In public statements, Federal Reserve Chair Janet Yellen and her counterpart at the European Central Bank, Mario Draghi, were both singing the same song last week about the lack of global economic growth, despite the unprecedented easy money policies that the American and European central banks continue to promote.
And the tune Yellen and Draghi were singing was music to Wall Street’s ears.
In her testimony before Congress on Wednesday about the state of the U.S. economy, Yellen said,
“Many Americans who want a job are still unemployed, inflation continues to run below the Fed’s longer-run objectives (of 2 percent) and work remains to further strengthen our financial system.”
In fact, Yellen referred to the same chart that I presented in my Money and Markets column last week that showed that the U.S. Labor Participation Rate had dropped to its lowest level since 1978.
Then, almost on cue, on Thursday Draghi said,
“The recovery in Europe is proceeding but it is proceeding at a slow pace, and it still remains fairly modest, and there are some downward risks now. The risks have to do with the possible weakening of global demand, geopolitical risks that are of serious significance and the euro’s exchange rate.”
Indeed, inflation across the 18-nation euro zone currently stands at 0.7 percent, but the financial markets expect it to fall closer to zero when the flash estimates of the May cost of living are published on June 3.
|Low inflation that borders on deflation can be just as destabilizing as runaway inflation to the global economy.|
“There is consensus about being dissatisfied with the projected path of inflation,” Draghi said. This means that Draghi and his team of bankers fear European inflation is too low.
These statements probably leave you asking: Does this make sense? Why are the Fed and ECB concerned that inflation is too low? Isn’t low inflation a good thing?
Of course, run-away inflation is a bad thing as the price of goods and services rise rapidly and lead to economic instability. Yet, on the other hand, low inflation that borders on deflation can be just as destabilizing to the global economy.
That’s because low inflation means slow economic growth and without growth there is no economic progress. Making matters even worse is the huge global debt overhang that remains in place after the 2009 financial crisis, since growth is essential to pay off that debt.
Through lowering interest rates and buying bonds, the Fed and ECB can try to stimulate the economy by making it cheaper for businesses and consumers to take out loans. Low interest rates can also boost the housing market by making mortgages cheaper, and fuel stock market gains by making equities a more attractive option than bonds with measly returns.
But as I explained in a previous Money and Markets column, there is little or no evidence that the wealth effect is actually working, because the chart below shows that economic growth, after the recession of 2009 ended, is the slowest since the 1950s.
That’s why — without any signs of inflationary pressures on the horizon — both Yellen and Draghi are recommending the same course of action, with Yellen saying that short-term rates would remain near zero for a “considerable time.” And then Draghi followed with his own hints of future European interest rate cuts, possibly backed by the start of a new euro-zone quantitative easing program.
With Yellen and Draghi committed to maintaining low interest rates and propping up economic growth for the foreseeable future, it’s obvious that the plan is to get the global economy moving again or bust.
Or said another way: They are following my lead and singing Risk on Regardless, because a deflationary environment devoid of any economic growth leaves no hope to eliminate the massive debt overhang that continues to plague the developed world.
In this environment, if your risk profile allows for it, large dividend-paying, blue chip companies should form the core of your portfolio.