Janet Yellen was in London this week, talking with Lord Stern at the British Academy. My main thought watching her was how lucky the Americans were to have her as chair of the Federal Reserve Board: calm, sensible, measured and wise. But of course the rest of us are lucky too, because the dollar remains the anchor of the global monetary system and it is good to be reminded that it is in safe hands.
Two things she said stood out. One was that she did not expect there to be another serious financial crisis in our lifetimes. This was largely because reforms in the US banking system after the last one would make the system safer. The other was that asset values were somewhat “rich” by historical standards. That is banker-speak for shares and property price being rather high – though she made it clear that the Fed did not target asset prices. It looked at inflation and unemployment.
The first point makes a lot of sense, because huge financial crises are indeed rare creatures and the memory of the most recent one will keep bankers and their regulators on guard for a generation at least. The Bank of England financial policy committee has just warned of there being pockets of risk in the UK, noting credit-card debt and car loans. But it thought on balance that the risks were “standard”, rather than “elevated”. Anyway it wants banks to set aside more capital against the possibility of borrowers being unable to service these debts.
But Janet Yellen was talking primarily about the US, and the problems of finance are elsewhere: in Europe and in the emerging world.
The European economy is on a bit of a roll at the moment, growing at an annual rate of more than 2 per cent. This week Mario Draghi, president of the European Central Bank, seemed to be hinting that the ECB would start to tighten policy later this year in response to this, and the euro promptly shot up on their exchanges. He was speaking at a central banking get-together that the ECB had organised in Sintra, a hilltop resort just outside Lisbon in Portugal. (Central bankers like to meet in nice places.) Shortly after he spoke, however, officials at the ECB downplayed his remarks saying they were being misinterpreted. The euro duly fell back.
Then yesterday it was the turn of Mark Carney, governor of the Bank of England, to shake things up. He told the same meeting that the UK might need to start raising rates soon. It was the turn of sterling to jump on the exchanges.
The point about all this is that everyone is hunting for clues as to how and when the various central banks will switch from easy money to tighter money. For the US the question is one of pace: one more rise this year, or several? For the UK it is when will the first rise come: this autumn? And for Europe it is when will quantitative easing (QE) be abandoned? The first change in rates is reckoned to be far off.
Why is Europe so far behind? It is partly because there is more economic slack in the eurozone. It has a second recession, whereas the US and UK avoided that. It is partly because some parts of the eurozone economy are still struggling to gain pace. But it is also because many European banks, unlike American and British ones, are still fragile. A couple of Italian ones had to be rescued last weekend. People are frightened as to what will happen when interest rates do go back to more normal levels, which at some stage they must.
In many parts of the emerging world there are similar pressures. There was a warning from the Bank for International Settlements (BIS) about this earlier this week. The BIS is known as the central bankers’ bank. It is based in Basel, in Switzerland, and was founded to help sort out reparations after the First World War. Now it still functions as an intermediary between central banks but it is mainly noted for its thoughtful and independent economic analysis. Almost alone in the world of officialdom it warned about the dangers of the financial system ahead of the last crash.
Now it says: “The main cause of the next recession will perhaps resemble more closely that of the latest one – a financial cycle bust.”
Oh dear. But it feels that the dangers are less in the developed world and more in the emerging markets, and I suppose if it is right the question then is whether the emerging market tail can wag the developed market dog. The emerging world is providing much of the global growth, but for the moment it is still smaller than the so-called advanced economies.
Maybe the fears of the BIS are unfounded; or rather the next potential financial crash will be better managed than the last one. That would surely be Janet Yellen’s view. In any case, the big message for the rest of us is that we should accept the possibility that interest rates will rise faster than is currently expected and that there could be a sharp fall in asset prices.
That is not to predict catastrophe – personally I think there will be at least another couple of years of decent growth for the developed world and I think if asset prices (including house prices) fall, it is more likely to be a correction rather than a crash. It is simply to remind us that there is such a thing as the business cycle. Things do eventually turn down, and though it may not feel like it, we have had a long upswing that won’t go on forever.
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