Analysis: Davos leaders uneasy over glut of easy money

DAVOS, Switzerland Tue Jan 22, 2013 5:57pm GMT

A woman cleans inside the Congress Hall of the World Economic Forum (WEF) at the Swiss Alpine resort of Davos January 21, 2013. REUTERS/Pascal Lauener

A woman cleans inside the Congress Hall of the World Economic Forum (WEF) at the Swiss Alpine resort of Davos January 21, 2013.

Credit: Reuters/Pascal Lauener

DAVOS, Switzerland (Reuters) - The world is awash in easy money, with consequences that are starting to worry some central bankers and business leaders at the Davos World Economic Forum (WEF), though so far inflation fears seem overdone.

With developed world government finances constrained by huge debts and deficits, central banks have pumped trillions of dollars into the system to try to revive sluggish economies, combat deflation and prop up weak banks.

The Fed, the Bank of England, the Bank of Japan and to a lesser extent the European Central Bank have strayed far from traditional inflation fighting to take into account objectives such as reducing unemployment, raising nominal GDP, and ensuring the smooth functioning of the sovereign bond market.

In pursuit of these goals, they have taken unconventional steps such as keeping interest rates well below the inflation rate, buying government bonds and mortgage-backed securities and providing long-term liquidity to banks at near zero rates.

Indeed, the Japanese central bank is now actively trying to create more inflation because prices are obstinately stagnant.

On Tuesday, the BoJ announced its most radical effort yet to end years of economic stagnation, after weeks of relentless pressure from new Prime Minister Shinzo Abe for a greater push to lift the economy out of recession.

In a joint statement with the government, the BoJ said it would switch to an open-ended commitment to buying assets next year and double its inflation target to 2 percent.

Central banking purists, especially in Germany, with its history scarred by hyper-inflation, worry that the guardians of sound money are losing their independence to governments and will find it hard to get the genie back into the bottle.

The leading hawk on the ECB's Governing Council, German Bundesbank chief Jens Weidmann, who cancelled his appearance at Davos, warned on Monday that central banks were being bullied by governments and it could lead to currency wars.

"Already alarming violations can be observed, for example in Hungary or Japan, where the new government is interfering massively in the business of the central bank with pressure for a more aggressive monetary policy and threatening an end to central bank autonomy," he said in a speech in Frankfurt.

"A consequence, whether intentional or unintentional, could moreover be an increased politicization of exchange rates."

INFLATION FEARS, ASSET BUBBLES

Within the Federal Reserve, dissident Richmond Fed president Jeffrey Lacker has been warning for months that the U.S. central bank's stimulus actions risk a surge in inflation after this year.

Management consultancy Bain & Co. said in a report that the most immediate effect of a world awash with capital has been "to paralyze, confuse and distort investment decisions".

Large financial flows were creating dangerous pockets of excess capital in some places, while simultaneously cutting off access in other places. At the same time, big institutional investors like pension funds face large gaps between the returns they will need to meet payouts and what markets will generate.

"Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles," it said, pointing to big risks for economies and businesses closely linked to commodities.

The U.S. central bank embarked on a third round of asset purchases in December that are meant to spur growth and pledged to keep rates near zero until the unemployment rate drops to 6.5 percent, as long as inflation expectations remain in check.

U.S. unemployment was 7.8 percent last month, and Fed Chairman Ben Bernanke made clear last week he is in no rush to tighten monetary policy. Speaking on January 14 in Ann Arbor, Michigan, he said "the worst thing the Fed could do would be to raise interest rates prematurely".

RACE FOR CURRENCY WEAKNESS

A survey of 1,000 business leaders and academics conducted by the WEF ahead of the Davos meeting found they continue to fear a possible "systemic financial failure", largely due to unsustainable government finances.

"Will the massive quantitative easing undertaken by key central banks to stave off deflation inevitably lead to destabilizing hyper-inflation?" the WEF's annual Global Risks survey asked, noting that some of the current extraordinary monetary policies were "essentially experimental".

In a sign of the times, one Davos panel discussion on Friday is billed as "No growth, easy money - the new norm?"

