Soros Issues Both Praise And Warning

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This week many of the world’s wealthiest meet amidst the snow banks in Davos, Switzerland, accompanied by business people and politicians chasing that wealth and eager to influence it.  Inevitably, a sizeable press corps pursues interviews or at least sound bites.  And assorted glitterati prowl the premises doing whatever it is glitterati do.

A regular attendee at the World Economic Forum over the years, hedge fund pioneer George Soros is always in demand by financial reporters eager for a story.  Headlines this morning proclaimed Soros’ conclusion that central bank quantitative easing has prevented a worldwide depression.  The increasing success of multiple central bankers’ reflationary efforts has emboldened investors and underlies the continuing progress in most of the world’s equity markets.

Notwithstanding rising equity prices, Soros argues that Europe’s fundamental problems “have been papered over,” not solved.  He sees Germany’s insistence on further austerity–the price for ongoing rescue funds for endangered Eurozone countries–leading to further recession.  The division of countries into creditors and debtors with Germany in charge is “…in the long run, intolerable.”  He views the political instability as creating the “danger of destroying the European Union.”

Soros pointed also to problems brewing between Europe and other developed countries and warned of prospective currency wars.  No country wants the strongest currency, because it boosts the price of a country’s exports.  That dilemma looms as a possible problem in 2013 as countries throughout the world fight to retain their export competitiveness.  Historically, currency wars are unpredictable and highly destabilizing.  They will remain a hard-to-evaluate wild card for investors in the period ahead.

With its succession of quantitative easings, the United States is in the forefront of widespread efforts to weaken currencies.  This month marks a milestone in that unconscionable effort.  Merely four years ago, the balance sheet of the Federal Reserve showed a figure of approximately $800 billion after almost a century of existence.  After less than half a decade of unprecedented money printing, that figure has just reached the almost inconceivable level of $3 trillion.  It is scheduled to reach $4 trillion by year-end.  Members of the Fed’s apprehensive minority, like Dallas Fed President Richard Fisher, argue that the current level represents a massive gamble, since there is no precedent for withdrawing such a volume of stimulus.  In fact, as pointed out in great detail in Reinhart and Rogoff’s “This Time Is Different,” similar attempts to rescue countries from banking crises over past centuries have typically resulted in severe economic dislocations for a decade or more.  The Fed and other central bankers are playing with fire.

For now, however, such aggressive stimulus is pushing stock and bond prices up.  As we pointed out in last week’s year-end commentary, that rise can continue as long as investors retain confidence in central bankers’ ability to overcome weak economic fundamentals.  Investors are well advised, however, to continue monitoring that level of confidence, which can reverse quickly.