Although the MSCI World index, which measures global stock markets, rose 1.8% in July, investor sentiment was not equally positive everywhere in the world. The S&P500 index, which tracks large US companies, rose 2.2% during the month, and the value of the Euro Stoxx 50 index, which reflects European stock markets, rose 0.7%.
At the same time, the Japanese and Chinese stock markets fell moderately: The Nikkei index lost 4.2% of its value and the CSI300 index, which reflects Chinese stock markets, lost 6%. In emerging markets, losses were even bigger: The MSCI Emerging Market index fell by 7.1% in euros during the month. However, Estonian investors had reason to rejoice in July, as the value of companies on the Tallinn stock market rose by 7% during the month.
The era of unsecured money
Fifty years ago, in August 1971, President Richard Nixon informed the world that the US dollar would no longer be pegged to gold. The era of the gold standard was over. Under the Bretton Woods agreement, many other countries pegged their currencies to the dollar, and the US Federal Reserve promised that dollars could be exchanged for gold at any time at a rate of $35 for an ounce of gold.
The current so-called unsecured monetary system is therefore only fifty years young and is not guaranteed by anything other than trust in the money-issuing government. The main reason why the US abandoned the gold standard half a century ago was that the US current account was strongly negative. Namely, the country imported significantly more goods and services than it exported, and the US liabilities to the rest of the world kept growing.
Since the gold standard, the world has seen various currency crises. Foreign exchange markets closely monitored both government fiscal policy and central bank monetary policy to predict changes in inflation rates and interest rate movements.
About ten years ago, however, investor attitudes to governments’ large budget deficits and their financing by central banks changed. In the past, it was feared this would lead to accelerating inflation and a fall in the exchange rate. Over the past ten years, on the other hand, markets have tended to favour government and central bank intervention, despite its long-term consequences.
The time horizon has become shorter for investors and society as a whole, and no one really ponders the fact that money-printing itself does not create value. The money borrowed must be productively invested so that it can be repaid with interest in the future. Record-low interest rates have another negative side effect, namely an increase in speculative and inefficient investments that do not create new value.
The declining utility of loan money
Marginal utility is one of the most important concepts in economics, and it also applies to lending. Each subsequent dollar or euro borrowed creates slightly less new value than the previous one.
While government debt was already alarmingly high before the pandemic, fighting the virus and reviving the economy have brought on commitments at an unprecedented rate. The cheap price of money has motivated spending too lightly at times. Inflation results when a growing money supply chases a limited supply of goods or services. Over the past ten years, inflation has manifested itself primarily in the prices of various assets, as it was possible to ask for additional loans secured by assets. This year, however, we have also seen the growth of consumer goods prices accelerate faster than before.
In the USA, the consumer price index rose by 5.4% year-on-year in July, and in Estonia, the inflation rate reached 5% last month. Central bankers argue that the rapid rise in prices is temporary due to the low base a year ago and the impact of the coronavirus on global supply chains.
Looking at long-term government bond yields (US and German ten-year bond yields are 1.3% and –0.5%, respectively), bond investors are not particularly worried about inflation either. Similarly, the decline in commodity prices in recent months points to a possible slowdown in inflation over the next 12 months.
More than an acceleration in inflation, I fear a possible erratic restructuring of a heavily indebted economy. In a situation where everyone owes everyone, the insolvency of a major corporation or even a government can cause a chain reaction. Moderate inflation would be welcome as long as it does not lead to higher interest rates.
We are getting ready to make payments
Central bank money taps have been open wide for a very long time and interest rates are very low, meaning that all asset classes trade at very high price levels. In such an environment, it is worth preferring companies with good growth prospects or investments that have a somewhat limited loss risk in the case of a negative scenario.
LHV pension funds made no major new investments in July. However, one of our largest bond investments ended when the new owners of Peetri Keskus decided to redeem their liabilities to pension funds that were assumed at the beginning of last year. The average interest return on the bonds was 7% per annum, plus an early redemption fee.
German and French government bonds currently account for a much more significant than usual share in our fund portfolios. We will finance payments to those leaving the pension system at the beginning of September from the sale of these. After that, the distribution of assets in higher-risk funds will become closer to the goal we have been moving towards for a long time.
Although the MSCI World index, which measures global stock markets, rose 1.8% in July, investor sentiment was not equally positive everywhere in the world. The S&P500 index, which tracks large US companies, rose 2.2% during the month, and the value of the Euro Stoxx 50 index, which reflects European stock markets, rose 0.7%.