Ultra-low interest rates and printing money have combined to fuel a race for weakness among currencies. This raises the risk of a mispricing of assets in the developed world, and of capital controls and trade protectionism in emerging economies.

Tied by its own rules and German resistance, the European Central Bank cannot join the downward currency race, raising the risk that an overvalued euro chokes off any economic recovery.

The outgoing chairman of euro zone finance ministers, Jean-Claude Juncker, voiced alarm this month that the euro's exchange rate was "dangerously high".

The euro has gained 10 percent against the dollar and more than 20 percent against the yen since ECB President Mario Draghi vowed last July to do whatever it takes within the bank's mandate to preserve the single currency.

Bank of England governor Mervyn King acknowledged last week the danger of asset-price bubbles and mispricing of risk by investors due to central banks' easy money policies.

"One of the things we want to be a bit concerned about is that interest rates have been so low for so long that some of the actions have reduced risk premia to levels where the search for yield appears to be beginning again," King said in testimony to a British House of Commons committee.

This is occurring at a time when the economy is operating well below full capacity, the banking system is stretched and central bankers are struggling to find instruments to ensure an economic recovery, he said.

EMERGING ECONOMIES HURT

Easy money policies by major central banks such as the Fed, the BoE and the BoJ have strengthened the currencies of developing countries, hurting those countries' exporters. That in turn has prompted some emerging nations' governments or central banks to ease their own polices in response.

Philadelphia Federal Reserve Bank President Charles Plosser, a long-time critic of the Fed's easy money policies, warned this month that central banks in many countries are adopting policies, often under pressure from governments, to control their currencies, calling it an unhealthy phenomenon.

"We do not want to get ourselves in a world where you have currency wars. Beggar-thy-neighbor policies ... would not be healthy," Plosser told a conference in Somerset, New Jersey.

Switzerland, Brazil and China have all taken steps to hold down the value of their currencies.

In Japan, Abe is applying a potent mix of stimulus spending and easy monetary policy to try to pull the economy out of deflation and a fourth recession since 2000, causing a sharp depreciation of the yen.

The government unveiled a 10.3 trillion yen ($116 billion) stimulus package this month before the BoJ announced its dramatic action on Tuesday.

Yet if loose fiscal and monetary policy were a cure-all, Japan's economy would not be in the sick ward in the first place. The government is running a budget deficit of about 10 percent of GDP, and its gross debt has risen from less than 68 percent of GDP in 1990 to more than 235 percent now.

In Europe, the ECB has focused on pumping cheap liquidity into banks and underpinning the government bond market while keeping its leading interest rate at 0.75 percent - higher than other major central banks but well below the inflation rate.

Just months after its very survival was in doubt, the euro zone may end up with a stronger currency than desirable, crimping its economic recovery, because the ECB's instincts are more conservative than those of its major peers.

(Writing by Paul Taylor; Editing by Will Waterman)

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Comments (7)
Bob9999 wrote:
During the 19th Century, before modern central banking was invented, there was an oscillating cycle of inflation during times of economic expansion and deflation during times of economic contraction. One result was that the dollar, to take an example, held its value over the long term. Another result was that times of economic contractions were very harsh. Modern central banking interferes with the deflationary side of that period of oscillation. One result appears to be that currencies do not hold their value over long period of time, because even a 2% annual inflation rate adds up over the long haul. That does not necessarily mean that we are in for a period of suddenly increased inflation, but it does mean that everyday consumer goods are at least 10 times more expensive in nominal dollars as they were in the mid-1960s and that they will be far more than 10 times more expensive in nominal dollars in the mid-2060s.

Jan 22, 2013 7:11pm GMT  --  Report as abuse
AdamSmith wrote:
Quoting from Abraham Lincoln, 1860:

“Corporations have been enthroned, and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed.”

Jan 22, 2013 8:53pm GMT  --  Report as abuse
stevedebi wrote:
AdamSmith:
No, you are quoting from a bogus report published 20 years after Lincoln died. He never said that.

http://www.snopes.com/quotes/lincoln.asp

Jan 22, 2013 9:56pm GMT  --  Report as abuse
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