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Central banks "cannot do 'whatever it takes' to return still-sluggish economies to strong and...

Central banks "cannot do 'whatever it takes' to return still-sluggish economies to strong and sustainable growth," says Bank for International Settlements head economist Stephen Cecchetti. In its annual report, the BIS blames unconventional monetary policy for delaying private sector deleveraging and for making countries especially vulnerable to rising interest rates which, "without an equal increase in the output growth rate will further undermine fiscal sustainability." Cecchetti also says that despite some high profile controversy, research suggests "Kenneth Rogoff and Carmen Reinhart are right in their original claims" regarding the effects of high debt ratios on economic growth.
Comments (19)
  • Finally a voice of actual reason. Bernanke and the other CBers should have waited for some real deleveraging to occur before they stepped in to save us all. That way their help would have come at bargain prices and would actually have been helpful instead of simply stalling the inevitable.
    23 Jun 2013, 03:43 PM Reply Like
  • This highlights the problems of trying to engineer a soft landing. I largely agree with the position taken by BIS, though I disagree with their statement on Rogoff & Reinhart, because the data used was flawed.
    23 Jun 2013, 06:58 PM Reply Like
  • He is 100% wrong about R&R. They lied about their results and all the evidence points to ZERO correlation between growth and debt.
    23 Jun 2013, 07:25 PM Reply Like
  • ...and people wonder why I am scooping up gold miners on the ultra-cheap...
    23 Jun 2013, 09:54 PM Reply Like
  • A better argument can be made that
    (a) China dealt with the post 2006 global and domestic economic situation by coupling robust, and sustained monetary expansion and fiscal stimulus to re-ignite their economy. With the EU adoption of resolute fiscal austerity and ill-timed monetary contraction at critical intervals and with the US wavering over fiscal stimulus to complement monetary easing, China (along with the other BRICKs) could not refloat global economic expansion. Further, China has much economic redesign and reform that needs to be achieved to right its domestic economy structurally and this also is holding its and the global economies back.
    (b) Except during 2009 (when the EU countries joined with other G20 counties in a planned deficit of 2% of GDP to counter the global credit crunch following the 2007/8 meltdown) and for the past 9 or so months when the ECB has adopted QE, the EU countries have largely followed a pattern of relative fiscal restraint and the ECB a pattern of monetary rectitude. In fact, for many EU countries (especially, France, Ireland, Spain, Portugal, Italy Greece etc.) have been so constrained by the confines of their common currency coupled by ECB restraint policy that, arguably, it was though the pre 1914 Gold Standard applied (i.e. the Euro functioned as though constrained by the classic Gold Standard rules) and we see the havoc this engendered in many countries. Proof, I suggest, that the policies suggested by Stephen Cecchetti (and, I understand, endorsed with added vigour by wmateri and Herr Hansa) would have been deflationary depression of great length and hardship and not the short but sharp drop leading to recovery.
    (c) The US did adopt monetary expansion on a scale that stabilized its (and helped stabilize the global) economy but failed to follow through with a consistent, timely and robust fiscal expansion to get this ‘new money’ working to reflate the economy.
    (d) Points (a), (b) and (c) argue that significant opportunities were lost to get the global and national economies reflated to a healthy level where the private sector could resume growing the ‘real economy’. In saying this, it is appreciated that public debt levels would have grown even larger than has been the case, that difficult and major structural and regulatory reforms needed to also be achieved and that, once the economies were in a sounder state, fiscal and monetary policy would have to have been reigned in to prevent inflation from eventually becoming a threat. In other words, even this preferable course would be hard to implement and full of dangers.
    (e) Arguably the leading nations should now belatedly follow the course suggested above even though the cost will be higher and the risks of failure grater because of the mistakes made over the past 7 years. The alternatives of bumbling along as currently (increasing cost with relatively little further progress) or rigorous fiscal and monetary restraint (triggering a deflationary depression) are really not acceptable.
    23 Jun 2013, 10:33 PM Reply Like
  • BA - a) Good, you seem to recognize that pushing only on the supply side (which was all China could do as a huge net exporter) was an ineffective plan for saving the global economy.
    b & c) I have little problem with TARP and QE1 as a way to stabilize an emergency financial situation. However, I believe that had a bit more deflation been permitted (perhaps the failure of another TBTF bank, most of AIG, GM) and a good one-year deep recession ensued, the resulting recovery would have been more robust and more believable. The Fed reacted vigorously (almost in panic) and its policies were not coordinated with fiscal policies from government. I thoroughly believe that Bernanke's response will be judged by history almost as cruelly as the response to the 1930s crisis; in acting too soon and too strongly, I believe the Fed's actions disallowed the required cleansing of the system.
    d) I agree. Once the immediate pressure was off, everyone went back to their old games instead of recognizing the persistent danger. I believe the European governmental austerity (i.e. fiscal responsibility) will ultimately prove to be a winning formula after a lot of pain. Europeans appear to have learned from past depressions and hyperinflation, while American overconfidence hardly ever abated. It's been argued that (with the Federal deficit reductions coming) there are no longer enough Treasuries available to completely slate the Fed's purchase appetites. As a result, tapering is required.
    e) I agree that bumbling along is not acceptable in the long run. We have postponed the pain that is necessary to adjust our economic models to new demographic realities. Doing so is going to hurt. The only questions are how many will be hurt, who, how deeply, and for how long. After a good, solid reset and a period of pain will markets be able to regain some credibility based on sustainable fundamentals (I almost laughed out loud when I wrote that) and once again attract investors rather than speculators.
    23 Jun 2013, 11:32 PM Reply Like
  • Very insightful comments. Long live Paul Krugman and Steven Keen.

