Bullish mar­kets, bear­ish boards

The Pak Banker - - OPINION - John Plen­der

AS the pe­riod of ul­tra-loose mon­e­tary pol­icy in the de­vel­oped world inches to a close, a para­dox calls for ex­pla­na­tion. Through­out this ex­tra­or­di­nary mon­e­tary experiment man­agers of listed com­pa­nies ap­peared to see risks ev­ery­where and have been re­luc­tant to in­vest in fixed as­sets de­spite en­joy­ing the low­est bor­row­ing costs in history. By con­trast fi­nan­cial in­sti­tu­tions have been fear­less in pro­pel­ling mar­kets ever higher.

This di­chotomy be­tween sub­dued risk tak­ing in the real econ­omy and ag­gres­sive risk tak­ing in fi­nan­cial mar­kets has prompted An­gel Gur­ría, sec­re­tary-gen­eral of the Or­gan­i­sa­tion for Eco­nomic Co­op­er­a­tion and Dev-el­op­ment, to re­mark that one or other of these views will be proved wrong. With the US Fed­eral Re­serve now pre­par­ing to raise in­ter­est rates we may soon know whose judg­ment is dan­ger­ously flawed.

The be­hav­iour of fi­nan­cial in­sti­tu­tions, whether ju­di­cious or in­sane, is at least com­pre­hen­si­ble. Cen­tral banks' post-cri­sis bond buy­ing pro­grammes were pre­cisely de­signed to prod in­vestors to take on more risk. This has given fur­ther im­pe­tus to a sec­u­lar de­cline in real in­ter­est rates that pre­dated the fi­nan­cial cri­sis, re­flect­ing such forces as the Asian sav­ings glut, de­fi­cient in­vest­ment in the west and ad­verse de­mo­graphic trends. The out­come has been the much-dis­cussed search for yield.

Down­ward pres­sure on yields has been re­in­forced by a short­age of so-called safe as­sets. Hence a stam­pede into sov­er­eign bonds with neg­li­gi­ble or neg­a­tive yields - in ef­fect, a search for non-yield. Even af­ter the re­cent up­turn in yields, in­vestors are still pay­ing some Euro­pean gov­ern­ments to take their money.

In a speech in June An­drew Hal­dane, chief economist of the Bank of Eng­land, pointed out that there had been no prece­dent for such neg­a­tive rates since the time of the Baby­lo­ni­ans. Among the var­i­ous po­ten­tial ex­pla­na­tions, Mr Hal­dane puts par­tic­u­lar em­pha­sis on the phe­nom­e­non of 'dread risk', a term used by psy­chol­o­gists to de­scribe an ex­ag­ger­ated sense of fear and in­se­cu­rity in the wake of cat­a­strophic events.

It cer­tainly pro­vides a plau­si­ble ex­pla­na­tion of pri­vate sec­tor sav­ings be­hav­iour af­ter 2008. Back then, house­holds and com­pa­nies were run­ning a com­bined fi­nan­cial deficit (in­come less spend­ing) of 2.4pc of gross do­mes­tic prod­uct in the US and 1.5pc in the UK, while the eu­ro­zone was run­ning a sur­plus of 2.4pc. So the pri­vate sec­tor was nei­ther sav­ing nor dis­sav­ing to any great de­gree.

By 2010 the pri­vate sec­tor had switched to a large fi­nan­cial sur­plus of 7.2pc of GDP in the US, 8.2pc in the UK and 5.8pc in the eu­ro­zone. Se­ri­ous thrift had set in.

Yet there are lim­its to the ex­plana­tory power of dread risk. Why should a once-in5,000-year event have struck now, rather than in the 1930s De­pres­sion, which saw far greater losses of out­put and em­ploy­ment?

Note, too, that the di­chotomy be­tween risk per­cep­tions in the real econ­omy and in the fi­nan­cial mar­kets is partly an il­lu­sion. In­dus­tri­al­ists them­selves are fuelling risk­tak­ing in mar­kets through buy-backs and - takeovers.

In their re­cent Busi­ness and Fi­nance Out­look, OECD econ­o­mists iden­ti­fied flawed in­cen­tive struc­tures as part of the rea­son for di­ver­gent per­cep­tions of risk. They are surely right. The growth of buy-backs stems from eq­uity-re­lated in­cen­tives and per­for­mance-re­lated pay. The most pop­u­lar per­for­mance met­rics, earn­ings per share and to­tal share­holder re­turn, are ma­nip­u­la­ble by man­age­ment.

A dif­fer­ent take comes from econ­o­mists at the Basel-based Bank for In­ter­na­tional Set­tle­ments. For them, the peo­ple who suf­fer most from dread risk - though they do not use the term - are cen­tral bankers. The folk in Basel be­lieve that low in­ter­est rates beget yet lower rates be­cause they cause bub­bles, fol­lowed by cen­tral bank bailouts. Their worry is that we risk trap­ping our­selves in a cy­cle of fi­nan­cial im­bal­ances and busts. Un­like Mr Hal­dane, they would like to see an early re­turn to mon­e­tary ' nor­mal­i­sa­tion'.

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