Perspectives économiques 2003

8/4/2019 Perspectives économiques 2003

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GaveKal Research

A Quick Review of the Cyclical Indicators A Look at MV=PQ



GaveKal Research

Presentation to Euro92

Alain MadelinSeptembre 25 2003, Paris



GaveKal Research3

An Expansionist Monetary Policy=M is Going UP

� Central banks all around the world hav e been printing money agg ressiv ely to either fig ht off the deflation/depression demons (USA, UK, EMU«) or to pre v ent their currencies from rising too quickly (Japan, China, India«). The recentle v el of monetary activism is reflected by the up-tick in our Global M Indicator.

� An expanding g lobal money supply is usually g ood for stocks and bad for bonds. In lig ht of the major central banks·activism, the recent behaviour of bond and equity mark ets is understandable.

Money Supply Growth (M2) in Major Countries

USA M2 Annual GrowthJapan M2 Annual GrowthEuroland M2 Annual GrowthChina M2

97 98 99 00 01 02 03

Y oY % C h an g e

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

Rebound in China, US, & EMU M2 growth

Mild rebound in Japan M2 growth

GaveKal M Indicator & US Bond Market

USA government bond index in local currency all matur. dailyGaveKal Indicator of Liquidity (M)

93 94 95 96 97 98 99 00 01 02 03 04

M

I n d i c a t or

-9

-7

-5

-3

-1

1

3

5

7

9

Y oY % C h an g e

-18.0

-16.0

-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0



GaveKal Research4

V is Rebounding very Strongly� Our v elocity indicators

bottomed in September

2002 and returned to

positiv e territory in

March 2003.

� W ith the continued

contraction in quality

spreads and the pick-upin bank lending , w e do

not f ear a ne w

contraction in v elocity .

� The question today isnot whether v elocity will

once ag ain collapse, but whether the v elocity rebound is already priced into the mark et?

The eKal Vel it (V) I i at r Vix I ex

V l cit I ic t r -

BO V l tilit (VIX) i , cl s il

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c

V l city F lli



GaveKal Research5

No inflation Risk on the Horizon.

� Our P indicatorindicates that there

will be v ery little

inflationary pressures

ov er the coming

months.

� As such, centralbanks will be able to

continue their

anchoring of short

rates and their

agg ressiv e printing of

money .

GaveKal P I i at r A E RI F t r e I flati Gauge

P I ! " ic # t $ r

% ! it

& " ' t # t & s, I ! fl # ti

$ ! ! .i.& .,

( ) RI F 0 t 0 r & i ! fl# ti

$ ! 1 # 0 1 & ,

% ' D

P I ! " ic # t $ r Source: EcoWin

94 95 96 97 98 99 00 01 02 03 04

95

100

105

110

115

120

125

1 9 9 2 =1 0 0

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

P Ind ic 2 t 3 r l 4 2 ds 5 y f

3 6 r m 3 nt 7 s

R= 0.84



GaveKal Research6

Conclusion: Q will Boom

GaveKal Quantity (Q) Indicator & O8

CD GD9

Q Indicator @ ECA Gross domestic product,

B

olume, sa C HSQ Indicator

92 93 94 95 96 97 98 99 00 01 02 03 04

QI n d i c a t or

-20

-16

-12

-8

-4

0

4

8

12

16

20

Y oY % C h an g e

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

R=D

.E

, lead ti F

e threeF

onths

� For most of the past year, the predominant concern of financial mark ets has been whether economic activity would

pick-up following the end of the Iraq W ar. In July , policy mak ers, economic data, and the financial mark ets seem to hav eput these f ears to rest!

� Our indicator of daily economic sensitiv e prices is now announcing a solid economic rebound; as is our monthly g rowth(Q) indicator. And so is the data: last w eek, US GDP increased by a much hig her than expected 2.4% in the secondquarter and jobless claims ov er the past two w eeks hav e been coming in better than expected.

� The recov ery is there. And it will be strong .

Daily Indicator of G

conomic SensitiveH

rices & OG

CD Ind.H

rod.

