2014-10-07 05:38:42
Financial markets
Monetary policy, the economy and the markets
The new trinity: Janet, Mario and Mark
Oct 2nd 2014, 16:01 by Buttonwood
EQUITY markets are showing initial disappointment at the latest announcement by the European Central Bank that purchases of covered bonds and asset-backed securities are on the way; it was not the big bazooka investors were hoping for. The worry is that the ECB is too complacent about the risk of deflation (the headline rate is down to 0.3%).
But perhaps investors have too much faith in the power of central bankers in general; perhaps politicians have left them to do too much of the work. In Britain, after all, the Bank of England has bought around a quarter of all government debt and is now refunding the interest to the Treasury; we would all like to borrow on those terms.
Stephen King, HSBC's economist, focuses on this issue in his latest research note. He writes, in an awkward mixed metaphor, that
the idea that each central bank can navigate its way to a future economic nirvana by doing enough to ensure sustained growth and price stability appears to ignore the international independencies that too often upset the policymakers' applecart
adding that
The consensus struggles to imagine a world in which central banks are doing anything other than regaining control over prices. If inflation is too high - as it has been in Latin America - it is bound to come back down. If inflation is too low - as it has been in Europe - it is bound to pick up.
In fact, inflation has continued to head in the wrong direction. Here is his table showing current forecasts for 2014 inflation and what they were in September 2013.
Sept 2013 Now
Euro zone 1.5% 0.6%
UK 2.5% 1.7%
US 1.9% 1.9%
Eastern Europe 4.9% 5.7%
Latin America 7.0% 12.1%
If the forecasts are as wrong about 2015, as they were about this year, then Italy and Spain will be in deflation, euro zone inflation will still be at 0.2% and Latin American inflation will be up at 16%.
The US is one country where inflation has matched the forecasts but over at SocGen, Albert Edwards's latest note points to the recent decline in inflation expectations, as revealed by the gap between nominal and inflation-linked bond yields. At the 5-year level, inflation expectations are down to 1.6% from 2% last year and at the 10-year, they are a little over 2% from around 2.5% last year. That is not a huge shift but it is surprising given all the talk of an exceptionally strong recovery. As he comments
if inflation can 't regain higher ground in this cyclical recovery, what on earth will happen when the cyclical upswing ends?
Meanwhile, currency markets are finally starting to move with the dollar making a six-year high against the yen and a two-year high against the euro. Some countries may be hoping that depreciation will solve their problems. But as Mr King remarks
as both Japan and the UK have discovered, a falling currency may do little to help improve export prospects in a world in which economic growth is in short supply. Indeed, it may only be that a weaker currency serves to export one country's deflationary problems elsewhere; after all, one country's devaluation is another's revaluation.
That leads me to the very interesting Geneva report from Luigi Buttiglione, Philip Lane, Lucrezia Reichlin, Vincent Reinhart on the debt cycle. What is remarkable (hence the title Deleveraging? What deleveraging?) is that the ratio of global debt (ex-financials) to GDP has increased from 174% of GDP in 2008 to 212% today. The developed market ratio is 272%, with the euro zone on 257%, the US on 264%, Britain on 276% and Japan on 411%. Where debt has come down (thank goodness) is in the financial sector; nevertheless, total debt (including financials) in the developed markets is close to its peak at 385% of GDP. More generally, there has been some reshuffling of the debt, with more owed by governments and a bit less by the private sector. So for example, US private debt has fallen by 16 percentage points (relative to GDP) while public debt has jumped by 40 points.
Regular readers will recall the mantra; the likely outcomes for the debt crisis are that economies will inflate, stagnate or default. As made clear above, inflation is falling in the developed world so that seems unlikely; the emerging markets may be able to inflate their debt away (again) and they have less of it. We have only really seen default in Greece. So as the authors of the Geneva report worry
Deleveraging and slower nominal growth are in many cases interacting in a vicious loop, with the latter making the deleraging process harder and the former exacerbating the economic slowdown. Moreover, the global capacity to take on debt has been reduced through the combination of slower expansion in real output and lower inflation.
They add that
potential output growth in developed economies has been on a declining path since the 1980s and that the crisis has caused a further, permanent decline in both the level and growth rate of output. Moreover, we observe that output growth has been slowing since 2008 in emerging markets, most prominently China.
Signs of slower growth have been highlighted in a recent blog post. The problems of high debt levels are manyfold - not least the link between debt and asset prices. But the authors rightly highlight that debt is constantly being rolled over; this depends on creditors having the confidence that it will be repaid. In turn, this depends on growth expectations. So slower growth forecasts can themselves result in a funding crisis. The question is not so much if, but when it will happen.