     

    One friendly quibble: "with the US wavering over fiscal stimulus to complement monetary easing..." Wavering??!! Stimulus is merely a fond memory of a dream. The House has insisted on spending cuts and Obama has insisted on tax increases, both of which have been implemented, so we have actual outright austerity fiscal policy now in progress, and further, there has been zero real, little nominal, federal spending growth since 2009.
    23 Jun 2013, 11:41 PM Reply Like
  • Hi Bob. Nice to see you commenting on this one. I think a bit of added detail is needed for clarity. You are not wrong in your assessment, though the additional detail may show we are not that far apart in views.

     

    It is true I was very opposed to the original bail-out and monetization of debt. However, once that path was chosen, it needed to be followed through to completion. We are not there yet.

     

    It is interesting to do "what if?" exercises with policy, though it accomplishes nothing. To wonder whether not following the path once started would make any difference, is not really the issue I have with the chosen direction. Rather the government, and Federal Reserve, jumped into the business of deciding that certain banks and insurance companies would not be allowed to fail. This is moral hazard, but for those in the financial world, it was a green light to take on risk. This is not new, since this attitude shift happened after the failure of Long Term Capital Management. We may as well throw in Brooksley Borne in the mix even earlier, as Rubin, Summers, Greenspan, et al pushed her out of the decision making process for warning about derivatives. Honestly, I think Dick Fuld was both surprised and disappointed that Lehman Brother's was not made fully whole again, though it now appears that JPMorgan had some hand in forcing that failure. The other failure was not prosecuting Joseph Casano, because that was an indication that risks could be taken with little to no recourse; sure, Casano is unemployed, but he is still living a fairly nice lifestyle.

     

    The issue of inflation is a weird one, but not because to the populist drift of inflation threats. While inflation can punish the common man (or at least those of lower income), if inflation matches the pace of population growth, then it is more synthetic in nature. As Bernanke implied, there is "not enough inflation". Of course inflation makes sovereign debt easier to manage. When we look at the United States, the bulk of debt is 10 year and 30 year denominations; and in a weird way the Federal Reserve is now one of the largest holders of shorter term Treasuries. I don't see a political side of this, because decades of groups in government managed the policies, and that is not just true for the United States.

     

    The one issue I have is with Greece, but there I see it as a structural problem, especially when tax evasion is a national past-time. Given a modern and effective tax collection system, the Greek economy would be functioning much better, and not just benefiting public workers. We shall see the issue of Greece come up again soon.

     

    As far as what to do in the future, I think the only choice is to continue the policies that began a few years ago. As long as all developed countries push monetization of debt, and engage in currency wars, and interest rate wars, then the balance is maintained. I don't personally have to like the direction of policies, though I understand the necessity to continue them, at least for the near term.

     

    If there is a potential failure point, it would be Japan, with 200% debt to GDP levels. They are very restrictive on immigration, and the population there is aging. Of course they could greatly increase taxes, though the real answer may be a massive devaluation of the Yen. Abenomics may work in the near term, but there is an eventual reckoning day for monetization. We could easily see the USD/JPY at 200.00 within three to five years.

     

    Another issue is growing inequality, though discussing this may lead to ideological rigidness that accomplishes nothing. Propping up the poor is not something I feel is a viable solution, nor is the idea of a "trickle down" economy. Unfortunately the political class treats the common people like children, and expects civil unrest, general strikes, and possibly even bank runs. I think Cyprus gave us an odd example, in that the public was mature enough not to devolve into chaos. I tend to give people much more credit for being civil, than it appears most politicians do. Obviously few people want to test the theory that bank runs would not happen, but so far it is amazing how well societies actually do function.

