Bigger impact: fiscal cliff or renegade meteor?

by Ralph Cole, CFA Senior Vice President of Research

Currency War Devaluing one’s own currency is one of the easiest ways to stimulate a country’s growth.  By doing so, the products and services of your country become cheaper compared to those products and services of competing countries.  There is however, a great deal of risk associated with a weak currency policy. These risks include inflation, discouragement of foreign investment, not to mention the potential backlash from other nations.  A recent example of weak currency policy can be seen with Japan, whose currency has fallen 19 percent since October.

As a result, Japan is in the eye of the storm during this week's meeting of G20 Finance Ministers and Central Bank Governors. Following the country’s slow response to their 15 year bout of deflation (falling prices), Japan is now focused on causing inflation. They have the stated goal of expanding their monetary policy in order to rekindle growth in the moribund country.  While inflation often carries a negative connotation, a little bit can be a good thing.

The yen’s fall is even more staggering when you consider the actions taking place in the U.S. on the monetary front.  Furthermore, some emerging market countries (Brazil being the most vocal) are starting to push back against developed countries (mainly Japan and the U.S.) that have devalued their currencies. They are frustrated by the fact that their own currencies are appreciating against most of the developed world, therefore making their products and services less competitive.

While we don’t currently have a currency war on our hands, it is one of the bigger risks to global economic recovery going forward.  If countries begin to feel threatened by other’s devaluation, we would expect protectionist policies to begin to creep up, which would inhibit global growth.

Finally, in an environment with multiple central banks printing money, we would have expected gold to do better. However, up to this point gold is basically flat for the year.

"Bigger impact: fiscal cliff or renegade meteor?" That was the question Principal Mark Kralj posed to the audience at our Investment Outlook in Bend this week.   While the “fireball meteor” that rocked Russia this week is stealing most of the headlines, the fiscal cliff is starting to bite the consumer.  Earlier in the week the U.S. Commerce Department announced that retail sales in the U.S. inched higher by just 0.1 percent in January.  That was followed up by rumors from Wal-Mart that February sales were off to their slowest start in seven years (as a result the stock was down over 2 percent today).

The repeal of the payroll tax cut is starting to hit home for the U.S. consumer.  The 2 percent increase in the payroll tax will take approximately $126 billion out of consumers’ pockets this year.  For the average family this amounts to over $100 per month in decreased income. We expect this drop to affect retailers and restaurants at lower echelons.

It is however, unlikely that this slowdown in spending will lead to a recession, because of the positives occurring in the economy this year, including growth in housing, the stock market and jobs.

Our Takeaways from the Week

  • Both the consumer and the stock market are taking a breather after robust runs
  • Currency wars are a newer risk to the global recovery, and something that needs to be watched