The Great Debate UK
-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.
But how long will citizens of Europe and the UK accept rising prices and how long can central bankers continue to stand by while inflation smashes their target rates? To answer this we need to find out two things: firstly, is this rise in inflation really that bad? Secondly, why are central bankers willing to let inflation pass them by without exercising monetary control?
Inflation is a tricky thing to get right. A little is good since it helps growth, but not enough is bad as it can stunt an economy and leave it in a deflationary spiral. There is also another benefit to inflation: it helps to erode debt levels in real terms. When many developed economies are struggling with unsustainable debt loads, a little inflation helps to lower the size of the mountain.
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.
-Morten Hansen is head of the economics department at the Stockholm School of Economics in Riga. The opinions expressed are his own.-
Latvia, with its 18 percent year-on-year economic decline, ruthless budget cuts to meet the demands stated by the IMF-EU bailout package and recurring rumours of devaluation, may be the most written about country in the world right now, at least on a per capita basis.
from The Great Debate:
The recession will soon be dead, laid to rest alongside the idea of the "Great Moderation", a set of hopeful assumptions that underpins expectations about economic growth and asset valuations.
This, when investors, bankers and executives ultimately realise it will cause them to pull in their horns, take less risks and be less willing to pay high prices for assets.