The Great Debate

Four years ago world leaders, meeting in the G20 crisis session, agreed they would all work to move from recession to growth and prosperity.  They agreed to a global growth compact to be delivered by combining national growth targets with coordinated global interventions. It didn’t happen. After the $1 trillion stimulus of 2009, fiscal consolidation became the established order of the day, and so year after year millions have continued to endure unemployment and lower living standards.

Only now are there signs that the long-overdue shift in national macro-economic policies may be taking place. The new Japanese government is backing up a “minimum inflation target” with a multi-billion-dollar stimulus designed to create 600,000 jobs. In what some call the “reverse Volcker moment,” Ben Bernanke has become the first head of a central bank for decades to announce he will target a 6 percent level of unemployment alongside his inflation objective. And the new governor of the Bank of England, Mark Carney, has told us that “when policy rates are stuck at the zero lower bound, there could not be a more favorable case for Nominal GDP targeting.” Side by side with this shift in policy, in every area but the Euro, there is also policy progress in China. It may look from the outside as if November’s Communist Party Congress simply re-announced their all-too-familiar but undelivered wish to re-balance the economy from exports to domestic consumption, but this time the promise has been accompanied by a time-specific commitment: to double average domestic income per head by 2020.

The intellectual case for change is obvious. A chronic shortage of demand has developed for two reasons. First, as the IMF announced at the end of 2012, the adverse impact of fiscal consolidation on employment and demand has been greater than many people expected. Secondly, the effectiveness of quantitative easing has almost certainly started to wane. As former BBC chief Gavyn Davies has put it, “the supply potential of the economy is in danger of becoming dependent on, or ‘endogenous to,’ the weakness of domestic demand. …With demand constrained in this way for such a lengthy period of time, supply potential is beginning to downsize to fit the low level of demand.” It is a new equilibrium that can be reversed only by boosting demand.

But why is there so little optimism when the paradigm shift sought in 2009 is finally starting to materialize? Why do experts continue to downgrade their forecasts for 2013 and even 2014, while discussion so often drifts toward talk of a lost decade? It is, I suggest, because while countries are today adopting national growth strategies, they have missed out on the other part of the 2009 decision — the necessity of coordinated global intervention. And the big question is whether the momentum for growth can be sustained by national initiatives alone in the absence of global action or will instead melt away once again under the pressure of narrow, self-defeating national policies.

There is depressing testimony to stagnation produced by a lack of global demand. Olivier Blanchard, the IMF chief economist, has deployed devastating figures to demonstrate how fiscal consolidation has depressed the Western economy. Jonathan Portes of the National Institute of Economic and Social Research underlines the point: Austerity in one country reduces demand in the next and vice versa. ”The hit to output in Germany is now 2%. In the UK it is 5%; and in Greece 13%,” he wrote. Still more shocking is the impact on debt-to-GDP ratios. As Portes points out, fiscal consolidation was supposed to improve fiscal sustainability; instead, it makes matters worse. “This isn’t true just in extreme cases like Greece – fiscal consolidation across the EU has raised debt-to-GDP ratios in Germany and the UK as well. In both the UK and the euro area as a whole, the result of coordinated fiscal consolidation is a rise in the debt-GDP ratio of approximately five percentage points. For the UK, that means a debt-GDP ratio of close to 75% in 2013 instead of about 70%. We are not running to stand still; we are determinedly heading in the wrong direction.”

The good news is that the European Central Bank will probably start a massive additional round of quantitative easing to fight the break-up of the euro zone.

The bad news is that they will, as ever, only choose the right policy, as Winston Churchill said of the Americans, after exhausting all of the alternatives.

Global share markets rallied furiously on Wednesday, fed by hopes that the ECB would increase its bond-buying efforts, a possibility raised by its chief Jean-Claude Trichet in an appearance before the European Parliament. Trichet faces stern opposition inside the ECB from fellow central bankers, notably German Axel Weber, who believe that policy should be normalized rather than loosened.

- The opinions expressed are the author’s own-

FOMC meetings are usually a strange combination of formality and easy-going familiarity but levity may be in short supply this week. The Fed’s institutional credibility is on the line, and the normal decorum that characterizes relations among committee members has become increasingly strained over the summer.

Divisions between proponents and opponents of a second round of quantitative easing (QE2) have been on display as never before. It is not clear what members will say to one another to fill two days since all the arguments have already been rehearsed in detail and in public over the last six weeks.

In a thinly veiled swipe at his colleagues, Kansas City Fed President Thomas Hoenig has stumped around his patch on the Great Plains denouncing QE as a “dangerous gamble” and “a bargain with the devil”.

-The views expressed are the author’s own-

A warning by an International Energy Agency (IEA) analyst this week that quantitative easing (QE) risked inflating nominal commodity prices and derailing the recovery drew a withering response from Nobel Economics Laureate Paul Krugman, who labelled the unfortunate analyst the “worst economist in the world”.

