Posts Tagged ‘monetary policy’

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If only interest rates were higher; it’s the lament of savers everywhere. Then they could enjoy a nice little income from hard-won savings. Some don’t merely sigh; they grimace; they are angry. They worked hard all their life. They saved hard, putting off holidays, sacrificed transitory pleasures today for security, and slowly built a nest egg. But, thanks to record low interest rates, and that policy straight from the devil’s workshop called quantitative easing, central banks seem to want to punish the prudent and reward the feckless. You can feel their anger, and you may share their anger. It is just that they are wrong. And they are wrong for a simple reason.

Dr Ros Altmann is very clever indeed. Until recently she was director general of SAGA, and is generally thought of as something of a guru; an expert on all things pensions. But she is especially famous for her hugely critical views relating to the Bank of England’s recent monetary policy. Her argument runs likes this: low interest rates penalise savers, they penalise those who are retired, and those who are trying to find a way to fund their retirement. She rarely misses an opportunity to slate the government and its central bank whenever it does anything to advance the course of low interest rates. If the anti-quantitative easing (QE) lobby has a face, it is that of Ms Altmann.

But think about this for a moment. If the economy is growing, if real incomes are rising, and if productivity is getting better all the time, then surely we can afford higher interest rates.

Or consider this. Why do we need savings? Across the global economy savings equal investment – they have to, it is a matter of definition. GDP equals consumption plus investment. Savings equals income minus consumption. Income equals GDP. For the economy as a whole, we need savings to fund investment. If we all try to save more, without a corresponding rise in investment, the result is an immediate fall in GDP.

So we save to fund investment. Does that not mean that in the long run, the reward for savings should be a function of the return on investment?

If our savings fund very low risk investment, that generates very little in the way of returns. Why do we think we should get a higher interest rate?

Consider the economy. It has had a very poor few years. There has been no shortage of money, no shortage of savings, but the money has found its way into bonds, and into mortgages. What money has not done – or at least has not done enough – is find its way into more risky assets.

“QE has hastened the demise of our pensions system,” said Dr Altmann earlier this year. She continued: “As scheme deficits rise, their sponsor company’s money is being forced into the scheme rather than expanding or modernising the company itself – thereby increasing the risk that the company will fail and the scheme will be forced into the PPF, with all members’ pensions reduced.”

She makes a good point. The return on bonds is incredibly low. Pension schemes need to generate a certain proportion of their income from bonds, and since bonds pay out such low yields that means pension schemes need to buy even more bonds to meet regulatory requirements.

The truth is that a good argument could be made to say that savers deserve a higher return on the money if their savings yielded better results, created more wealth. Borrowers could afford to pay higher interest rates if, as a result of their borrowing, they made more profits, and enjoyed higher income.

This connection between savings, investment and the return on savings versus the return on investment gets forgotten, overlooked.

It would be a good thing if interest rates rose, but only if they rose because all of a sudden savings were being used to fund innovation, and as result created more wealth.

This, of course, is why savers need to re-evaluate, and start looking at putting their savings in assets other than low risk, low yielding bonds.

© Investment & Business News 2013

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You may remember the ads – it must have been around 20 years ago. They were for a magazine called ‘Fast Forward’ and for a few months they were on TV all the time – or so it seemed. Jeremy Beadle features in the ads and the jingle went “fast, fast forward, forward forward’ and the tune went like this laa, laa, la, la, la. Okay you may not remember the ads, maybe you have subconsciously blocked them from your memory, but if you do remember them apologies. You may now hear that tune in your head every time you hear the phrase ‘forward guidance’. And so, forward guidance is out and now it appears we have an inkling about how long rates will stay at 0.5 per cent.

The latest inflation report, out yesterday, came with a section talking about forward guidance. The Bank of England says that monetary policy will remain ultra-loose for as long as UK unemployment is greater than 7 per cent.

In forward guidance, if inflation does this, and jobs do that, says the Bank of England we will do as follows.

Accept that it’s forward guidance that may change as we move forward. The 7 per cent unemployment rate does not necessarily represent the end of the line for record low rates; rather it is, as Mark Carney called it, a ‘way station’.

Based on Bank of England predictions, for UK unemployment, it appears the first rate hike will be in late 2015.

Then again, if inflation picks up, and even if unemployment is still quite high, Mr Carney suggested the bank may change policy.

So it is a kind of forward guidance, based on current thinking. Well, Carney is human. He can’t do much more than that, but it does leave you wondering what the fuss is about.