GaveKal Indicator of I aily Economic Senstive P ricesGaveKal Indicator of I aily Economic Senstive P rices Q EC I I P total industry,

R

olume, sa

92 93 94 95 96 97 98 99 00 01 02 03 04

I n d ex

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

G aveKal I ndi S ator leads bT

1U U

daT

s



GaveKal Research7

Back to the Deflationary Boom Prices

++

Inflationary BoomBuy: Scarcity Assets & Cyclicals

Sell: Bonds,

Interest Sensitive Stocks

Deflationary BoomBuy: Efficiency Shares

Sell: Price Inelastic

Inflationary BustBuy: Gold, Cash

Sell: Financial Assets

Deflationary Bust

Buy: Government Bonds

Sell: Equity,

Negative Cash Flow Assets

++

E conomicactivity

� Accelerating g rowth,accelerating liquidity and tame prices: we are back tothe glory days of thedeflationary boom.

� A deflationary boom is a v ery exciting , and dangerous, in v estmenten vironment (see Theoretical

Framework for the Analysis of A Deflationary Boom on our w ebsite ).

� It is v ery propitious to ov er-in v estments, ov er-excitements, and bubbles.

W here will the next bubble be? Our g uess is Asia«and

w e want to participate in it!

� In any e v ent, the mark ets·recent mov es mak e sense in lig ht of economicfundamentals.



GaveKal Research

Who will benefit structurally from the Boom

A Wicksellian Analysis of the World

Central Banks, Inflation, Deflation and

Financial Mark ets



GaveKal Research9

Introduction.� W icksell, the Sw edish economist had a v ery pow erful intuition. His vie w was that economic cy cles

could be explained by the div ergences betw een what he called the ¶· natural·· interest rates, and what he called the ¶·mark et·· rates. (More on those two later)

� If the ¶·mark et rates·· w ere too low i.e. if money was too cheap , it led to a boom centred on excesscapital spending , excess borrowing , excess consumption.

� These ¶·boom conditions·· led e v entually to a rise in the mark et rates abov e the natural rate, and this changes in the price of money e v entually broug ht about a bust, which would lead in due time to a fall of the mark et rates below the le v el of the natural rates.

� And on and on«

� W ith e v ery country (at the time of his writing ) operating under the Gold Exchange Standard, there

was little that could be done to stem these periodic booms and busts, more a function of g old discov eries and international capital flows than the results of conscious decisions by the centralbank ers.

� This is not the case any more: central bank ers do control mark et rates at the short end.



GaveKal Research10

Wicksell·s Children

Three economic schools can be traced to W icksell.

1. The K eynesians. Their vie w is v ery simple: since the rise of the mark et rate abov e the naturalrate creates the bust, the central bank should pre v ent the mark et rate from e v er g oing abov e the natural one. Their vie w was de v eloped during a depression, and was dominant up to the end of the se v enties.

2. The Austrians. They belie v e that pre v enting the mark et rate from g oing up distorts the price mechanism and that the central bank should leav e the interest rate as close as possible fromthe natural rate all the time. Their vie w, represented by the Bundesbank was de v eloped during an inflationary period and pre vailed from the end of the se v enties to the end of the nineties.

3. The Fischerians, who after Irving Fischer considered that the role of the central bank was tomanage short rates contra-cyclically . Their vie ws w ere de v eloped into a historical period full of

potentially v ery dangerous financial accidents ( Oil shocks, Banking collapses, countries g oing bankrupt etc«) Their best representativ e is of course the Fed with Mr Greenspan



GaveKal Research11

The Goal of this Presentation

Once in a while, w e indulge in a little bit of theoretical work.

Not because w e want to bore our readers to death, but simply to ¶·reposition·· ourselv esintellectually .

We belie v e it leads afterwards to better understanding and thus better ad vice.

The work that w e hav e done ov er the last f e w years (in fact since the re-emergence of our researcheffort in 1998) has in fact con vinced us that the W icksellian analy sis is the correct one.

Thus w e will:

1. Present our ow n definitions of what the ¶·natural·· rate is

2. Show that div ergence betw een the natural and the mark et rate is indeed at the orig in of the economic cy cle.

3. Show that the ¶·core beliefs·· under which a central bank is operating , leads almost naturally to a series of economic and financial consequences ov er time, alway s the same for the same set of core beliefs.

4. Show that when a central bank changes it sets of core beliefs, (from K eynesian to Austrian

etc«), it has a huge influence on the underly ing financial mark ets.5. Identif y the sets of beliefs under which the main central banks are operating today , and draw

some investment conclusions.



