Might the global economy all go horribly wrong again?
Lorenzo Bini Smaghi, an ECB executive board member, has just warned that those who think the world will return to where it was before the economic crisis are “deluding themselves”.
Addressing a crowded Frankfurt reception hosted by the city’s chambers of commerce, he said: “If the world economy were to return to the pre-crisis situation, within a short timespan a new crisis would be likely to occur because the same imbalances that led to the crisis would build up again.”
In what I thought was a pessimistic comment – even by ECB standards – he went on: “Considering some recent developments and behaviour, and considering the way certain policies are being discussed and the thinking of some key players, such a scenario does not seem that unlikely.” Read more
Jeffrey Lacker, president of the Richmond Fed, today gave an upbeat view of where the economy is heading in 2010. So upbeat, in fact, that explicitly answered the question: How can economists be so optimistic?
His view for 2010:
Putting the whole picture together, I think the most likely outcome is that the economy will grow at a reasonable pace this year – housing should continue to recover from a very depressed state, consumers should gradually expand spending, business investment should make something of a comeback, and these components of demand should overcome a continuing drag from commercial construction.
His explanation for his optimism: Read more
In the wake of the financial crisis, the Federal Reserve has made much of the dangers of using interest rates to “lean against” asset bubbles, such as the one in the housing market whose collapse brought the US economy to the brink. Fed governors have implied that this was their only practical tool. (There have been quieter on the influence they may have wielded by warning of the bubble). The problem, several Fed governors have said recently, lied in a failure of regulation.
At today’s Financial Crisis Inquiry Commission hearings, Sheila Bair, chairman of the FDIC, had a response: the Fed, she said, should have regulated. Read more
If I heard him right, Jamie Dimon, the head of JP Morgan, just told the Congressional inquiry into the financial crisis that in the pre-crisis years his firm never stress tested what might happen if there was a big fall in house prices. Remarkable.
Dimon is a tough risk manager and JPM came through the crisis in relatively good shape. Heaven knows what the others failed to consider.
Now everyone is stress-testing like crazy. But how long will this private sector discipline last? Read more
A Bank of Canada official earlier today sought to dampen concerns that the Canadian housing market be caught in the same type of bubble that threw the US into recession.
In the Bank of Canada’s view, it is premature to talk about a bubble in Canadian housing markets. Recent house price increases do not appear to be out of line with the underlying supply/demand fundamentals. Moreover, with housing starts below long-term demographic requirements, inventories are still declining. It is likely, though, that a significant part of the surge in housing sector activity is associated with temporary factors – notably the historically low borrowing costs, as well as pent-up and pulled-forward demand – which cannot continue to drive increases in house prices and activity. Thus, we see the housing market as requiring vigilance, but not alarm.
One measure of the “underlying supply/demand fundamentals” of housing is the amount home prices rise relative to rental prices. In normal times they rise at roughly the same rate. In the US, house prices rose over 100 per cent between 2000 and the peak of the housing market in 2007, according to the 20-city Case Shiller index, while rental prices grew just 24 per cent. By contrast, in Canada rental prices rose 11 per cent from 2000 to 2008, while the price of a houses in the Teranet 6-city composite index rose 85 per cent over the same time. Read more
A confession: I missed the Fed’s regulatory guidance to banks on interest rate risk yesterday. Some have misread this as a hint that rate increases are coming soon. I think that is the wrong take.
Bernanke and Kohn have talked about using regulatory tools rather than interest rates in the first instance to combat future bubbles and avoid the build-up of financial excesses. The latest guidance looks to me to be a very modest example of this -not a signal on rates. Read more
A summary of Ben Bernanke’s conclusions, from yesterday’s speech.
We must remain open to using monetary policy as a supplementary tool for addressing build-ups of financial risk, but regulation would have been a more effective and surgical tool to combat the house price bubble.
The direct linkages between monetary policy and house prices are weak. Although the most rapid price increases occurred during periods of low short-term interest rates, the price rises seem too large to be explained by rates alone. The most important source of lower initial monthly payments, which allowed more people to enter the housing market, was the increasing use of more exotic types of mortgages and the associated decline in underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary.
OK so it’s not exactly Goldilocks. But maybe we are seeing a post-recession version of Goldilocks – call it Goldilite. The markets must be not too hot and not too cold, but just right.
The Fed marked up its assessment of growth yesterday but made no change to its assessment of inflation. In fact recent data suggest inflation risk has gone down not up: core inflation is flat, surveyed inflation expectations have edged lower and the dollar, commodities and gold have stabilised. Read more
Fed chairman Ben Bernanke responded to Senator Jim Bunning’s written questions posed as a part of the confirmation hearing. In responses to 70 questions ranging from the transparency of the Fed to the use of Tarp funds as capital, to the Fed’s agency debt purchase programme, Mr Bernanke restated his positions and defended his tenure as Fed chief.