It is tempting to say that forward guidance is little more than PR; a communication tool. But then again, the markets seem to be taking to it like proverbial ducks to water.

It does rather seem that forward guidance means the bank does not need to engage in any more QE. If you see QE as kind of weapon of mass financial destruction, then the threat that you may use it means that it is not necessary to do so.

© Investment & Business News 2013

Phew, that was close. UK inflation was 2.9 per cent in June, which was 0.1 percentage points less than expected and 0.2 percentage points less than feared, and some might say it was a relief.

If inflation had been 3.1 per cent, as some dreaded, then poor old Mark Carney, new in his job, would have been obliged to write a letter to the chancellor.

Even so, 2.9 per cent isn’t very good. In fact it is the highest rate of inflation since April 2012.

So here is the dilemma. The Fed is slowly moving towards tightening monetary policy. If it does this, the pound may come under pressure. The Bank of England has made it clear that it is in no hurry to follow the Fed, but can the UK afford inflation of around 3 per cent, and then for the pound to fall?

Remember, between February 2013 and April 2013 total pay (including bonuses) rose by just 1.3 per cent year on year, which was much less than inflation. If the pound falls, inflation will rise, and real wages will fall even further.

A cheap pound may help the UK’s long awaited export led recovery, but the UK also needs households’ real income to rise.

© Investment & Business News 2013

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“I think I should warn you,” said Ben Bernanke, “if you think I am making myself clear, then that means you have probably misunderstood me.” Witty, and a tad daft. It is just that actually those words were not spoken by Mr Bernanke at all; rather they were spoken by his predecessor as the Fed chairman Alan Greenspan.

In fact, when Ben took over at the Fed he went to great lengths to say he was not one for cryptic remarks. He would say it as he saw it. He promised to be something of a blunt speaker. (Ay up lad, I say wat I mean tha noes). Last week, however, he seemed to do an impressive impersonation of Mr Greenspan. His lips and eyes, or his statement and his inference, seemed all seemed out of sync.

Don’t get confused,” said the Fed Chairman, “The overall message [from the Fed’s rate setting committee] is accommodation.”

His words had been eagerly awaited. Last month Ben suggested the Fed may be tightening monetary policy soon. This time he said they will be doing no such thing. Rather that we may see a “gradual and possible change in the mix of [monetary] instruments.”

So what does that mean? A change in mix suggests the details are different but the overall thrust the same.

So that’s the headline.

What about the substance?

The latest minutes from the Fed said that many members of the FOMC – that’s the Federal Open Market Committee – “indicated that further improvement in the outlook for the labour market would be required before it would be appropriate to slow the pace of asset purchases.” Again this needs translating. “Many” is supposed to be code for slightly over half. Subsequent to the meeting of the FOMC to which these minutes relate, job data on the US has seen another big improvement. That rather suggests that more than half of the men and women who determine monetary policy are on the cusp of agreeing to “slow the pace of asset purchases.”

So Ben says one thing, and the minutes say something else.

The minutes also said that ‘some members’ wanted to see evidence that GDP growth was picking up before they agreed to tighten policy. So let’s decode that. In this case, “some” means fewer than half. The data on GDP is not expected to be so good in Q2. In other words, fewer than half are not ready to tighten policy.

Would you believe it? The markets loved all this. Somehow they concluded that the Fed is not going to tighten monetary policy as quickly as they had feared, so they went out and bought, pushing the Dow and S&P 500 to new all-time highs.

Capital Economics took a look at the Fed’s words and concluded that they suggest QE will be reduced somewhat in September, will cease altogether in 2014 and rates will rise in 2015. This is actually pretty much the same as what it was saying before the Fed released its minutes.

In other words, all that has really changed is that the Fed is saying much the same thing as it was a few weeks ago; it is just using more ambiguous words to say it.

And that was enough to get the markets all bullish again.

© Investment & Business News 2013

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The IMF is a critic. It reckons the US has hit the brakes too fast, and wants to see more stimulus measures. As for the UK, it wants to see more short term borrowing to fund investment into infrastructure. The Bank of International Settlements (BIS), often called the world’s central bank, is a critic too, but for almost the opposite reasons.

Time to stop doing whatever it takes.

In a report out today, the BIS began by referring to Mario Draghi’s famous words when he said: “We will do whatever it takes to save the euro.” The BIS said: “But we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth. Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets.

Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks. Only forceful efforts at such repair and reform can return economies to strong and sustainable real growth.”

