Tag Archives: Central Banks

Biting the Hand that Fed Us

Mr. Kevin Warsh, a former member of the Federal Reserve board, now a distinguished visiting fellow in economics at Stanford University’s Hoover Institution, pens a damning Commentary of the Federal Reserve in today’s US print edition of the Wall Street Journal.   

In “The Federal Reserve Needs New Thinking“, he slams the Fed for “….[T]he economics guild push[ing] ill-considered dogmas into the mainstream of monetary policy. The Fed’s mantra of data-dependence causes erratic policy lurches in response to noisy data. It’s medium term policy objectives are at odds with its compulsion to keep asset prices elevated. It’s inflation objectives are are far more precise than the residual measurement error. It’s output-gap economic models are troublingly unreliable.”

If that were not enough he adds: “And it expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.”

Wow- this is a damning perspective from a ex-member of the Fed. I have to say that I tend to agree with his perspective. However the Comment falls short of the title: there is little new policy offering or suggestion to warrant any ‘new thinking.’ The challenge is to query what could or should the Fed and other central banks do differently.
One odd idea I toyed with a few months ago (see The ghost of Keynes haunts our global leaders and economic conditions today) is to globally reset interest rates as if a new normal had been established. What I mean to say is that central banks around the world should all raise their interest rates at the same time by an agreed amount in order to:

  • Preserve current interest rate differential between central bank authorities
  • Establish a more natural rate in order to reestablish normal market and investment operations

If we had nearer-normal interest rates the following would happen:

  • Private capital investment decisions might once again take on a normal demand curve and pattern, thus contributing and steering toward increased productivity
  • The cost of money will rise and so private firms will stop issuing bonds or taking out cheap loans only to increase share buy-backs, thus decreasing the inequality in invest class assets
  • M&A levels would fall to more normal competitive levels
  • Consumers will start to save again
  • Pension funds will have their unfunded portion of their liability reduced

All in all that would be a good day at the office. But it only works if the Fed and central banks in UK, Canada, Europe, Japan, and China agree and collaborate closely.  Additionally the IMF probably needs to leed this effort.

The other problem is the large overhang of debt that central banks now have on their balance sheets. These acquisitions represent government (and some private) debt. These enlarged balance sheets also distort the market. The problem is that central banks have no idea how to jettison these debts without completely upsetting the market again.  

So I guess the only option might be to collaborate with other central banks and agree some kind of normalized write-off. If all central banks agreed to write-off 75% of the government debt they hold, it would free up government spending (since they can start up again, hopefully on the right things this time like education and infrastructure) and the market prices will be balanced. This is of course a silly idea. But how else can we make progress with this challenge?

Yes, new thinking is needed. And a lot more collaboration. The solution will not be found in one central bank. We are too connected. We need a new Bretton Woods 2.0 agreement.

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More Important than the US Fed: The Chinese Economy in 2016

You will have noticed this last week how a sneeze in China can create strong flu symptoms around the rest of the world. Not even the Fed, with its desire to raise interest rates, has the power to move the markets as much. To be fair, the data from China that spun the markets this last week was somewhat unexpected – and the Fed communicates its plans ahead of time. But the real point is that small changes in data from China have a bigger impact on global markets than small changes in data from the US. And this is just the start.

Economists and market pundits have been fixated on when, if, and by how much and fast, the US Federal Research will raise interest rates. The false start in September 2015 was superseded with an as-expected rate raise in December. Now the expectation is that through 2016 the US economy will experience a full 1%  raise. This may or may not take place. I am of the opinion that it won’t – and that the US Fed will regret raising rates and will be forced, due to worsening global economy conditions, to lower rates again before the year is out. But even if they continue to raise or cut rates, I don’t think it matters much. It matters a whole lot less than what is going on in China.

China’s economy is in a unique position. It has been the largest single contributor to global growth for several years. This growth has been created by debt induced spending, mostly related to manufacturing and massive growth in state controlled businesses.  Growth we know is slowing and continues to show signs of falling further.  The country sits at a cross roads as the authorities know that they need to shift the economy from a manufacturing/export-based market to a consumer/consumption-based market, but this cannot be achieved in a year. As we sit here and ponder these shifts, manufacturing and confidence in manufacturing are contracting and this continues to drive down commodity processes which transmits deflation globally. At the same time, debt levels are at all time highs and the profits from state controlled industries are falling and showing signs of remaining negative for some time. See China Faces Era of Hard Trade-Offs in Saturday’s US print edition of the Wall Street Journal.

