Why hasn’t ultra-easy monetary policy revived global economic growth? Why is the global economy increasingly mired in secular stagnation despite record-low interest rates and the flood of central bank liquidity? Last year, the supply of global liquidity, measured as the sum of non-gold international reserves held by all central banks plus the Fed’s holdings of US Treasuries and Agencies, rose to a record $16.6 trillion during August. That’s up $8.7 trillion, or 116%, since the start of 2009.
Central banks responded to the financial crisis of 2008 by pumping lots of liquidity into the global economy since then. They also lowered their official interest rates close to zero, with some of them now below zero. Bond yields are at historical lows in most of the major advanced economies. Rather than deleveraging, borrowers around the world were enabled by the central banks to borrow more.
Losing Its Edge
The problem is that easy money has been around for a long time, and seems to be losing its effectiveness in stimulating economic growth. During the previous two decades, many of the borrowers were consumers of commodities, goods, and services. Their debt-financed spending boosted economic growth. That encouraged producers to expand their capacity by borrowing as well. In recent years, easy money seems to have lost its ability to boost consumption, while enabling producers to stay in business.
The result has been mounting deflationary pressures. The major central bankers have responded by lowering their interest rates to zero and providing more liquidity through various QE programs. They’ve been doing so since the financial crisis. That’s more than six years, yet secular stagnation seems to be spreading along with deflationary forces around the world.
In addition, populist politicians are gaining power, especially in the Eurozone and particularly in Greece. They want to end their governments’ austerity measures. In other words, they want to reduce the burden of the debts that their countries and countrymen accumulated during the so-called “debt super-cycle” of the past couple of decades. That means restructuring their debts by forcing lenders to extend maturities, to lower borrowing rates, to take haircuts, or to accept defaults. Of course, the last option is the one that would put a stake in the heart of the debt super-cycle and destroy the credibility of the central banks.
Is there a solution to this mess? Beats me. Central banks have been going down this road for a long time. They are likely to continue doing what they have been doing without recognizing how they might have inadvertently created the mess. Their mess has spread to the foreign exchange market, triggering an undeclared currency war. The central bankers have declared that their ultra-easy monetary policies aren’t aimed at driving down their currencies, but that’s what they are doing.
The Bank of Japan’s contribution to Abenomics was to devalue the yen with its QQE program. The currency plunged 34% from September 13, 2012 through yesterday. ECB President Mario Draghi started talking down the euro late last summer and pushed it lower with the QE program announced last week. The euro is down 19% from last year’s high on May 6. Commodity currencies are plunging around the world because the commodity super-cycle wasn’t as super as many producers had anticipated when they expanded their capacity.
What Happened?
Instead of fretting over where this is all leading, let’s take a brief stroll down Memory Lane to recall how we got here:
(1) Fed. The Fed provided lots of easy money since the late 1980s. Under Fed Chair Alan Greenspan, the result was a bubble in high-tech stock prices during the late 1990s and a housing bubble during the previous decade. Under Fed Chair Ben Bernanke and now Janet Yellen, bond and stock prices have soared. Home prices have recovered.
The economy finally seems strong enough that Fed officials are aiming to start raising interest rates at mid-year. The problem is that the soaring dollar is pushing inflation further below the Fed’s 2% target. In addition, it is depressing corporate profits, causing companies to reduce their labor costs, which may continue to keep wage inflation around 2%, below the Fed’s 3%-4% preference.
This increases the likelihood of either one-and-done or none-and-done for rate-hiking this year. Thursday’s FOMC statement reiterated: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” The word “patient” is ambiguous enough that the FOMC dropped the “considerable time” phrase without upsetting the markets yesterday.
(2) ECB. The introduction of the euro at the start of 1999 caused bond yields to converge in the Eurozone as investors no longer distinguished between the credit risk of the different members of the monetary union.
The spread between both Spanish and Italian government bond yields versus the comparable German yield narrowed to zero during the previous decade. Spreads widened again at the beginning of the current decade, but narrowed significantly after Mario Draghi pledged to do whatever it takes to defend the euro on July 26, 2012.
ECB data show that loans to the Eurozone private sector soared by €4.0 trillion to a record €11.1 trillion from the start of 2004 through the end of 2011. As of November 2014, this debt measure was down to €10.4 trillion. In other words, the ECB’s various attempts to revive lending since the financial crisis have failed. That might be because borrowers are already maxed out on their ability to service more debt.
(3) PBOC. The Chinese responded quickly to the financial crisis of 2008 with a large fiscal stimulus program and lots of easy money. Banks were encouraged to lend freely, which they did. Bank loans soared by $8.9 trillion from the end 2008 to a record high of $13.3 trillion at the end of last year. Yet China’s economic growth continues to slow as the economy gets less bang-per-yuan of borrowing.
(4) BOJ. Last Wednesday, the BOJ monetary policy committee cut its core inflation forecast to 1.0% for the fiscal year starting in April from 1.7%. Despite the latest QE (introduced on April 4, 2013) and then QQE (October 31, 2014) under Abenomics, Japan’s monetary policymakers can’t seem to get core inflation up to 2%.
FX Distortion
The BOJ has succeeded in devaluing the yen and boosting stock prices. But it is distorting the bond market. Thanks to QQE purchases by the BOJ, the Japanese 10-Year government bond yield was down to only 0.28% yesterday. The 30-Year yield was 1.29%. The flattening of the yield curve near zero is bad news for financial companies, especially insurance companies and banks.
Already some forex watchers are watching out for a Swiss-style jump in the yen if the BOJ finds that it’s getting harder to buy JGBs because no one wants to sell them.