     

    Regarding austerity, we should remember that money was going to recapitalize banks, who were then repaying debt. The issues were more of a short circuiting of the velocity of money. I think austerity was overdone, and poorly implemented. I don't think reigning in government spending is a bad idea, but when it takes years to build up the debt, then it should be set so that years are the pace given for austerity. In most cases, too much was attempted to be accomplished too soon, which I saw as a knee-jerk populist approach. Some in public may have liked the heavy handedness, but I think it was poorly implemented. I also disagree with some who suggested further debt and further monetization. Perhaps that places me in the middle ground, where I will be criticized from all sides.
    24 Jun 2013, 02:26 AM Reply Like
  • Herr Hansa,

     

    Thanks for the detailed response to my earlier comment.

     

    I think the circumstances you describe amply illustrate that we collectively have all been flying for some time by the proverbial seats of our pants.
    24 Jun 2013, 01:16 PM Reply Like
  • wmateri,
    You and I agree that half measures at critical stages in response to changing circumstances as they have unfolded over the past 7 years may have had modestly good short term effects (and, in particular, have delayed even worse circumstances occurring) but that their longer term utility is open to question, that these measures consequently have entailed deeper costs than were warranted and that, now, very difficult choices will have to be made in even less auspicious circumstances to get matters back on track.
    We differ fundamentally on the question of whether the appropriate road forward entails austerity (your preference) or reflation (my choice). We probably also differ on the nature and scope of the reforms that must also accompany fiscal and monetary initiatives now needed.
    We probably both agree that devising and implementing timely initiatives in these circumstances will be exceedingly difficult.
    23 Jun 2013, 11:55 PM Reply Like
  • Bob - We don't disagree that much but the main question is who will pay for rebalancing and how. Heavy monetary and fiscal initiatives simply place today's problems in the hands of tomorrow's citizens. Reflating simply punishes savers and pushes prices back to levels that make Americans live on credit card debt (do we really believe we could get a balanced 2% inflation rate? Japan certainly won't be able to without driving bond yields up to levels that will make their debt load unmanageable). How can anyone be expected to buy Treasuries and other government debt when it's return lies below inflation? Interest will rise (no doubt to exceed inflation) but, if the debt is not controlled, eventually all interest rates become excessive (and lead to default). However, deflation punishes today's voters and requires both political and personal courage and that is in short supply.

     

    I'm in favor of basic stability with room for novelty and growth. I just don't believe that our current financial systems give us that (by the way I am definitely NOT a gold bug). We get too many positive feedback loops that lead to shocking instabilities. Any engineer could tell you that damping negative feedback is required to limit this reaction. For example, our existing "price discovery" system which allows everyone's price of an asset to be set to the last paid price, could be weighted by volume of the last transaction to avoid overly-rapid changes, manipulation, rampant speculation and HFT. When stock markets were first designed, this would have been impossible, but now it's trivial to implement. There are too many examples like this that have caused people to lose faith in saving, investing and even (dare I say) in our financial and governmental institutions. Many of our current systems assumed that honest people of good intention would be in charge; when that's not the case the weaknesses in the systems become all too obvious. Maybe it's time to design better systems. I believe that over the next five to ten years, Basel III will give way to Basel IV and a resetting of parts of the current monetary systems to encourage renewed responsibility, honesty and openness. At least, I hope so.

     

    Sorry for the rambling. All that said though, I definitely agree with you that navigating these circumstances will be both personally and globally a challenge.
    24 Jun 2013, 12:23 AM Reply Like
  • Wmateri,

     

    Borrowing your engineering analogy, it is especially difficult to dampen negative feedback and otherwise calm other sources of instability in a multifaceted, complex, high energy system running beyond control in unexpected ways. The danger is that an intervention, viewed theoretically in isolation to have a calming effect, will in practice in the context of the system as a whole in crisis prove to push the system further into crash mode. In your 11:32 PM comment of June 23rd you suggest that allowing another TBTF bank to fail before the Fed and Treasure intervened decisively would have facilitated enough deflationary pressure in the financial system to create a base upon which a recovery through such intervention would have been more effective. I mention this point because I suggest it illustrates a predilection on your part to opt for tough love measures – to let a crisis peak and then hammer it down.

