Fed’s bungled strategy multiplies market risks
THE US Federal Reserve has jumped the gun. It has mishandled its exit strategy from quantitative easing, triggering a global bond rout that it did not anticipate and that it is struggling to control.
It has set off an emerging-market shock and risks “blowback” from a fresh spasm of the eurozone debt crisis, and it is letting all this happen at the same time — before the US economy is safely out of the woods.
It has violated its own counter-deflation strategy, tightening monetary policy even though inflation has fallen to the lowest levels in living memory. It is doing so even though the revival of bank lending has faded.
The entire pivot by the Federal Open-Market Committee is mystifying, almost amateurish. It risks repeating the errors made by the Bank of Japan a decade ago and perhaps repeating a mini-1937, when the Fed lost its nerve and tipped the US economy into a second leg of the Great Depression.
The Fed could have kept policy steady, welcoming the shake-out in frothy markets over the past month as a useful “fire-drill” for a future quantitative easing exit, without pushing its point too far. It chose to escalate. That it should tighten even as it cut its own growth and inflation forecasts for this year is bizarre.
Tim Duy from Fed Watch said the bank seemed to be looking for any excuse to extricate itself from quantitative easing “as soon as possible”. Its reflexes have changed. It aims to press ahead with bond tapering come what may, retreating only if growth really tanks and news is shockingly bad.
This is not just a debate over whether or not to reverse quantitative easing, or whether markets have become addicted to Fed amphetamines. It is whether we still know what is going on in the heads of those who command our destiny, those who have, with other central banks, bought up almost the entire $2-trillion issuance of AAA bonds worldwide over the past year and therefore have become the market themselves.
But if the Fed has erred again, it cannot hold a candle to the Bank for International Settlements (BIS). This club of central bankers — now entirely in thrall to the Bundesbank — demanded a halt to quantitative easing this week, as well as rate rises, yet more fiscal tightening, and an even faster pace of credit deleveraging.
If such a nihilist cocktail of BIS contraction were imposed on the world in its current condition, it would kill recovery altogether, throw millions more out of work and probably extinguish a few democracies along the way.
It would cause debt trajectories to explode and therefore prove selfdefeating on its own terms. The ultimate outcome would be a chain of sovereign defaults and bank crashes. This is one way to achieve a cathartic debt jubilee and wipe the slate clean, but by Stone Age methods and with Stone Age results.
The BIS is right to warn that quantitative easing as currently implemented is fuelling asset bubbles. But it recoils from the awful implication of its analysis — awful for the BIS and central banks, that is — which is that other forms of quantitative easing should be found to inject stimulus directly into the veins of the economy, such as building roads or nuclear power stations.
Takahashi Korekiyo pursued just such a radical experiment in the early 1930s, turning the Bank of Japan into an arm of the treasury and forcing it to fund government spending until the economy was on its feet again. It worked like a charm. Neville Chamberlain tried a lesser variant in Britain, with success. Lord Turner, former head of the defunct Financial Services Authority, proposes such a plan today, should recovery falter.
This is complex territory and may prove an idle debate if the US does indeed achieve the Holy Grail of “escape velocity”. But if it does not, and if the reason for abjuring low-inflation monetary stimulus is because it causes dangerous asset bubbles, then for goodness’ sake do it without causing asset bubbles. — © The Daily Telegraph, London