The reality is that the Chinese economy will either have what is called a hard landing in 2016, or a soft landing. A hard landing is a more disruptive collapse of demand that will create damaging ramifications, I mean more damaging ramifications, for the global economy. A soft landing may result in a gradual softening of demand and a chance for the Chinese leaders to cope with the result and so smooth out what would otherwise be disruption. The fact is that China is not a market economy, it’s currency is not free floating, and despite all the kind words from the IMF, it won’t be so for some time – if at all. China is a managed economy and unless its decision makers are well versed in economic theory and history, their ability to manage all the necessary levers across industry, monetary and fiscal policy, while at the same time balancing social upheaval with political dominance and a rising middle class, it can only result in one outcome: volatility.  

We don’t need to bet on whether China will succeed with a soft or hard landing. We can assume one or other will take place but we should assume that increased volatility in the Chinese economy, and thus the global economy, will be the norm for at least 2016, possibly into 2017. With that said, we can also conclude that there is little that the US can do to mitigate such dynamism. China’s movements and policy changes, however communicated (or not communicated), will have more impact on the global stock market, funding/debt levels and currency movements than anything anyone else can do.  
If ever there was a need for real coordination, between central banks of US, Europe, Japan, China and UK, it is now. If only the IMF had the mettle it was meant to have it would call just such a meeting – a Bretton Woods 2.0. Fat chance. Hang on chaps, it’s going to be a bumpy ride. And look to the East. From there is where the economic dragons breath will hail.

Update January 12 2016 – Aee “FT Big Read.  Markets – Looking for Clues” for a good write-up concerning the strengths, and otherwise, of the Chinese economic leadership.

Can Central Banks Run Out of Things to Buy?

There was an interesting article hidden in the depths of yesterday’s US print edition of the Wall Street Journal titled, Could Japan’s Central Bank Run Out of Bonds to Buy? This is not as far out as it sounds. Of course, the question arises from the massive amount of “quantitative easing” Japan’s central bank has undertaken in the name of driving demand in a sluggish economy. The USA has done the some thing, the U.K. And Europe too. It has been the second weapon of choice for central banks once interest rates hit rock bottom, or even gone negative.

There is not much research that proves that QE actually drives economic demand. In fact, there is ample evidence that QE does not drive demand in an economy. In fact recent data points to how firms report that their treasury departments do not seek new investments to drive growth if interest rates are rock bottom or cash is cheap; they fund their plans that are based on other factors to do with their industr.  These same firms have though sold bonds and acquired loans in order to drive M&A and larger share buy-back schemes. Thus the invester class has gotten much richer while the rest of the middle class has not.

Such massive amounts of bond buying has created huge market distortions. The interest rate at which sovereign governments can offer bonds remains depressed as central banks swallow up larger and larger amounts of bonds. Such a large buyer in the market should crowd out private sector demand for the same bonds. To help spread the impact central banks, as in Japan, have expanded the definition of what it is the central bank can acquire in the name of QE, even to the point of including shares.

In a nutshell QE has not resulted in the behavior central banks sought. And now we are in a pickle. Central bank balance sheets are ballooning, and just as the business cycle passes its peak, central banks have little wiggle room to help smooth the downswing: interest rates remain rock bottom (for the US, they are a smidgen above rock bottom) and balance sheets are full. Even in the US, words of “normalization” does not yet include the Fed selling off its war chest of invested bonds. Such offloading will take years since its impact on the market will be huge: it would drive up the need for bond issuers to offer higher returns in order sell them.

So the question asked by the WSJ is not fanciful. It is a sad reflection of the times we are in.  2016 will be a challenging year for central bankers – as well as for the rest of us. The bad news for us is that we don’t get the chance to write a book after the story has been completed and make a million from that effort. 

Happy New Year to you!