According to New York Times columnist Krugman “Higher commodity prices will hurt the recovery only if they rise in real terms. And they’ll only rise in terms if QE succeeds in raising real demand. And this will happen only if, yes, QE2 is successful in helping economic recovery”.

Krugman’s criticism is unfair. There are clear links between QE and investor appetite for commodity derivatives and physical stocks (via the Federal Reserve’s “portfolio balance” effect), and from investors’ holdings of derivatives and physical inventories to cash prices (given the relatively inelastic supply and demand for raw materials in the short term).

QE2 — a second round of quantitative easing — means that soon the U.S., Japan and Britain will all be busily exporting their deflation, raising the question: Just how much pain can the euro zone take?

If by November we have three of the largest economies printing money and buying up their own debt, the outcome — in fact the intention — will be to drive their currencies lower against their trading partners, opening new international markets for their goods and, by raising the price of imported goods, fighting deflation before its debilitating psychology can take hold.

That is the plan, at any rate, and, unless something else happens, it will force the euro up against all major currencies, including, as it is tied to the dollar, the Chinese yuan. The euro has risen about 9.5 percent against the dollar in the past month, a trend that ultimately will murder European exporters and its stock market.

While “decoupled” is not the same as “immune”, look for growth and investment performance in emerging markets to be better than in the sclerotic developed world.

In the short term emerging markets will be free riders as the U.S. launches the second round of quantitative easing. A portion of the stimulus generated by “QE2″ will inevitably leak cross border, while the risks of the gambit will fall almost entirely on the U.S. and on dollar-denominated assets.

QE2 is designed to work in two ways: to stimulate investment by making it cheaper to borrow money and to lift consumption by boosting asset prices.

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

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.

A bubble can simply be defined as an occurrence that begins when the price of an asset has been driven significantly above it "fair" value. According to the efficient markets theory this would not happen.

-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

Go on. Admit it. You didn’t see it coming, did you? You never thought a member of the G20 nations would dare to break ranks and raise interest rates this soon.

But Australia has done just that. The Central Bank of Australia has increased the cost of borrowing by 0.25 percent to 3.25 percent. It is doing what it thinks is right for the country regardless of what the rest may think. Now, Asian countries, keen to avert another bubble, may follow Australia’s lead and ratchet up interest rates before long.

– John Kemp is a Reuters columnist. The views expressed are his own –

The Bank of England’s decision to continue with its asset purchase programme, or quantitative easing (QE), at the rate of 50 billion pounds per quarter in Oct-Dec, unchanged from Jul-Sep, shows bank officials are more worried about ending support for the recovery too soon than about risking inflation by leaving it too late.

The problem with QE is that you have to keep buying the same amount of assets each month to maintain the same monetary stance. With interest rates, the Bank can cut them and they stay cut. If asset prices drop with QE, it represents a tightening of monetary policy.

-- John Kemp is a Reuters columnist. The views expressed are his own --

LONDON, April 9 (Reuters) - The Bank of England's terse press statement announcing it will maintain overnight rates at 0.5 percent and continue the existing 75 billion pound quantitative easing (QE) programme gives no clue about whether the Bank intends to extend the programme when the first tranche of asset purchases are completed in June.
But officials will have to make a decision soon: unless they signal a commitment to extend QE, gilt yields will rise even further in anticipation that the major buyer in the market will withdraw.
The QE programme is dogged by ambiguity about its objectives (which a cynical observer might conclude is deliberate).
Officially, the aim is to prevent inflation falling below target by accelerating money supply growth, not manipulate the yield curve for government and corporate debt.
In this, the Bank's avowed strategy is more conventional than the Fed's ambitious efforts to determine the cost of credit for borrowers throughout the economy. It is a straightforward quantitative easing patterned on the Bank of Japan, rather than a credit easing patterned on the Fed.
If true, the measure of success is how much the money supply has been boosted at the end of the three month period; the Bank should be indifferent about whether ending QE causes yields and borrowing costs to rise.
So long as money supply has risen consistent with the inflation target, and the Bank can discern some green shoots of stabilisation if not recovery, officials can declare victory, end the programme, and keep the other 75 billion pounds of asset purchases authorised by the chancellor in reserve. Yields can be left to find their natural level.
But many suspect the Bank's real objective is yield control -- in which case it will have to announce another round of buy backs of gilts and corporate bonds in good time, well before the current programme is completed, to shape market expectations.
The results of the existing round have been unimpressive.
After falling initially, gilt yields are almost back up to the level they were at before the Bank's foray into unconventional monetary policy.
The snag is that if the Bank stops buying, other investors will struggle to absorb all the new government paper on offer without a major increase in yield -- pushing up borrowing costs for everyone, precisely what the Bank has sought to avoid.
The Bank's dilemma is whether to push on (heightening fears about inflation) or call a halt (risking a spike in yields all the same).
Either way, the Bank needs to give the market, as well as the Treasury and the Debt Management Office, plenty of warning about its intentions.
(Editing by Richard Hubbard)