 %, but it has now fallen to 3.5 %. This success is based on a comprehensive “shock program”, which included far-reaching cuts:

  • Reduction in government spending: Milei halved the number of ministries and laid off numerous civil servants. Subsidies, for example for energy and transportation, as well as social benefits such as food subsidies and support for soup kitchens were also cut.
  • Monetary and fiscal policy: Argentina’s national currency, the peso, was devalued and a strict austerity program was introduced to reduce the budget deficit. The aim was to achieve a balanced national budget.
  • Market-oriented reforms: Milei was guided by ultra-liberal principles, aiming for a drastic reduction in the state apparatus and greater deregulation.

The FED or the ECB take years to get inflation under control, surrounded by crowds of employees, in their towers in Frankfurt (ECB) and Basel (BIS), in their bunkers in Fort Knox, cut off from reality, with the media serving them, convincing the public of the efficiency, caring and reasonableness of central bankers, leading us from one crisis to another. The ECB can do nothing about the deepening recession in Germany. An Argentinean who is going against the tide, a showman whom all the Western media despised a year ago and predicted his quick downfall, has succeeded. Against all odds. Though he is on the side of Ukraine and Israel in their conflicts, though he speaks out against the BRICS, Venezuela, Iran, Russia and China, nonetheless he argues against woke culture and all left-wing ideas for social transformation. Note that he was the first head of state Donald Trump met with (informally) after his election. While Trump is a protectionist who will try to control the US market with administrative measures, Milei is an opponent of liberalism and open markets. After 20 years of socialist government in Argentina, came a man who keeps his promises: he is putting an end to socialism and its failed ideas. First in the economy, then in all areas of life. One man, one word.

Preparing for new trade wars

Donald Trump wants to increase tariffs on Chinese even by up to 60%, and Democrats will have no choice as to agree to at least some of protectionism planned by the Republicans, or else China will flood the market w its products to the detriment of American domestic industry. In recent years, Western companies and financiers have invested heavily in China only to withdraw from the country at present.

Source: bloomberg.com

In the second quarter of 2024, 15 billion dollars were withdrawn from China. At the same time, exports from the Middle Kingdom are on the rise as companies increase their inventories of Chinese parts, components, etc. so as not to be so affected by potential trade wars. Put simply, we buy what we can from China, but we no longer invest there. This strategy is being pursued by many countries. As a result, freight costs are also rising. Below you will find transport costs from main ports in China (Containerised Freight Index – green line). The situation is similar to that after the end of the pandemic, when inflation began to rage.

Source: tradingeconomics.com

Companies are filling their warehouses and politicians will have a tough nut to crack if inflation rises as a result of trade wars. Already, 59% of Americans believe their country is in recession, despite good economic data.

It is worth remembering that the development of the global economy has been due to free trade for several decades, with the focus on China. This process is now set to be halted and many Americans would even like to see it reversed. This will benefit many European or American companies, but unfortunately it will be at the expense of ordinary citizens, who will pay more for many products. This will fuel inflation and at the same time slow down the economy. Such a situation is known as stagflation. Stagflation is therefore a possible scenario as downside risks dominate the markets, including geopolitical tensions and trade fragmentation.

 

The Netherlands and Germany between inflation and recession

For public finances to be healthy, the economy must be sick

The fiscal conservatism of Germany and the Netherlands clearly limits the growth potential of both countries. The 45% of economists and think tanks active in the AIECE research network consider the current monetary policy in the eurozone to be too restrictive, while only 25% consider it to be correct. In particular, the respondents pointed to the governments of Germany and the Netherlands as those that are only insufficiently supporting their economies. The budget deficit of these two countries will amount to 1.6% of GDP this year for the former and 2% of GDP for the latter. By way of comparison, the figure for Italy is expected to be 4.4% and for France 5.3%. At the same time, many countries are struggling with much higher inflation than those between the Rhine and Oder, for example. It’s like between an anvil and a hammer: either you spend less money on stimulating businesses, leading to a slowdown in the economy and ultimately to recession in the country (Germany, Netherlands), or you increase public debt and the budget deficit through excessive spending, pumping money into the economy, which brings inflation with it (Italy, France).

In 2023, it paid off to pursue an expansionary fiscal policy that avoided a recession. In terms of GDP, higher government spending in Italy and France replaced falling demand, leading to positive growth rates. Countries that cooled their fiscal policy achieved lower growth rates and in some cases paid for this with a recession (see the Netherlands, where GDP fell by 0.3% year-on-year according to the latest figures). Denmark stands out from this pattern, as it achieved growth of almost 2% despite its restrictive fiscal policy. However, it is worth noting that economic growth was boosted by the huge success of Novo Nordisk, the manufacturer of weight loss drugs. Without the pharmaceutical industry, GDP would probably only have grown slightly.

