Three cheers for central banks! That may sound strange coming from someone who has long been critical of the world’s monetary authorities. But I applaud the US Federal Reserve’s long-overdue commitment to the normalization of its policy rate and balance sheet. I say the same for the Bank of England, and for the European Central Bank’s grudging nod in the same direction. The risk, however, is that these moves may be too little too late.
Central banks’ unconventional monetary policies – namely, zero interest rates and massive asset purchases – were put in place in the depths of the 2008-2009 financial crisis.
This strategy did arrest the free-fall in markets. But it did little to spur meaningful economic recovery. The G7 economies (the United States, Japan, Canada, Germany, the United Kingdom, France, and Italy) have collectively grown at just a 1.8% average annual rate over the 2010-2017 post-crisis period. That is far short of the 3.2% average rebound recorded over comparable eight-year intervals during the two recoveries of the 1980s and the 1990s.
Yet this massive balance-sheet expansion has had little to show for it. Over the same nine-year period, nominal GDP in these economies increased by just $2.1 trillion. That implies a $6.2 trillion injection of excess liquidity – the difference between the growth in central bank assets and nominal GDP – that was not absorbed by the real economy and has, instead been sloshing around in global financial markets, distorting asset prices across the risk spectrum.
Normalization is all about a long-overdue unwinding of those distortions. Fully ten years after the onset of the Great Financial Crisis, it seems more than appropriate to move the levers of monetary policy off their emergency settings. A world in recovery – no matter how anemic that recovery may be – does not require a crisis-like approach to monetary policy.
A failure to do this was, in fact, precisely the problem during the last pre-crisis period, in the early 2000s. The Fed committed the most egregious error of all. In the aftermath of the bursting of the dotcom bubble in early 2000, and with fears of a Japan scenario weighing heavily on the policy debate, it opted for an incremental normalization strategy – raising its policy rate 17 times in small moves of 25 basis points over a 24-month period from mid-2004 to mid-2006. Yet it was precisely during that period when increasingly frothy financial markets were sowing the seeds of the disaster that was shortly to follow.
In the current period, the Fed has outlined a strategy that does not achieve balance-sheet normalization until 2022-2023 at the earliest – 2.5-3 times as long as the ill-designed campaign of the mid-2000s. In today’s frothy markets, that’s asking for trouble.My view:
Stephen Roach writes a fine article outlining the situation central bankers face and fear 10 years after the beginning of the great financial crisis. While he suggest normalization of interest rates is the solution, he does not point out the consequences of the debt deflation that would ensue.
Central Bankers, like central planners in government, do not operate in the same world as a business person who is trying to make a profit or control costs. They operate in the ephemeral world of politics and political correctness where "truth" consists of whispers that the ultra wealthy and well connected want to hear.
So hear is some straight to the point truth from PW, the interest rate on capital can not nor should it remain near zero for any longer than a fleeting instant. We have near zero rates for almost 9 years in the United States, Europe, Japan, and Canada. This is madness as it inflates non yielding assets to unbelievable values. Who really thinks an ordinary house in Toronto or Sydney or Vancouver is worth $1.5 million?
Consider gold, the purest form of money, which is also a non yielding asset, that has grown from $264 per ounce in 2001 to $1290 today, a factor of 5 in 16 years. How can gold out perform the S&P 500 (index of the largest companies in the USA) which was in the 1100 range in 2001 and now is 2550, an increase of 2.5 fold in the same period of time?
This should tell us that something is amiss. Non yielding assets should not outperform those that yield dividends and interest. But something is very wrong. Central planners and the central bankers that are their instruments have created a massive bubble in government debt (bonds) and other obligations that can not be repaid, particularly if the G7 economies only grow at 1.8% annually.
So what we see is that the risks of tinkering in the economy are showing up in gold and other non yielding assets as the froth grows frothier. As we have mentioned before, gold is the thermometer of the financial system, if it is going up, that is likely not a good thing for the economy as a whole in the not too distant future. So in our view, personal debt elimination is paramount in this environment along with a savings and useful skills strategy. We expect the ride in the economy will get quite rough in the next 12 to 18 months.