Satyajit Das: Ditching expansionist policies is like trying to escape from Hotel California
Das Capital: It's like listening to Monty Python's mortally wounded Black Knight
Satyajit Das writes the Das Capital Column in the Independent. He has worked in financial markets for over 35 years, as a banker, a corporate treasurer and now as a consultant to banks, fund managers, governments, companies and regulators around the world. He is also the author of Traders Guns and Money and Extreme Money as well as a number of reference books on derivatives and risk-management, which double as 'door stops'. He became a banker because he wasn't good enough to be a professional cricketer, but would give up finance if anyone offered him a job as a cricket commentator or allowed him to pursue his other passion- wildlife (he is the co-author with Jade Novakovic of In Search of The Pangolin: The Accidental Eco-Tourist). He lives in Sydney, Australia.
Tuesday 14 January 2014
The official policy throughout the world is "extend and pretend". Rather than deal with the fundamental issues, policy makers have adopted an expedient mix of expansionary policies. Public spending has been used to boost demand. Low or zero interest-rate policies ("ZIRP) and quantitative easing ("QE") have been used to make high levels of debt more manageable. Central banks increasingly finance governments through the purchase of sovereign debt. Currency devaluation is used to increase competitiveness and also to reduce the value of sovereign debt held by foreign investors.
Unfortunately, these policies have not created the strong economic growth, or the inflation, needed to address the problems exposed by the crisis. Instead, the policies intended to deal with the issues have spawned toxic problems of their own.
The effect of ZIRP, QE and budget deficits on the real economy (activity, employment, investment) has been limited. Instead, the policies have set off rapid and destabilising asset price rises.
ZIRP and QE have encouraged a switch to risky assets, such as high yield and emerging market bonds, to generate some returns. Mis-pricing of risks is now increasingly evident. Aggressive lending, inadequate covenants and use of discredited financial techniques (such as collateralised debt obligations) have re-emerged, in some cases almost reaching pre-crisis levels.
Commenting on the increased investment by banks of structured securities (which caused big problems in 2007/2008), Adam Ashcraft, head of credit risk management at Federal Reserve Bank of New York, observed: "We're not learning the lessons we need to learn. We haven't done anything meaningful to prevent the securitisation market from doing what it just did."
Policy settings seem curiously similar to those which contributed to the global financial crisis in the first place. In many markets, such as the US and UK, governments continue to stimulate the housing market, despite the fact that this was one of sectors that created problems during the crisis.
Policy makers seem to have forgotten the sage old advice: repeating the same thing over and over and expecting a different result is indicative of insanity.
Official policies are complicated by the Hotel California problem – you can check out any time you like, but you can never leave! As Ben Bernanke, the outgoing US Federal Reserve Chairman, discovered with his "taper" talk, quitting the present expansionary monetary policy may be difficult or even impossible without disrupting the market, which could truncate the weak real economy recovery.
In the coming months and years, a number of issues will increasingly dominate discourse.
First, it is unlikely that economic growth will reach the levels needed to power the global economy back to health, at least in the near future.
Second, inflation levels will remain low with disinflation or deflation an ever-present risk.
Third, sovereign debt problems in developed countries, as well as in a number of emerging markets, will remain an important concern.
Fourth, problems in emerging markets will continue. Overall growth will moderate and several countries may experience debt crises of different magnitudes. This will drag down global growth and affect the chances of recovery in developed countries.
Fifth, the impotence of policy makers and the inadequacies of available policy options will become increasingly evident. Policy makers quietly talk about major "macroeconomic failures". It is oddly similar to Monty Python's search for the Holy Grail, in which a defeated, limbless and mortally wounded Black Knight refuses to concede defeat, threatening to bleed on the victor.
Sixth, the economic problems will increasingly manifest themselves in social and political problems, both at home and internationally.
High levels of unemployment or under-employment, rising income inequality and the state's inability to provide the level of services that people expect will fuel increased social discontent. It will also fuel political extremism, as is already evident in the rise of parties of the far right and far left.
Interestingly, in Italy's "pitchfork" protests, the police took off their helmets to signal their solidarity with and support for the protesters.
Disparities in economic activity levels between countries will feed distrust and beggar-thy-neighbour policies. Limited growth will fuel economic isolationism and nationalism. Recent territorial disputes attest to the battle for resource security, but also to the political advantage of deflecting attention from domestic problems and making a naked appeal to nationalism.
Other issues, such as climate change or environmental degradation, the management of non-renewable resources and geopolitical instability (the Arab spring seems to have been followed directly by the Arab winter without ever seeing summer or autumn), remain ever present.
There is a growing gap between financial markets and real economic activity, between the 1 per cent who continue to gain in the current environment and the 99 per cent whose fortunes have declined, and between the promises of policy makers and the economic reality. This gap must close at some time. Unless real economic activity picks up, financial markets and prices will have to adjust, perhaps sharply, in the feared "crash".
Satyajit Das is a former banker and author of 'Extreme Money' and 'Traders, Guns & Money'
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