The Great Debate UK
–Michala Marcussen is global head of economics at Société Générale Corporate and Investment Bank. The opinions expressed are her own.–
The reflex induced by three decades of success is to look to central banks to steer the economy back to a path of sustainable growth, but five years on from the outbreak of the crisis, it is becoming increasingly evident that, despite the introduction of multiple unorthodox policy tools and huge balance sheet expansion, central banks can only help buy time, they cannot fix the underlying issues of huge debt mountains and weak trend potential growth. For this, government action is required, and as each new round of monetary policy easing seemingly comes with diminishing returns – both in terms of the absolute impact and its duration – there is a growing sense of urgency for governments to act.
Steering the economy in the right direction, however, is no easy feat. Stronger financial market regulation is welcome, but the wrong mix implemented too quickly could force disorderly deleveraging of the economy. Well functioning credit channels are an essential part of any recovery. Fiscal austerity is clearly required, and all the more given ageing populations. Fast track austerity, however, comes with increased fiscal contraction multipliers weighing on real economic growth, pushing the economy into an austerity trap. This entails not only missed public finance targets as growth falters, but triggers a loss of confidence with financial markets and electorates alike – each with its own dangers. Boosting trend potential growth is a pre-requisite for both sustainable public finances and for recovery. Often slow to deliver and unpopular with electorates, such reforms become harder to implement the weaker the economy is.In the euro area, there is also the special challenge of risk sharing.
The consensus is that the euro zone will either move to a fiscal and banking union or break-up. Full break-up remains an extreme tail risk; but reaching a fiscal and banking union will take time. As such, a by now all too familiar pattern is set to repeat: market turmoil, a peek into the abyss, an additional policy patch, market relief rally, policymakers declaring the worst over … only subsequently to see turmoil return. The likeliest next policy patch is to give the European Stability Mechanism a banking licence, potentially double its fresh lending capacity to €1 trillion and allow the institution to recapitalise banks directly. This solution does not require a Treaty change (although it needs to be ratified by national parliaments); nor does it place huge potential liabilities on Germany (and the other fiscally strong member states). Ultimately, such a move would only be an additional stepping stone towards a banking and fiscal union and would not secure the longer term credibility required to see sovereign risk premia durably reduced.
This Thursday, Turkey's new central bank governor Erdem Basci will chair his first monetary policy meeting. What can we expect from the man who is seen now as the architect of the country's novel monetary policy? Most analysts predict there will be no change this month to interest rates and banks' reserve requirement ratios. But could the bank, which shocked markets with an out-of-the-blue rate cut in December and a big further rise in short-term RRRs last month, throw another curveball?
ING Bank is among those which believes the central bank could again surprise markets this week. Using Turkish banks' net off-balance sheet currency positions as a proxy, ING analyst Sengul Dagdeviren reckons short-term capital inflows are on the rise again. Banks' net off-balance sheet FX positions had halved between Nov 5 to March 4 to just over $12 billion, as the central bank drastically widened the gap between the overnight borrowing and lending rates -- a move that discouraged short-term swap positions. But these positions have risen back over $21 billion in the month to 8 April, Dagdeviren says, noting this coincides with a 5 percent gain in the Turkish lira against the dollar.
-Kathleen Brooks is research director at forex.com. The opinions expressed are her own.-
Looking through the minutes of the Bank of England’s policy meetings for the past year, there are a couple of patterns that you see emerge. Firstly, that rates are on hold, and secondly, that the UK’s elevated inflation rate is temporary. Now the European Central Bank has joined the chorus. ECB President Trichet recently sounded confident that prices will moderate, even though consumer prices rose above the ECB’s target rate of 2 per cent in December.
Gary Smith, head of central banks, supranational institutions and sovereign wealth funds at BNP Paribas Investment Partners, has written a special guest blog for Macroscope in which he argues that central banks should consider ways to hedge their FX reserves against the crisis.
"After the 2008 crisis, a mathematical approach to measure the adequate level of foreign exchange reserves – import cover or an equation relating to short-term debt – no longer has much credibility. In the absence of sensible guidelines on adequacy of reserves there is now a general desire to have plenty of reserves.
Central banks in debt-strapped countries have a golden opportunity ahead of them, if you will excuse the pun, to help their countries' finances by selling their yellow metal holdings.
At least, that is the message that Royal Bank of Scotland's commodities chief Nick Moore has been giving in recent presentations -- and he thinks it might happen. The gist is that gold is now at a record price but banks have not come close to meeting their sales allowance for the year.
What is an acceptable return on equity (ROE) for a bank? That question is likely to dominate the debate among executives, investors and regulators in the coming year. After the spectacular losses of the crash, there is no doubt that banks' future returns should be lower than the super-charged profits earned during the credit boom. But if ROEs fall too far, the consequences could be severe.
Returns are already on the way down: just look at Goldman Sachs. Between November 2007 and September 2009, the Wall Street bank's tangible common equity swelled by 74 percent. In 2007, its best-ever year, Goldman earned a 38 percent return on that equity. This year the bank is expected to report the second-highest profit figure in its history. But its ROE is likely to be just half its level of two years ago.
from The Great Debate:
Stocks and other risky assets are rallying around the world this week because the Group of 20 nations said on the weekend they would keep the economic stimulus flowing, a state of events which illustrates where we are and what a very strange place it is.
The G20, the only group of big hitters that matters because it is the only group which includes the Chinese, met in Scotland over the weekend and, as is the way of these things, did very little with immediate consequences for anybody.
The discrediting of the efficient markets theory in the aftermath of the financial crisis appears to have been accompanied with growing support for the view that rather than efficient in nature, financial markets are predisposed towards the formation of bubbles.
Having wrapped up the two-day get-together in London, G20 central bankers moved down to the Swiss city of Basel (I counted central bank governors and officials from at least 9 countries onboard the same flight) to discuss more about the global economy for a two-day meeting.
The focus here again is the global economic recovery, which seems to be gathering momentum, and the timing of exit policy -- which is essential in the future to avoid inflationary pressure.
It just won't go away, this needling worry about the U.S. dollar losing its coveted top-dog status.
No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency -- namely there's just no alternative -- for perhaps decades to come.