As the IMF meetings close in Tokyo this weekend, it is obvious that governments are struggling to find the correct balance between controlling public debt, which now exceeds 110 per cent of GDP for the advanced economies, and boosting the rate of economic growth. The former objective requires more budgetary tightening, while the latter requires the opposite. Is there any way around this?
One radical option now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely. Read more
The annual meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.
There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.
However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory. Read more
It is often claimed by economists that the central banks have run out ammunition to boost economic activity, but they certainly have not lost the ability to have an impact asset prices. Since the latest round of quantitative easing was signalled back in June (see this blog), global equity prices have risen by 14.5 per cent, and commodity prices are up by 15.4 per cent, despite the fact that economic activity data have shown no improvement whatever over this period.
Clearly, these impressive moves in asset prices have been triggered by a sharp decline in the disaster premia that were priced into markets only three months ago. Mario Draghi and Ben Bernanke have, in a sense, purchased global put options on risk assets, and have offered them without charge to the investing community.
By doing the market’s hedging for it, the central bankers have certainly had an impact. Confidence, while not fully restored, is much improved, which is exactly what was intended. But there is no sign yet from hard data that the downward slide in global GDP growth has been reversed. Until that happens, the market rally will remain on insecure foundations. Read more
Ben Bernanke, Fed chairman, will speak about “Monetary Policy Since the Crisis” at the Jackson Hole Symposium at 10 am (EDT) on Friday. The markets have learned to focus intently on such occasions, since there is something in the clean air of Wyoming which seems to inspire Mr Bernanke. On several occasions in recent years, the tone he has adopted at Jackson Hole has set the trend in financial markets for many months to come.
This year, there are doubts about what the chairman might say. The markets have already assumed that a further monetary easing by the Fed is just around the corner, almost certainly to be announced at the next FOMC meeting on September 12-13. At the very least, this will probably involve an extension of the Fed’s guidance on “exceptionally low” levels for the federal funds rate from the end of 2014 at least to mid 2015.
However, there is uncertainty in the markets about whether the FOMC is minded to do anything more aggressive than that in September. That possibility was raised by the dovish set of minutes for the 31 July/1 August FOMC meeting which were published last week. The key question is whether Mr Bernanke will choose to clarify the ambiguities in these minutes in either direction. Read more
As the eurozone crisis enters a critical phase, market attention is once more focused on the central banks to contain the crisis. They have promised in advance to provide unlimited liquidity to solvent financial institutions if necessary in coming weeks, which is now their standard response to financial shocks. However, the slowdown in global activity caused by the euro crisis may mean that they are thinking of acting more aggressively than that. A further large bout of unconventional easing is now on the agenda. Read more
The Federal Open Market Committee of the Federal Reserve is no longer expected to announce a further round of monetary easing when it concludes its two day meeting in Washington on Wednesday. The fact that the hawks have lost enthusiasm for more quantitative easing is scarcely surprising, given the fall in unemployment, and the stickiness of inflation.
But until very recently the hawks have not been in control of the committee. What is more surprising is that the powerful group of doves which includes Ben Bernanke, Bill Dudley and Janet Yellen, and which normally has disproportionate weight on the FOMC, has also taken QE off the agenda .
As they meet today the Federal Reserve’s governors face a dilemma; with unemployment creeping lower while inflation rises, can they justify a third round of stimulative quantitative easing? Gavyn Davies, chairman of Fulcrum Asset Management, explains to Long View columnist John Authers that while the Fed is keen for QE3, it needs to bring inflation more under control first. (5m 27sec)
The initials LTRO, barely ever discussed prior to last December, now form the most revered acronym in the financial markets. Before the first of the ECB’s two Longer Term Refinancing Operations in December, global equity markets lived in fear of widespread bankruptcies in the eurozone financial sector. Since LTRO I was completed on December 21, equities have not only become far less volatile, but have also risen by 11 per cent.
With LTRO II completed last week, over €1tn of liquidity has been injected into the eurozone’s financial system. Private banks were permitted to bid for any amount of liquidity they wanted, the collateral required was defined in the most liberal possible way, and the loans will not fall due for three years. Any bank that might need funds before 2015 should have participated to the hilt, thus eliminating bankruptcy risk fora long time time to come. Read more
In 1951, an epic struggle between a US president who stood on the verge of a nuclear war, and a central bank that was seeking to establish its right to set an independent monetary policy, resulted in an improbable victory for the central bank. President Harry Truman, at war in Korea, failed in a brutal attempt to force the Federal Reserve to maintain a 2.5 per cent limit on treasury yields, thus implicitly financing the war effort through monetisation. This victory over fiscal dominance is often seen as the moment when the modern, independent Fed came into existence.
The idea that the central bank should place a cap on the level of bond yields is firmly back on the agenda, at least in the eurozone. This week, Italian prime minister Mario Monti said that he was increasingly optimistic that his country’s bond yields might soon be capped. Although he stopped short of saying that this would be done by the European Central Bank, there really are no other viable candidates to achieve this. Furthermore, many economists are arguing that this is the right policy, since Italy is now following a sustainable budgetary policy which deserves to be rewarded by ECB action in the bond market. Read more
Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.
He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.
Gavyn Davies is an active investor and may have financial interests and holdings in any of the topics about which he writes. The views expressed are solely those of Mr Davies and in no way reflect the views of Prisma Capital Partners LP, Fulcrum Asset Management LLP, their respective affiliates or representatives. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations. Readers are urged to seek professional advice before making any investments.