GaveKal Research12

Identifying the ¶· Natural ·· rate

USA IP Total I ex GDP : 10 Year Aver ages A ual I r eases

IP t t l i , V l , sr ss D stic Pr ct, V l , R, s

72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

1 2

t s V

r i t i

s T

Y

r s

r

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

The V W

N X t Y r X l Rat e m Y st ̀ e ar a Y

nd 3%

A b er ag e Gr a c

t h Rat e a f t he GDP

A b er ag e Gr a c

t h Rat e a f t he V W

IP

� O v er the last

tw enty fiv e years,

the US GDP has

g row n by 3% per

year on av erage,

and the IndustrialProduction by 2.7%.

� So the ¶·natural

rate for the US

economy must be

slig htly below 3%

real

� W hy ?



GaveKal Research13

Reasoning ¶·ad absurdum··

US GDP (Volume) US ash--Flows

r ss D stic Pr ct, V l , R, sr r t c s -fl s, B s 100 i 1982

rt R t s it lis ( T Bills)

74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

DP &

s

-F l

s B

s

1 0 0 i

1 9 8 2

40

90

140

190

240

290

340

� O v er the long

term, the g rowthrate of the USGDP=the g rowthrate of the USCorporate cash-flows (profits).

� If short term

rates capitalised (the g reen line )g re w faster than corporate profitsor the GDP,overtime the sy stem would implode.

� Erg o, the upper limit of the naturalrate must be the g rowth rate in volume of the economy ,



GaveKal Research14

Defining ¶·Real·· Rates

So, the upper limit of the ¶· N atural ¶· rate is 3 %.

Interest rates should not stay abov e 3 % for a sustained period of time real without creating substantial damages to the economy . Big help indeed.

It leav es us with more questions than answ ers.

The question w e hav e to address now are:

1. W hich market interest rates are w e g oing to use as a proxy for our market interest rates?2. W hich inflation rate are w e g oing to deflate these interest rates with?

Fortunately , w e hav e done ov er the last f e w years quite a lot of work on these topics, and hav e come

to the following conclusions.

W hen it comes to interest rates, w e cannot introduce a ¶·risk· ·element in the picture, so w e will hav e to

use Gov ernment related tools.

We cannot use short rates only (too short a period ), nor can w e use long rates (volatility in inflation expectations). So w e will use the av erage of three months T Bills and 10 Y ears bonds.

As far as inflation is concerned, our readers k now that w e hav e alway s favoured the av erage inflation

of the last ten years, as the best proxy for the ¶·perceiv ed·· inflation rate.

R esults



GaveKal Research15

Our Measure of Real Rates

� We are reasonably happy with ourmarket rate proxy .

� It mov es betw een 0 and +3 %,

which is what w e w ere expecting ,and there is nodiscernible trend,a sign that w e are using the rig htinflation rate todeflate the

nominal interestrates.

� Next question of course: does it

work ?

Mar et Rates i the US

R l R t s i t

6 2 6 3 6 4 6 5 6 6 6 7 6 8 6 9 7 0 7 1 7 2 7 3 7 4 7 5 7 6 7 7 7 8 7 9 8 0 8 1 8 2 8 3 8 4 8 5 8 6 8 7 8 8 8 9 9 0 9 1 9 2 9 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3

R

l R

t s

-1

0

1

2

3

4

5

6

7

8

P r d xy f d r t he Wick selli an M ark et Rat es



GaveKal Research16

The Proof

� Every recession

since 1968 in the

US took place after

a rise in real rates

above 3% (Gray boxes abov e zero).

� W hen mark et rates w ere below the

natural rate, the

US economy g re w

¶·normally ··.

