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Gordon Pape
Gordon Pape

Get Ready for 2-1/2 More Years of Slog

June 24, 2012 | About:

Get ready for 2-1/2 more years of slog - and that's the optimistic view. That's the message we're getting in increasingly definitive tones from central bankers, politicians, and economists. It won't be until 2015 - if then - that the world emerges from the long slump that was triggered by the credit crunch of 2008-09 and exacerbated by the sovereign debt crisis.

The U.S. Federal Reserve Board acknowledged that reality several months ago when it announced that it would maintain its target rate at an all-time low of zero to 0.25% until the end of 2014. The Fed reinforced its stance last week by reducing its estimate for U.S. growth this year to a maximum of 2.4%, down half a point from its April prediction. In response to the deteriorating outlook, Chairman Ben Bernanke announced an extensive of "Operation Twist" until year-end. It's a financial manoeuvre that involves selling billions of dollars worth of short-term bonds and buying longer-term issues in an effort to keep interest rates low.

Moreover, there are indications the Fed might reluctantly consider a third round of quantitative easing (QE) if conditions worsen, although that may not happen until late in the year. QE is a euphemism for turning on the printing presses and flooding the economy with more cash. The aim is to prime the lending pump and encourage consumer spending but the longer-term results include higher inflation and a debasement of the U.S. dollar. In other words, short-term gain (maybe) for long-term pain (certainly).

The U.S. is not the only country to resort to QE to try to stimulate growth. The Bank of Japan tried it in the early years of this century as a means of fighting off deflation. It didn't work. The European Central Bank has used it twice in the past few years, although they have avoided referring to it as QE - they call it long-term refinancing operations (LTRO). As far as anyone can tell, the positive effects have been negligible.

Britain has a £325 billion QE program in place and Bank of England Governor Mervyn King wanted to pump in an additional £50 billion to try to right the faltering economy. However, that move was defeated earlier this month by the Bank's monetary policy committee in a tight 5-4 vote.

Does it work? The International Monetary Fund (IMF) says QE helped to ease the credit freeze that seized up financial markets after the collapse of Lehman Brothers in September 2008. The IMF also credits QE with boosting the stock market recovery that began in March 2009. However, many members of the U.S. Congress on both sides of the floor strongly oppose the strategy.

"I think it's a bad idea," said Ohio Republican Congressman Steve Chabot last year. "Just printing more money and throwing it out there is devaluing the money we already have. Over the long term it's inflationary. It sends the wrong message."

On the other hand, investors love the idea because QE theoretically stimulates lending and encourages people to buy homes, expand businesses, and hit the malls. All of that is good for stock markets. That explains why the expectation of another round of QE sparked a short-lived rally from June 11 to 19, during which the Dow rose 426 points. Then the Fed spoiled the party by rejecting QE3 in favour of more Twist. Stocks promptly sold off.

Gold was also hammered after the Fed statement was released. Bullion had been on the rise because it is priced in U.S. dollars so any devaluation in the currency would increase the value of the metal in world markets. When QE3 didn't happen, gold (and silver) sold off.

Clearly, the Fed is reluctant to implement another round of QE, especially in an election year given the opposition on Capitol Hill. So any decisive action to revive sagging U.S. growth is likely on hold until after the first week of November, unless the economy falls off a cliff in the meantime.

This means we should prepare ourselves for more of the same, both short and long term. Europe's crisis will not be solved any time soon, the Americans are almost powerless to deal decisively with their situation until after the election, and we're caught in the middle. Stay defensive with your portfolio, focus your stock selections on top-quality companies that can do well in a weak economy, and don't abandon bonds. That may be my core advice for the next two years.

About the author:

Gordon Pape
Gordon Pape is the best-selling author/co-author of many acclaimed investment books, including the recently-published Sleep-Easy Investing (Viking Canada ). He is also publisher and editor of five investment newsletters, including the Internet Wealth Builder, Mutual Funds Update, The Income Investor, and The Canada Report, which was created specifically for U.S. residents interested in investing in Canada . He is a columnist for several magazines and websites and a frequently quoted media source. He has been a featured speaker at numerous events including the World Money Show in Orlando . His websites can be found at www.BuildingWealth.ca and www.TheCanadaReport.com.

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