He also sought to dampen concern on asset bubbles, saying there was “not much evidence to suggest that the stock market is currently in a bubble” and that “it is not clear [the gains in gold's price] have been out of line with fundamentals”. But then, his first reason for reticence in using monetary policy to lean against bubbles was that “we would have to be confident in our ability to detect bubbles at an early stage in their development.”
Federal Reserve governor Elizabeth A. Duke today spoke to the Mortgage Foreclosure Policy Conference about the conditions that led to the housing crisis and her vision of the future of housing finance.
“A speculative mentality took hold among investors and consumers who expected limitless house price appreciation,” she said. Read more
The following is a summary of research by Pivot Capital (h/t Naked capitalism)
China’s capital spending boom will not be sustained at current rates and the chances of a hard landing are increasing. The coming slowdown in China has the potential to be a watershed event for world markets similar to the sub-prime crisis.
China’s current expansion cycle is surpassing historical precedents in its duration and intensity. Growth is being powered by investment, principally from the government (measured by gross fixed capital formation), which accounted for almost 90 per cent Chinese growth in the first half of 2009. This has led to overcapacity. But what is more worrying is Read more
This is a summary of part of Goldman Sachs’ 2010 commodity outlook
Gold will rise to $1,450 / toz by 2011 if the US government maintains its near-zero interest rate policy. However, as inflation is expected to remain subdued, gold prices are likely to come under significant downward pressure once the recovery strengthens and the Fed starts to raise rates.
Goldman Sachs’ gold forecasts now stand at $1,200/toz, $1,260/toz, and $1,350/toz on a 3-, 6-, and 12- month horizon respectively, with an average price forecast of $1,450/toz in 2011.
The Fed will take asset prices into account when setting monetary policy, writes Krishna Guha of the Financial Times Read more
Congress may not share Bernanke’s vision of what the Fed should look like, writes Krishna Guha of the Financial Times
Competitive devaluations threaten trade wars, says Michael Pettis, citing the Vietnamese devaluation. The theory is that countries unable to devalue will be forced to raise tariffs. This comes as North Korea strikes two zeros off its currency, the won. But the picture is more complex than that. Chris Giles agrees that competitive devaluations could lead to currency trade wars, but argues the devaluation of the dong – still under pressure – is not the trigger. Neither is the won.
Creditors of Dubai World, including hedge funds and banks, have formed a group. It seems that investors in $3.5bn of Nakheel’s bonds will form 25 per cent of the issue, meaning they can block bond restructuring plans. Read more
In a characteristically combative speech today, Adam Posen, an external member of the Bank of England’s Monetary Policy Committee, insists interest rates are a blunt tool for combating asset price bubbles. He suggests property taxes instead, writes Chris Giles of the Financial Times, but fails to analyse whether these would work any better than interest rates Read more
“Investors view this as shockingly bad news”: one assessment of Dubai’s request for a freeze on all financing to Dubai World, the government’s heavily indebted flagship holding company. The requested freeze would last till May 30, and would cover DW’s troubled property unit Nakheel, which is due to pay back $4bn on an Islamic bond on December 14. Dubai sovereign CDS spreads rose 130bps from an overnight level of 318 and LSE shares fell – the exchange has a 20 per cent stake in Borse Dubai.
Meanwhile the “gold up, dollar down” trends continue. Sri Lanka has bought 10 tonnes of gold from the IMF Read more
Forget commercial real estate, the next shoe to drop is private equity. Apparently, private equity firms themselves are not the problem, it’s the companies they own, which employ some 7.5 million workers in the US alone. Private equity firms buy up struggling companies, aiming to turn them round and flog them off. The purchases are often highly leveraged using short-term loans, which are coming due. One estimate is that half of those companies will fail between 2012 and 2014.
Roubini argues further unemployment is on the way and Jeffrey Immelt, GE chief, has joined predictions of a second stimulus in the US. So the IMF’s speech this weekend was timely: Strauss-Kahn said the IMF should provide global financial insurance Read more
Liu Mingkang – the Chinese bank regulator who attacked Fed monetary policy over the weekend for fuelling the carry trade – is a sharp guy and worth taking seriously. But China would do well to acknowledge that it shares some responsibility for preventing a new wave of asset price bubbles across the emerging world. The best way to deal with capital inflows is to allow your currency to appreciate – but other emerging economies cannot do this, at least to the extent necessary, because China is not allowing its currency to appreciate. Not yet, anyway.