� So it works«

US GDP Variations Mar et Rates vs Natur al Rates

r ss D stic Pr ct, V l , R, s

0 rk t R t s r B l N t r l R t

68 6 9 7 0 7 1 7 2 7 3 7 4 7 5 7 6 7 7 7 8 7 9 8 0 8 1 8 2 8 3 8 4 8 5 8 6 8 7 8 8 8 9 9 0 9 1 9 2 9 3 9 4 9 5 96 9 7 98 9 9 00 0 1 02 0 3

Y / / Y

s

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

-5

-4

-3

-2

-1

0

1

2

3

4

5

M ark et Rat es Bel e f

N at g r al Rat es

M ark et Rat es Ah

e i e N at g r al Rat es

Ever Recession Took Place AFTER

M ark et Rat es r e se ABOV p

N at g r al Rat e

R ec essi e ns



GaveKal Research17

The Keynesian Central Bank

� The characteristic of

a K eynesian central

bank is that short

rates will be

maintained all the

time below the g rowth rate of the

economy .

� This alway s leads to

e v ery body and his

brother borrowing ,

money supply

exploding and

inflation going up

structurally «US

1958. 1979

US T Bills ields & US GD nnual Growth ate

Market q ates r ominalG

s t Growth q ate (

u

alue)USA C t I 12 Months

u

ariations four Years Moving A verage

58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

v

er c en t

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

Interest rates lower than G Interest rates higher than G

I nflationw

esinflation/ w

eflation

?



GaveKal Research18

Moving from Keynesian to Austrian

� A K eynesian monetary policy is aimed at what K eynes called the ¶·euthanasia of the R entier··.

� It can work only if the financial mark ets are heavily reg ulated (reg ulation Q, credit controls, foreign

exchange controls etc...)

� W hen the Futures mark ets in Chicag o in v ented the contracts on the US interest rates, then this

policy was doomed.

� The futures allow ed the in v estors to hedge ag ainst the future inflation, thereby leading to a massiv e

rise in real rates immediately .

� This rise in real rates broug ht those way abov e 3 % (the natural rate ) for an extended period of

time and killed the incentiv e to borrow.

� And the US mov ed from inflation to des-inflation-deflation.

� This mov e has huge financial consequences, which w e are g oing to study now using the Japanese

example.



GaveKal Research19

The Japanese Drama in Three Acts

� At the end of a K eynesian period, real rates are deeply neg ativ e, and nominal rates are hig h.

� In the first phase (boom, bubble ), w e see a g radual fall in nominal rates and a g radual rise in real rates.,at the same time. Since nominal rates are used to discount future cash-flows, w e hav e an incredible boom cum bubble.

� Ev entually (second act), real rates (mark et rates) rise abov e the long term g rowth rate of the economy , e v en thoug h nominal rates k eep falling . This is when the bubble bursts. As long as real rates (Market Rates) remain above the structural growth rate of the economy (which might be falling due to the liquidation of the bad investments of the bubble period), the economy keeps stalling or falling.

� The wav e of bankruptcies destroy the banking sy stem, V elocity collapses, and deflation kicks in

(third phase )

� See next g raph for the three phases«



GaveKal Research20

A Graphic view of the Japanese Drama

Japan GDP Real Inter est Rates (Str uctur al Inflation)

12 x

y

� t� s V�

ri�

tiy

� s�

DP i� Vy

l� � �

[� �

12]

x

�

rk�

t R�

t�

s R� �

l

x

�

rk�

t R�

t�

s Ny �

i �

�

l

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

%

-2

-1

0

1

2

3

4

5

6

7

8

9

B �

� �

l e B � st

Banki ng � ri si sM ark et Rat es > N at � r al Rat es

V el � city � �

ll apses

M ark et Rat es < N at � r al Rat es



GaveKal Research21

Preliminary Conclusion

� A French Politician once confronted with a v ery favourable de v elopment in France said ¶· Let · s feign to be the organisers of these phenomena that we do not understand ·· . This is a luxury that a centralbank cannot afford.

� The most dangerous phase when a central bank mov es from K eynesian to Austrian is after af e w years of boom when real (mark et) rates start moving abov e the structural g rowth rate of the economy ( natural rate ), when e v ery body has understood and borrows to buy financial assets«

� This usually coincides with the peak of the bubble (Japan 1989).� The central bank must then talk tough , but be willing to cut short rates agg ressiv ely and very

quickly to pre v ent a collapse of the house of cards, i.e. it must mov e from Austrian to Fischerian in no time«

� Maintaining real rates abov e the structural g rowth rate of the economy during more than fiv e years as the BO J did was suicidal.

� If such a mistak e is made then the third phase unfolds, centred around a collapse of the

financials in general and the commercial banks in particular«and monetary policy becomesineff ectiv e.



