This week we have seen the signs that the global financial crisis (or "GFC" as it has become known after five years of familiarity) is far from over. The US stock market lost more than two percent of its value on Thursday, the Australia market suffered similar losses, China is reporting that business purchasing for the year is much lower than expected, and here in New Zealand our own stock market was down 1% (on top of news that GDP growth is an anemic 0.3% for the March quarter instead of the predicted 0.6%).
What caused the market jitters? Well, US Federal Reserve chairman, Ben Bernanke, made an announcement on Wednesday that set the cat amongst the financial pigeons. Those of you who follow the US economy will know that the Federal Reserve has been 'printing' money and injecting it into the economy at a rate of $85 billion per month (that's a trillion dollars, or around $3000 for every man, woman and child in America, per year). Ordinarily, printing money at that rate would produce fairly massive inflation but Bernanke, who is almost too clever by half, has been buying huge amounts of Treasury Bonds and mortgages (to the extent that the Federal Reserve is by far the largest purchaser of both), thereby keeping interest rates down and containing US Dollar inflation.
Of course, all this money printing and economic sleight of hand can't go on forever. You can't keep writing yourself cheques and expect everyone you buy stuff off to keep honoring them - well, not unless everyone else is completely stupid. There have been signs recently that the world is starting to regard the US economy as much too risky and the US Dollar as something less than the iron-clad reserve currency it has been for many decades. The reason the Federal Reserve has to buy all those Treasury Bonds is that China no longer wants them - not at the low interest rates the US Treasury expects to pay at any rate - and we're seeing the impact in the declining value of the US Dollar.
So what did Bernanke say that spooked the market? Did he call an end to his trillion-dollar a year printing of money? Well, not exactly. He signaled that he might start reducing it towards the end of this year with a view to ending it by the middle of 2014. Hardly what you would call cold turkey, but enough for the markets to suffer their biggest fall this year.
I've been predicting in this blog that the world economy is going to get a lot worse before it gets better. The economic situation in Europe is not improving and the US is plainly addicted to printing money. There is no way out of this except for a major correction that restores equilibrium between the money supply and real market demand for capital. Interest rates must go up signficantly to bring about this correction and that will force a corresponding correction in asset prices, particularly in major capital markets such as real estate and stocks. This loss of equity will have huge flow-on effects for a while on on business investment. In other words, before this is all over many more people are going to lose their savings, their houses and their jobs and we're all in for more pain before things get better.