Why global markets think tomorrow doesn’t matter: Kohler
A month ago equities and bonds were in a funk over the Irish fiscal crisis, selling off risk and driving bond yields higher until the Irish government did enough to bring its citizens onto the streets in agonised protest.
Across Europe governments are bringing down austerity budgets to placate the bond vigilantes, not to mention the IMF and flint-eyed bureaucrats of Brussels.
But this week the risk trade is back on and markets are rallying... because the United States has cut taxes, or rather extended the tax cuts that destroyed the national budget 10 years ago, while China has done nothing about another kick in inflation apart from tinker with its reserve ratio again.
According to data released yesterday, Chinese inflation increased from 4.4% to 5.1% in November. In response, the government increased the bank reserve ratio for the sixth time this year, from 18 to 18.5%. Reducing liquidity has plainly failed to control inflation, but they keep doing it.
Meanwhile, the People's Bank of China lending rate remains at 5.56% this morning, more than 1% lower than it was in 2007 when inflation was last at this level. And China continues to hold down the value of its currency, which is also inflationary.
Clearly, the Chinese authorities don't care much about inflation. They might talk the talk, but their actions speak louder. In response, the Shanghai Composite index rallied 2.9% yesterday.
Meanwhile the Dow Jones has rallied 100 points since President Obama turned his back on the Simpson-Bowles Fiscal Commission's recommendations, and extended the Bush tax cuts for two years in a deal with the Republicans.
The juxtaposition was excruciating: on Friday the National Commission on Fiscal Responsibility and Reform recommended deficit reduction measures totalling $US3.9 trillion over 10 years and at the same time Barack Obama was putting the final touches to a deal with Republicans that would add $900 billion to the national debt over two years by extending George W Bush's tax cuts for a further two years.
The tax laws of 2001 were due to expire on January 1, 2011. The tax cuts also had a slow phase-in, which was removed by a second Bush law in 2003, and now the sunset clause has been removed as well.
The original tax cuts, along with the War in Iraq, sent the US budget deficit by $500 billion; Obama has now increased it to almost $2 trillion.
So it's clear that just as China's communist leaders aren't too worried about inflation, America's politicians aren't too worried about the deficit. In fact, you would have to conclude they all think today's inflation and deficits are good things, and that tomorrow can look after itself.
The surprise is that the market agrees, although perhaps that's no surprise when you think about it. The marginal investors who set prices – the big players shifting money around each day on the basis of how they feel about "risk" that day – are as short-term in their thinking as politicians are.
But why are they so tough on Europe, while forgiving devil-may-care insouciance in China and the US? Perhaps it's just because they can.
This article first appeared on Business Spectator.