At the same time, it should be noted that the higher inflation in countries with a more expansive fiscal policy is due to the fact that government spending has had to react to cost shocks. For example, countries that are more susceptible to supply shocks due to a higher share of food and energy in the basket of goods have taken more comprehensive and longer-lasting shielding measures for ordinary consumers. However, the reversal of these measures is slow, which is also slowing down the disinflation process.

A new threat to inflation is the escalation of wage demands in the major EU economies. Figures from the European Central Bank (ECB) indicate that growth in collectively agreed wages was stable at just under 3% in the fourth quarter. At the same time, these figures are published with a considerable time lag and show a rather outdated picture that ignores the ongoing negotiations between employers and employees. A completely different picture emerges from the internet search data, where questions about pay rises are reaching historic highs in almost all major EU economies. For example, Dutch internet users are now twice as likely to search for terms relating to pay rises than in 2016-2019, i.e. before the pandemic. In such an environment, rapid disinflation is highly unlikely.

Quelle: Google Trends | Gehaltserhöhung = salary increase, Lohnerhöhung = wage increase, Loonsverhoging = wage increase, Salarisverhoging = salary increase, Augmenter = Increase, Aumento = increase

To summarize, the impact of fiscal policy in 2023 has proven to be quite intuitive and textbook, although it is worth noting that the consequences of some fiscal tools will also show up over a longer period than just a few quarters (e.g. investment, education spending, etc.). Countries that pursued expansionary fiscal policies had to accept higher inflation but managed to avoid recession, while governments that focused on central bank support had to accept recession/weaker growth but achieved lower inflation rates at the end of the year.

The US economy ahead of the elections

The biggest surprise on the financial markets this year is that inflation is continuing. While investors had hoped not long ago for 4 interest rate cuts by the Fed this year, there are now only 3, and with a significant delay. This underpins the thesis we have often expressed that central banks do not fully understand the dynamics of the current inflation. The indicators suggest that parts of the economy, such as real estate and the automotive sector, are struggling with high interest rates, while other sectors, such as the defense industry, the semiconductor industry, the AI industry and the manufacture of anti-obesity drugs, are experiencing a boom. So, after the pandemic, due to new IT technologies and the war in Ukraine, a two-speed economy has emerged, where monetary policy is more difficult, as supporting the weak parts of the economy can go hand in hand with persistent inflation, which is more costly for companies.

Investors try to glean from the Fed’s statements the level of future interest rates (i.e. how much the money – the loans – will cost businesses in the future). It is often the case that the worse the situation in the economy is, the higher share prices rise as investors hope that in response to weak economic data, the Fed will cut interest rates to stimulate the economy. Just yesterday (July 3, 2024) we had an example of this: the ISM index for the service sector collapsed and – excluding the Covid-19 pandemic – fell to its lowest level in almost 15 years. And Wall Street hit record highs in response.

So investors believe this two-speed economy will continue to work. Meanwhile, fiscal spending in the US is unsustainable in the long term and current government bond yields are increasing government spending related to debt, taking away funds for citizen welfare and infrastructure. The US government has to deal with the risk of an economic slowdown or risk letting inflation run high for longer. So the scenario is: whether Democrats or Republicans win, they will have to increase spending (read: inflation), which will cause the Fed to perhaps raise interest rates even higher.

Investors need to understand that the real killer for stocks is recession, not inflation. Yes, I know that the examples, such as the behavior of the stock markets in Turkey or Argentina, clearly show that high inflation need not be a particular problem for equities in the long term. But one day the moment will come: even large companies will not be able to generate higher profits in the face of expensive loans, high taxes and wages. On that day, it will no longer be worth putting money into shares. Even in the USA.

Serfdom enhanced

A few centuries ago it was all visible. A peasant – a serf – was obliged to work, say, three days a week for his landlord, and he was obliged to give away a part of the agricultural produce from his household. The amount of work and the amount of the produce were all visible, palpable. If a landlord wanted to extend the time of work done by his serfs for his benefit or take away from the serfs more than was prescribed, the serfs would have rebelled because it was a matter of survival and the maintenance of the standard of living. A serf needed the three remaining days to work for the upkeep of his family; the serf needed to have the rest of the agricultural produce at his disposal for his family to survive. If a serf had been forced to work four rather than three days and give away more than usual from his produce, he would have had less for himself and his family. In other words, working as much as before, he and his family would have had less. The serf would have known who was to blame for this.

