As we reflect on the various speeches delivered over the last week there appears to be more questions than answers to the issues that weigh on the markets. Mr. Draghi was the one central banker that had the courage to ponder the issue: What if central banks have misjudged the strength of consumers and the effort to bring DEMAND forward to energize the economies of the developed markets may be flawed? Again, drawing upon the Draghi speech to the IMF on May 14:
“Secondly, there are always distributional consequences to monetary policy decisions. When monetary policy acts to stave off disinflation by lowering interest rates, this has inevitably a distributional effect by reducing the interest income of savers and lowering the debt burden of borrowers. But such interest rate cuts are necessary to raise aggregate demand by encouraging firms and households to bring forward spending decisions–that is, they discourage excessive savings and incentivize investment by lowering the cost of finance.”
This is an honest assessment of why the ECB is in a full-blown war on SAVERS in an effort to generate economic growth in an immediate fashion. Financial repression in the form of destroying the return on savings is meant to incentivize consumers to either take on more financial risk or spend all of their earnings, which OUGHT to promote growth and lift the animal spirits of entrepreneurs to invest in capital expansion. But Draghi has the courage to admit, “For pensioners and those saving ahead of retirement,low interest rates may not be an inducement to bring consumption forward. They may on the contrary become an inducement to save more, to compensate for a slower rate of accumulation of pension assets.” If we substitute Germany for pensioners, it raises the issue of the potential severity of Draghi’s problems. In economic terms, this is the problem of “intertemporal misallocation” constantly bringing forth demand in order to slay the business cycle.
It is the prospect of INTERTEMPORAL MISALLOCATION that may be responsible for the decline in productivity for business seems to be adverse to invest in new capital because of fears for future demand. It is easier to hire more labor because it is easier to fire workers if the economy slows than it is to work off excess capital.
In Janet Yellen’s speech May 22 at the Providence Chamber of Commerce, the FED Chair raised the issue of low productivity. She doesn’t definitively say why she believes productivity is low–an on the one hand and then the other hand–but states: “Firms slashed their capital expenditures during the recession, and as I noted earlier, the increases in investment during the recovery have been modest. In particular, investment in research and development has been relatively weak. Moreover, a lack of financing may have impaired the ability of people to start new businesses and implement new ideas and technologies.”
The problem with Yellen is that she hasn’t the heart to accept the idea of an economy in intertemporal misallocation. Ms. Yellen opined that stock market valuations are stretched but how can equity prices be overvalued if there is a lack of financing in the system. Between the FED‘s zero interest rate policy and the power of shadow banking to generate financing, it is highly doubtful that capital investment is suffering because of a lack of money available. It would be wise for Chair Yellen to comprehend the advice of Schumpeter’s Pushing On A String theory: A central bank can stop businesses borrowing by raising rates but it cannot generate investment activity if entrepreneurs cannot generate adequate returns. Chair Yellen needs the strength of HEART to admit the possibility of intertemporal misallocation as a reason for the low growth in productivity.
Vice-Chairman Stanley Fischer delivered a speech in Tel Aviv yesterday, “The Federal Reserve and the Global Economy.” Fischer seems to be on a mission to prepare the global financial system for an inevitable rise in U.S. interest rates.
“The actual raising of policy rates could trigger further bouts of volatility, but my best estimate is that the normalization of our policy should prove manageable for the EMEs (emerging marketing economies). We have done everything we can, within the limits of forecast uncertainty, to prepare market participants for what lies ahead.”
It certainly seems that the FED wants to limit the fallout and deflate the global response to a raise in U.S. rates. The May 2013 taper tantrum has stirred the Fed to preemptive strikes against excess market volatility. This appears to be monetary policy in the times of excess fear and overvaluation.
My problem with Fischer is not his efforts of preemption but his claiming that the FED seems to have a third mandate: “responsibility to the global economy.” The FED has to be concerned about the global reactions to policy actions because of possible negative consequences for financial stability. He continued: “Thus, as part of our efforts to achieve our Congressionally mandated objective of maximum sustainable employment and price stability, the Federal Reserve will also seek to minimize adverse spillovers and maximize the beneficial effect of the U.S. economy on the global economy.” Mr. Fischer needs to reset his brain for the FED is under intense scrutiny and Congress will not be wanting to hear that the Vice Chairman is raising the issue on that international stage that the Fed will be extremely conscious of global concerns in its efforts to set monetary policy. The dual mandate is tough enough to defend in Janet Yellen’s appearances before Congress.
***Bank of Canada held rates steady and there were no surprises in the BOC statement. It is apparent that the Canadians are waiting to see if U.S. GDP accelerates before becoming more optimistic about the Canadian economy. All in all a very neutral outlook and appears to be “data dependent.”
***Posting a response to a comment from reader MarkT on last night’s blog post as he raised some very thoughtful issues on the IMF role in the Greek Debt Drama. In thinking this through, I don’t believe the German and French banks took that large of a haircut, for much of the loses were loaded onto sovereign wealth funds, pensions and the ECB‘s books. The banks took very little write downs and have been disposing of their Greek paper through the ECB‘s asset purchasing schemes during the last three years. The IMF was a deep pocket composed of OPM (other people’s money), which irritated the Chinese and other emerging markets and highlighted the dual standards applied to Europe and the emerging world.
Also, as one of the previous blogs highlighted at the bottom of yesterday’s NOTES acknowledges, the typical IMF advice could not be followed for Greece because Greece did not have the power to devalue its currency, the euro. The IMF conditions for the bailout thus put the entire burden on the austerity side of the equation. SYRIZA is correct in calling for a greater sharing in the burdens foisted upon the Greek polity and economy. This, I think, is an important point for any type of realistic settlement and the IMF should not be allowed to escape from further responsibility.
Tags: BOC, ECB, Euro, Fed, IMF, Janet Yellen, Mario Draghi, QE, Stanley Fischer, U.S. Dollar