Wednesday, September 10, 2014

Central Banks And IMF Clueless On How To Proceed

The recent drum beats and flames of war have distracted many people from focusing on the economy. The markets are extended beyond beyond, all this comes at a time when the IMF is calling for more QE. It seems this might be a good time to review the reasons this is economically unsound and a bad idea. Remember markets are setting new record highs at the same time economies continue to struggle. The policies of the last six years have yet to produce the desired and expected results promised, all this money has benefited Wall Street but not Main Street. As a consolation many economist, bankers, and those who have benefited greatly tell us we would be in far worse shape if we had not taken this course.

It seems Central Banks and the IMF are clueless on how to proceed and a policy going forward. A glaring example of the current mess is one how the implied cost of borrowing for Spain and Italy for five years, which is close to the average maturity of their debt, is now lower than the cost of borrowing for the same period for the US and the UK. We see this when looking at the yield on five-year government bonds, which is 1.33% for Spain, 1.44% for Italy, 1.65% for the US and 2.02% for the United Kingdom. It was not long ago when Spain and Italy were basket cases close to collapse because of legitimate fears of default on the poisonously intertwined debts of their respective banks and governments.

The debts of Spain and Italy are not "made of gold" in fact their economies have massive issues that could fracture the entire euro-zone. If they were to stand alone it is blatantly obvious the risk of default by Spain and Italy is significantly greater than for the UK and US. This makes it seem a bit insane that "investors" are willing to buy the debts of Spain and Italy at a price that makes them appear more creditworthy than the US and UK. This is why the issue of world debt is again creeping to the forefront. Yes, the myth of an economic recovery is flawed and that is reflected in the massive growth of inequality across the world.

The Bank for International Settlements, which is the central bank for central banks, issued a report recently saying world debt levels are too high, and that continuing the current low interest rate policy has too many bad effects. Something needs to be done to normalize monetary policy. Everyone  is making statements about the issue of how to fix our current economic problems. Janet Yellen, Federal Reserve Chair, and Christine Lagarde, managing director or the International Monetary Fund both appear clueless as how to forge a new path forward.

Both these so called economic leaders have it seems long ago abandoned austerity as the answer and thrown under the bus anything that resembles tough love. Getting  back to the main point of this post, how is this debt crisis, and the likely outcome, different from previous crises?  One big difference is the economies of the world have become more intertwined leaving us open to more problems from contagion. Another is that we have tried to put patches on the problems for six years and after printing money at an unbelievable rate we are still unable to achieve a decent rate of growth.

Central banks are responsible for having made credit cheap in recent years because of all the "almost-free' money they've created since the financial crisis of 2007-08. Still it required the reckless lending and investing by financial institutions such as banks and hedge funds to push asset prices up to these high levels. This leads to the risk that asset prices will tumble, at just the wrong inconvenient moment, causing serious harm to these financial institutions and wreaking their ability to finance the economic activity crucial to our prosperity. In many ways it might appear we are back where we started six years ago only this time our base is weaker and the intertwined interest of contagion even greater.

 Footnote; This post dovetails with many of my recent writings, for more I might suggest reading the article below. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged.

1 comment:

  1. Bruce:
    The U.S. has paid very little principal back on our loans over the last 40 years.
    Even the interest is paid back with additional debt.
    How does we deserve such low interest rates based on the full faith and credit of the U.S. government?
    Don Levit