Today it is all for all practical purposes invisible. A government prints more and more money and causes inflation. The government does not need to raise taxes. The amount of the tax that is levied on workers may stay the same. Still, due to inflation, labourers or present-day serfs, although they work as much as before, can buy less and less. Of course, sooner or later the present-day serfs notice that they are worse off, but they notice it belatedly and – what’s worse – there is no one person, known to them by name, who is to blame. Yesterday’s serf could have rebelled against his landlord and oftentimes he did; today’s serf can rebel against… inflation, which means against nobody. Yesterday’s serf could have threaten his landlord with a pitchfork – and sometimes it happened. Today’s serf can cast his vote from time to time, to vote out of office some, and vote into office others and, as a result, receive more of the same in terms of economic policy. None of the politicians that currently hold power can stop inflation, even if he wants to. The purchasing power of the present-day serf is constantly diminished, and though the present-day serf is not referred to as serf but, rather, as a citizen with a batch of human rights, he can do nothing about being robbed of the fruits of his work.

Historical record shows that prices used to be stable over decades. Our day-to-day experience teaches us that generally in a longer perspective prices can only rise. If they level off, then but for a short time, while they never fall if viewed over a longer period.

Turkey, a NATO member, to join BRICS!

The leftist West is getting a blow back!

– The elections to the European Parliament elevated parties that are maliciously referred to as far-right;

– the war in Ukraine is going badly for the collective West;

– in the United States Donald Trump, maliciously labelled as populist is about to win the presidential election;

– France and the United States are being pushed out of Africa;

– de-dollarization is in progress;

– Slovakia’s Prime Minister Robert Fico has survived the assassination (how the EU commissioners would have wished he had died!);

– Hungary’s Prime Minister Viktor Orbán is openly against the European Union’s policy of confrontation with Russia; and now – to top it all

– Turkey – has announced its willingness to join BRICS!

What a mess! Turkey, which boasts the second largest army in NATO, is about to seriously partner among others with… Russia, a country against which the same NATO is waging war!

The West is getting blow after blow after another blow. How ungrateful the world is! The collective West has been meaning to

– save the planet from the man-made climate change;

– extend the human rights by bringing to the forefront homosexuals and lesbians;

– eradicate racism by coercing races and nationalities to share the same ares, towns and villages, schools and factories,

and it turned out that the world has remained blind and deaf to all those advances… Goodness me!

All of which might suggest one serious suspicion: out of impotence and a thirst for vengeance the collective West might be thinking about retaliatory steps. What are these going to be? The leftist West needs to disrupt BRICS, to keep Russia at bay, to stop the march of the “far-right” through the institutions (a historical irony, indeed), to thwart Donald Trump from winning the elections, to preserve the dollar as the instrument of global exploitation and dominance, and so on, and so forth. What are they going to do? A wounded and hitherto domineering animal can be terribly dangerous.

FED is not playing fair – can it go bankrupt?

The most important central bank in the world, the US Federal Reserve (FED), recently presented its financial report, which shows that it had a substantial loss of USD 114 billion last year. Why such a large loss for the FED? To explain this, one should first distinguish between two aspects of the central bank’s activities.

Firstly, the FED holds large quantities of US bonds, which in turn yield interest. Of course, in this case, this interest is income for the central bank. It is worth noting that since the FED began buying bonds on a large scale in 2008, interest rates have also risen considerably
Secondly, the Federal Reserve allows commercial banks and various types of funds to hold money in an account at the central bank. At the same time, it pays a certain amount of interest on these funds, which depends primarily on the level of interest rates.

Well, between 2022 and 2023, there was a series of interest rate hikes in the US. Eventually, a level of 5.5% was reached. This meant that the FED had to pay 5.5% interest to banks and funds (and there were a lot of them) that wanted to keep their money in a central bank account.

So on the one hand, the Fed still held a similar amount of bonds in 2023, for which it received interest rates close to the 2022 level (i.e. much lower than this 5.5%). On the other hand, it had to pay much higher interest rates to commercial banks or money market funds. This resulted in the loss.

You may ask: What happens when a central bank suffers a loss? From a purely financial point of view: Nothing significant happens. It is assumed that this loss will be covered by future profits. In the context of a central bank, it is difficult to talk about bankruptcy, especially as central banks can create gigantic amounts of money under the current system.
Gefira is critical of the monetary policy of central banks, but for completely different reasons. No one from the central bankers is commenting on the following questions:

1) Is it fair that the central bank only rescued and wants to rescue selected financial institutions simply because they operate on a large scale?

2) Is it normal for these institutions (especially banks) to hold their reserves at the central bank and safely receive a few percent interest in return?

3) What’s more – is it fair that unprofitable companies are kept alive by the central bank printing money, which in turn makes it more difficult for new companies to enter the market?

4) Is it good for the economy that unprofitable zombie companies are kept afloat in this way, which otherwise – in the real free economy – should have gone bankrupt long ago?