Daniel Stelter on the consequences for investors

 

Recently there was a sudden alarm on the stock markets, then the fear of a crash calmed down again. How do you explain the development?

Due to investor euphoria over artificial intelligence, the valuations of many companies have risen sharply. However, hopes about the productivity effects of AI were probably exaggerated. The trigger for the turbulence appears to have been the Japanese central bank’s small interest rate hike. Investors borrowed yen and used it to invest in technology stocks – now they had to close their positions. This shows that many financial market players still work with a lot of borrowed capital and loans.

Have loans become more expensive in recent years due to interest rate increases by central banks?

Despite the central banks’ interest rate increases, there was and continues to be a lot of liquidity in the market. The good development of share prices, especially technology stocks, has obscured the fact that there are fundamental structural problems. The states, but also private households, are heavily indebted in many industrialized countries. This makes the system vulnerable to crises. The private sector will not be able to cope with higher interest rates in the long term. At the same time, states are unlikely to be able to get debt growth under control.

Which countries do you mean?

This applies to Europe, but also to the USA. The American economy is booming and there is full employment, yet the American budget deficit is 6 percent or more – so the government is taking on new debt instead of reducing it. But one could also argue the other way round that the USA has to have such budget deficits in order for the economy to run well.

 

Despite these risks, the financial markets quickly calmed down again. Wasn’t it just a false alarm?

I would rather describe this as a warning shot. Historically, overvaluations on the stock market are followed by corrections and crashes. It’s just that central banks have often prevented such shakeouts in recent decades by cutting interest rates or otherwise calming markets. Some market observers compare the current situation with the crisis surrounding Russia and the LTCM hedge fund in 1998. After that, prices continued to rise and stock market euphoria continued until the new economy bubble burst in 2000.

So you expect the stock market to recover before a crash occurs?

Nobody knows that. I’m just looking at the situation as it is. The financial system is already having problems with the current interest rate level, as can be seen from the state finances. French Finance Minister Bruno Le Maire, for example, said that the French government’s interest spending was largely to blame for the rising budget deficit. And every month that interest rates stay higher, the problem gets bigger because old bonds expire and new debt costs more. In addition, productivity growth in the economy is unsatisfactory.

In Europe or the USA?

Throughout the western world. However, in the past two years there has been at least hope that productivity will increase in the USA. However, I think it is premature to talk about a trend reversal. The huge programs to support the economy during the Corona crisis are likely to have played an important role here.

What is the situation in Europe?

There is definitely no such trend reversal in Europe. Added to this is the demographic development. Europe is shrinking, but aging is not quite as bad in the USA. Nevertheless, both regions have the problem that they have not made provisions for this aging society. That’s not a good scenario.

So from your point of view there are now going to be lean years ahead?

We have great decades behind us with the fall of the Berlin Wall and the entry of Eastern Europe and China into the global economy. The borders opened, there was liberalization, and states reduced trade barriers. This is now turning around. The conflict between China and the USA will continue to be reflected in higher tariffs and technology bans and slow down the economy. No matter who wins the presidential election in the USA, this policy will continue, and it will also affect Europe. The American Inflation Reduction Act is a very good example: This is nothing other than a protectionist and debt-financed reindustrialization program for the USA that comes at the expense of Europe. At the same time, it is becoming more difficult for Europe to do business with China.

And China is also a very serious competitor.

China has such cost advantages that tariffs of 20 percent play practically no role. Now Europe can isolate itself here. It just means less growth in the world and higher inflation rates. In addition, there is climate policy, which also causes higher inflation rates.

So you expect permanently higher inflation rates?

We live in a world in which debt can only be repaid in nominal terms if we devalue it through inflation. Higher inflation doesn’t even require an escalation in the Middle East or an oil price of $200 – if that happens, the problem is much bigger. The level of current share prices and real estate prices is only justified if one assumes that interest rates will fall.

Isn’t there also a risk of national bankruptcies due to the high level of debt?

The answer here is very clear: States will not go bankrupt because central banks are financing them. And that will also happen in the euro zone. In a monetary union in which no one wants to save, the savers are the stupid ones. The euro only has a chance of surviving with structurally higher inflation. The assets of savers in the euro are likely to gradually depreciate.

They say that interest rates cannot rise at all because of the high level of debt. Why were the central banks’ significant interest rate increases in recent years even possible without the system getting out of control?

The one reason why there have been few accidents so far, apart from the collapse of some regional banks in the USA following the interest rate hikes, is the continued high level of liquidity in the system. This is shown, for example, by the Financial Conditions Index from the Chicago branch of the US Federal Reserve Bank. The second reason is that many players acted cleverly in times of low and negative interest rates and took on long-term and cheap debt. At that time, many companies in the USA were literally saturated with liquidity.

And what about private households?

In the USA this is evident in the real estate market. A lot of financing there is done with 30-year fixed-rate mortgages. At the moment we see that only a few property owners are selling their houses. If they were to buy a new property, they would have to take out a new mortgage and they would not be able to afford that due to the increased interest rates. Therefore, there are far fewer transactions in the market and property prices continue to rise even though interest rates are higher.

Isn’t there a chance that the economy will grow out of its debt woes?

Believe me, I personally would like nothing more than that. In order to solve the debt problem, growth would have to be very, very high. It cannot be solved with higher taxes either. As a result, inflation is likely to occur in the euro zone.

Conversely, this means that the euro is increasingly becoming a soft currency.

The euro has long since taken this path. In Europe, the creation and preservation of wealth is not on the political agenda, neither in Germany nor in other EU states. This will take a bitter toll. The further the EU moves away from its promise to nurture people’s prosperity, the greater the risk of political tensions.

What does that mean for Switzerland?

Switzerland has the franc. But the sad thing is that it is in the middle of Europe. The negative development in Europe is of course dragging down Switzerland. The country benefits when companies from the euro zone migrate to Switzerland. However, the Swiss export industry will suffer from the further devaluation of the euro.

Will the euro survive in the long term?

I said in 2011 and 2012 that the euro was unlikely to survive – and now, twelve years later, it is still here. Therefore, it can last for a few more decades. In another twelve years, debt in the euro zone may be at Japan’s current level. There is much to suggest that there will not be an economic boom, but rather another gentle decline.

What does that mean for the population?

The price of maintaining the euro is an erosion of prosperity that we hardly notice every day. It’s a bit like the frog sitting in a pot of cold water that is slowly brought to the boil. Many of the baby boomers in Germany are coming to terms with the situation and trying to settle down – according to the motto “It will be enough for me”. My concern is that this is a mistake.

Can’t German politics counteract this? After all, Germany is still the anchor of stability in the euro zone.

As already said: Anyone who saves in the euro is stupid. The problem is that if the Germans do the same as the French and Italians and stop saving, then trust in the euro will erode more quickly. This is a dilemma. Nevertheless, I think it would make sense to make Germany economically fit – that would also help the euro zone. To do this, you should invest more in the country, for example in infrastructure and digitalization. Today, a large proportion of government money is not used productively. The state is not short of money, the money is being spent incorrectly.

It is not easy for savers and private investors to build and secure assets these days. What do you advise them?

The best solution is to invest part of your assets inexpensively and globally diversified in stocks and stock products. I also think it makes sense to have a certain amount of gold in your portfolio. I would advise against real estate in the Eurozone; demographic developments and politics speak against it.

An article from the «»