     

    My bias is otherwise. In the days before computer augmented power braking systems drivers faced with their car beginning to spin out of control on an icy or wet road were advised to
    (a) maintain or increase speed in the hope of regaining traction, and
    (b) pump the breaks gently to slow the car once control had been regained
    and thereby avoid the reflex impulse to slam on the brakes (which, while it might work, was more likely to send the car spinning truly out of control). I believe I owe my life on at least two occasions to following this advice and also believe this approach to crisis management provides a sound analogy for management of the dysfunctional economy within which we have been living for well over a decade and which has been in crisis since 2007.

     

    Further to my car analogy, in the days soon after the car is back under control it is wise to have the safety features thoroughly check by a competent mechanic (and correct any flaws – even though this might be costly).
    24 Jun 2013, 12:58 PM Reply Like
  • Bob - Thanks for the comment and the car analogy. I've spent the past 20 years in northern Canada and my life has also been saved numerous times by "pumping the breaks gently". I have no problem whatsoever with the wise allocation of stabilizing systems especially when they are used to bring systems in crisis under control. However, current financial/economic systems are designed to oscillate between jubilation and crisis contraction and it is wrong to try to intervene to stop their natural progress.

     

    An example of what I mean: An aging population requiring financial stability in retirement must save and invest for that retirement. Money saved is placed into debt or equity instruments; the former encourages the formation of excess debt (much of it bad) while the latter leads to excessive stock prices (especially in a zero-sum stock market focused on capital gains rather than dividends). While some people approaching retirement will do well in these investments, their very nature will lead to price collapse as the amount of money pulled out by retirees starts to equal the new money put in. Thus, by nature of its design, this system is guaranteed to go through periodic crises whereby prices adjust to meet new demographic realities. In a similar way, periodic collapses are required throughout the financial system to rebalance excesses that have diverged from economic reality. I like to say that one cannot breathe only by inhaling. If you try to take the biggest breath in that you can, eventually you will need to exhale, usually vigorously. This is analogous to today's economic models. If we design an economic model that is geared more toward a steady state and less toward limitless growth, it might behave better (at least until space colonization opens up a large new frontier).
    24 Jun 2013, 01:24 PM Reply Like
  • wmateri,

     

    I agree that "current financial/economic systems are designed to oscillate between jubilation and crisis contraction" but am firmly of the view it is this very bipolar bias that is a major root of the problem. I don't think that the benefits of encouragement of innovation or of timely and ongoing reallocation of capital from inefficient to productive uses in the economy would be impeded (it would be enhanced) if the short-termism and boom-bust mentality and reality of capital markets was toned down several notches - in other words, I would gladly trade the current casino capitalist model for a more tempered version (think of an updated version of that which pertained through the 1950s and 60s).

     

    To borrow again from my car analogy - there is no doubt that cars would run faster and cheaper if not encumbered by brakes, air bags, air emissions controls etc. etc. etc. - faster and cheaper that is until the inevitable crash. The trick therefore is to find the best trade-off between safety features (knowing full-well that they reduce efficiency and increase cost) and operational efficiency.

     

    By the way, I taught in north west BC (longer ago than I care to remember) and share your experience with winter conditions on dangerous roads.
    24 Jun 2013, 02:21 PM Reply Like
  • Why is BIS coming out with this statement now? That's the real worry. Are they hinting we're soon going to find out all those CDS's wont "net out" like they've been promising...?
    24 Jun 2013, 12:42 AM Reply Like
  • I doubt it. Current suggestions from BIS bias towards CDS being effective hedging, which allows more leverage. After all, they are managing expectations from the banking sector. Maybe Basel IV, whenever that happens, will change the stance, but it will take years to implement. FT Alphaville has some great articles on this exact issue.
    24 Jun 2013, 02:31 AM Reply Like
  • I'm glad someone in a place of responsibility understands that the policies of the last 5 years have devolved into madness.
    24 Jun 2013, 09:24 AM Reply Like
  • bob adamson , i totaly agree with you but i wat to emphasize that

     

    BEN's policy would have great results if USA has no trade deficit.
    Now much of fresh USD goes to CHINA ..... and many americans are jobless.

     

    What to do all that money if walmart sell us all that cheap chinesse stuff?
    24 Jun 2013, 12:13 PM Reply Like
  • About BIS i would say that is full of european bankers that they have too much power over real economy.

     

    They dont speak about deflicts and jobless economies .... the fault is the monetary policy. Ok ...lets make an deflation policy and live 1929 again!

     

    They think that they will be (by deflating) economies reacher. They dont see the risks after that misery!
    24 Jun 2013, 12:15 PM Reply Like
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