GaveKal Research22

What about a Central Bank being Austrian since its

Origin ? The reader still with us may then ask: OK, then I should k eep my money all the time in a country

ruled by a central bank which has operated for e v er under the Austrian theory . If only lif e was thatsimple«

� Because to operate efficiently , this central bank must hav e a pretty g ood idea of what the structural g rowth rate of the economy is .

� If this structural g rowth rate of the economy mov es down for one reason or another, and if the central bank does not adjust downwards the short rates target, then the economy will mov e, ov ertime, into a deflation-depression«

� The same is true on the other side if the g rowth rate mov es up« We could hav e an inflation boomemerg ing

� Moreov er the mandate of the central bank may change from one country to a g roup of countries,and if the central bank follows a policy aimed at the average of all those countries , then all those with a

below av erage natural rate will g o bust, e v entually .� This is what is happening in EuroLand.



GaveKal Research23

Incompetence & Arrogance

Fr ance: Mar ket Rates and Natur al Rate

Fr �

� c�

�

DP t� t�

l, V� l, s�

[�

�

3, c.� .�

12] �

�

rk�

t R�

t�

i � R� �

l T�

r � sFr

�

� c�

�

DP t� t�

l, V� l, s�

[�

�

3, c.� .�

12]

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

P

r c

t

-3

-2

-1

0

1

2

3

4

5

6

7

M ark et Rat e �

el

N at r al Rat e= Gr

t h

M ark et Rat e abov e N at r al Rat e = B st

� Rates in France

are 200 bp too

hig h.

� The French

Economy should

continue collapsing .

� Question: is it

g oing to be sav ed

by a positiv e

mov ement in

foreign trade

(boom in exports)?

� See next pages



GaveKal Research24

The French Example

France Deflationary ressure Inde (D I)

Using I

*C

I0

rench

I

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

er c en t

-5

-3

-1

1

3

5

7

9

11

13

15

Mar j et Ratek

bove l atural Rate

Mar j et Rate m elow l atural Rate

� Mark ets

rates hav e

been abov e

the natural

rate 95 %

of the time since 1987.



GaveKal Research25

Back to Purchasing Parity

Purchasing Parity djusted for the differences in Productivity

n

rance Exchange rate USo

/n n

urchasing

arity

ne Standardo

eviation U

ne Standardo

eviationo

own

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

U S

/

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

0

1

2

3

4

5

6

7

8

9

10

US ollar ver alued

US ollar Undervalued

� On a PP

adjusted for

the

diff erences in

productivity ,

the Euro isov ervalued by at least 15

%...and this is

not to

mention the

PP with

China, Korea

etc«



GaveKal Research26

France is not Price Competitive

Productivity Differences & uro vs Dollar

roductivity Europe- roductivity USTaux de Change

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

i f f er en c e s

-6.0

-5.5

-5.0

-4.5

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

E x c h an g e

a t e

0.8

0.9

1.0

1.1

1.2

1.3

1.4

The Euro should be at .

� The

EuroLand

economy is

not benefiting

from the rise

in

productivity which w e are

seeing in the

US.

� In fact

productivity

k eeps

decelerating in

Europe (UK

included )



GaveKal Research27

The Rise of the Euro Will Keep Hurting

Eur o vs Dollar Fr ench Exports

c r t D/ RFr c rts f s s r ic s, V l , s , Ri t c l

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

1 2

z

t {

s V

|

r i |

t i

z

s

-20

-15

-10

-5

0

5

10

15

20

1 2

z

t {

s V

|

r i |

t i

z

s

-20

-15

-10

-5

0

5

10

15

20� The collapse of

French (read

EuroLand ) exports

is just starting .



GaveKal Research28

Who is going to Pay?

Purchasing Parity en uro & dded alue in French Industry

rance alue added, by sector, industry, alue, saeviation rom urchasing arity with the Yen

Jul 95 Jul 96 Jul 97 Jul 98 Jul 99 Jul 00 Jul 01 Jul 02 Jul 03 Jul 04

al u eA d d e d

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

E U

/ J

Y

-20

-15

-10

-5

0

5

10

15

20

} ren ~ h Corporate Profits to Collapse

� W ho else butthe Frenchcompanies?