This is pure austerity economics, right out of the Austrian school of economics.

Then the BIS laid into what are often called the zombies.

It said: “Productivity gains and employment in the major advanced economies have sagged in recent years, especially where pre-crisis growth was severely unbalanced. Before they can return to sustainable growth, these countries will need to reallocate labour and capital across sectors. Structural rigidities that hamper this process are likely to hold back the economy’s productive potential. Both productivity and employment tend to be weaker in economies with rigid product markets than in ones with more flexible ones.

Similarly, employment rates tend to be lower where labour markets are more rigid.Conversely, countries with flexible labour markets recover more quickly from severely imbalanced downturns. They also create more jobs. Reforms that enhance the flexibility of labour and product markets could be swiftly rewarded with improved growth and employment.”

So what is it really saying?

Firstly, that QE has run its course, and monetary policy needs to return to normal. Secondly, that we need to see more creative destruction; let businesses fail, because the vacuum that is created can be filled by more efficient firms, and productivity will start to improve.

But is that really right? The BIS might be saying that QE has done its job, and now it is time to go back to normal, but frankly it never was a fan of QE in the first place. It may say that now is the time for governments to pay back debts, but then it also said that last year and the year before.

It is suggesting that as the economy changes, now is the time to implement the changes that it wanted to see implemented even before the economy had changed.

Do we really need to see create destruction? Take one sector, as an example, the UK High Street. This has seen rather a lot of destruction to date, precious little creativity has followed.

Then again, the recovery does appear to be starting in the US, and say one thing for the US, it does have an extraordinary ability to reinvent itself.

Being a cynic is fun. It is a good laugh, finding the flaws in any hint of optimism. And many have had a ball of a time laughing at the argument that it is good news on the US economy that lies behind the Fed announcing plans to ease back on QE.

But actually, there really has been good news coming out of the US of late. And with signs that US manufacturing is finding new opportunities, even that 3D printing may create new jobs, we could even be at the early stages of seeing something of a reversal of what we have seen in recent years of the trend of growing inequality.

The BIS might be right to say we are approaching the time when the US needs to see monetary policy return to normal – but that is happening anyway.

But the euro needs is own version of QE, proper QE that is, not Draghi playing with words. Japan’s experiment in Abeonomics needs to be given more time, and QE needs to be used more imaginatively to directly fund investment in the UK.

History tells us, that monetary policy has often been reversed too soon while an economy recovered from a depression recession/depression. Right now, there is a real danger that monetary policy will be tightened too soon. And the BIS seems to be oblivious to this risk.

© Investment & Business News 2013

If QE in the US is coming to an end, what does that mean for the rest of the world?

Two countres that may be vulnerbale are Canada and Australia.

There are certain parallels between the Australian and Canadian economy today and the US and UK in 2007/08.

Take household debt.

Or take house prices:

Both the Canadian and Australian economies may be large and independent enough to be relatively immune from the effect of changes in US monetary policy.

However, such large levels of household debt combined with historically high house prices, does appear to suggest vulnerability, and if interest rates were to rise globally, the two economies may be susceptible to a sharp slowdown, maybe something more serious.

© Investment & Business News 2013

The markets like QE. You could say that in much the same way as you could say the sun is quite hot – that is to say the sun the star, not the ‘Sun’ the newspaper. But what will happen when QE is finally stopped, even reversed? Yesterday may have seen a dry rehearsal for such a moment, when markets across the world fell sharply, and with the Nikkei 225 losing 7.5 per cent.

But oddly enough, the main catalysts for their fall may have been based on contradictory comments out of the Fed.

Yesterday afternoon the latest Minutes from the FOMC – that’s the Federal Open Market Committee, which is responsible for setting US monetary policy – stated that: “Despite some softness in recent economic data…a number [of FOMC members] expressed willingness to adjust the flow of purchases downward as early as the June meeting.”

Those comments send a shiver of fear down the markets’ spine.

But earlier in the day, Fed Chairman Ben Bernanke spoke to the US congressional Joint Economic Committee. He said: “A long period of low interest rates has costs and risks,” but “a premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

So what was that then? Bernanke warning against relaxing QE too soon! That sent a shiver of excitement down the markets’ spine.

So what happens when shivers collide? Based on yesterday’s findings fear trumps excitement.

Here is your question: if markets tumble as a result of ambiguous words – with some saying QE is coming to an end and some saying it won’t – what will they do when the news is unambiguous, and the Fed puts an end to QE?

© Investment & Business News 2013