Counterparties: ‘Bridges to nowhere’ in central banking
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Traders and financial journalists have a favorite game: guessing when the Fed will step in and juice the markets. “The Fed signals possibility of something!” “Fed governor leaves door open for potential action at an unknown date!”
We all know this pattern; it still moves markets and sends CNBC anchors into a lather. But it’s worth taking a step back and taking in the latest comments from Mohamed El-Erian and George Soros about central banks. The real problem here isn’t Fed-obsessed traders making the market more volatile. Rather, they suggest, the world’s central banks could be doing more macroeconomic harm than good.
Both El-Erian and Soros are adamant that the European crisis is getting worse, despite the ECB’s huge interventions. Soros says: “the crisis has entered what may be a less volatile, but potentially more lethal phase.” The ECB’s LTRO operation, he writes, has helped the markets but “obscured underlying deterioration” that threatens to break up the EU.
El-Erian, for his part, says “the problems in Europe are getting bigger.” But his most fascinating comments are focused on the U.S. (His full speech, given at the Federal Reserve bank of St. Louis, is a must-read.) Cut through the wonkiness of El-Erian’s speech, and you have some of the harshest warnings about modern central banking in recent memory.
Among the potential consequences of central bank actions, according to El-Erian: damage to pension and money market funds; “artificial pricing, lower liquidity and a more cumbersome price discovery process”; contributions to higher commodity prices; pressure on emerging economies to lower rates; a gusher of speculative cash destabilizing emerging economies; and, last but not least, exacerbated income inequality, as the stocks and bonds owned by the wealthy become more valuable.
The broader idea, says El-Erian, is that the world’s central banks have transformed the world’s priorities, so that traders with a short-term outlook are dominating investors who might be able to make distinctions more useful than simply “risk on” and “risk off”.
We trade too much and invest too little – and a lot of that is the fault of the Fed and the ECB. Their liquidity helped to put out the fires of 2008, but looking to central banks to fix the world’s economic problems, El-Erian says, is just asking for expensive “bridges to nowhere.”
On to today’s links.