� After all, w e hav e a

Gov ernment which has notrepealed one of the stupid Socialist laws

� Lik e the UK conservativ esbefore Mrs

Thatcher, they are ¶·manag ing ··the decline.



GaveKal Research29

The EuroLand Drama: End of Act 1, Moving Towards

Act 2� From 1970 to 1991, the German Industrial production g re w on av erage by 2.5 % per year.

� From 1992 to 2003, this g rowth rate has fallen to 1.2% per year. ( Our objectiv e here is NO T toexplain this decline, but simply to mention it).

� In the 80·s real rates in Germany w ere most of the time abov e 3% when the g rowth rate was at2.5%. Tig ht but not unbearable.

� Those rates are still close to 3%, e v en thoug h the g rowth rate has fallen to 1.25%. The diff erence betw een the natural rate and the mark et rate has seldom been hig her.

� An Austrian central Bank by gravely misreading the long term structural growth rate

of its economy can create a disaster about as bad as anything a Keynesian central bankhas achieved in the past.This state of affairs cannot not lead to the collapse of the Euro.We are not sure that the Euro will survive in its present format.



GaveKal Research30

The Economy is very Sensitive to the Variations in

Short RatesFed Funds vs. Industrial Pr oduction in the US

USA IP total index, Volume, sa [ma 3, c.o.p 12] Changes in Fedeal Funds Rates RHS Inverted [ma 3, c.o.p 12, lag 12]

70 71 7 2 7 3 7 4 7 5 7 6 7 7 7 8 7 9 8 0 81 82 83 8 4 8 5 8 6 8 7 8 8 8 9 9 0 91 92 93 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 02 03 04

Y Y %

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

F

F

s V

r i t i

s i

r t

-75

-50

-25

0

25

50

75

100

125

Lead T ime

M ont hs

W ar+T a x Incr eases

� Tw elv e monthsafter a fall in USrates, Economicactivity picks up,the re v erse being

also true.� As a result the

US central always maintain the f ed funds ratesbetw een the long term g rowth rate of the USeconomy and 0(in real terms)«



GaveKal Research 31

A Fischerian Central Bank

Real Rates US GDP

DP i V

l

12

t�

s V� ri � ti

sR

� l R� t s

T Bills

si

�

10 Y I fl � ti

2.3 0

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

R

l R

t s

-2

-1

0

1

2

3

4

5

Boom. t he F ed T i g ht ens

B � st, t he F ed �

ases

R eal Rat es R emai n Bet � een - and +3...

� There is noalternativ e (TINAas Mrs Thatcher

was fond of say ing ) , but to be a Fischerian central bank,manipulating short rates,putting themabov e the g rowthrate of the economy when the economy isbooming , and putting them at

zero or below when the economy isbusting .



GaveKal Research 32

Conclusion

� Of all the countries which w e follow, the biggest positiv e spread betw een the natural rate and the mark et rate are to be found in Asia in general and China in particular. (see our R esearch on

Asia & China) A ne w boom there has started or is imminent. The way the local central banks will manage the passage from K eynesian orthodoxy to Fischerian prag matism will be the k ey betw een a ne w boom and bust cy cle or a sustained period of economic g rowth.

� In the US the fundamentals hav e seldom been better for risks tak ers and corporate profits. The US companies are back to positiv e cash flow. In the US, w e should see a massiv e depreciation of the US dollar vs. the Asian currencies, and an export surge, accompanied by a boom in capital spending . The Fed will hav e to tig hten pretty soon, or run the risk of inflation accelerating mark edly .

� No hope for EuroLand, except if the Euro collapses and bring s about a surge in nominalactivity throug h exports, allowing the mark et rates to mov e below the natural rate at leasttemporarily . Unfortunately , w e tend to belie v e that if the Euro w ere to fall the ECB mig ht be

raising rates «

� The procedures of the ECB are economically incoherent, and cannot work. We are not sure that the Euro is g oing to surviv e in its present format. It could v ery w ell disappear. EuroLand isentering into a massiv e political crisis.



GaveKal Research 33

For more information, please contact Louis-Vincent Gave

at [email protected]

or call us on 852- 2869 8363, fax: 852- 2869 8131.

This presentation is available on our website:

www.gavekal.com

Documents

Perspectives économiques 2003