Carney's first week abroad a predictable success
Back from holidays in a place where they read The New York Times each morning, and better for it. Of all the world news I read last week, the fact that Bank of England Governor Mark Carney released forward interest rate guidance during his first days in office was the least newsworthy of the lot:
Answering critics who said they were running out of ways to promote growth and lending, the European Central Bank and the Bank of England on Thursday did something neither had done before, committing themselves to keeping interest rates low indefinitely.
Mark Carney, governor of the Bank of England, which said in a statement that any expectations that interest rates would rise soon from their current record low levels were misguided.
The bid to reassure investors brought the two central banks into closer alignment with the Federal Reserve, which, under Chairman Ben S. Bernanke, has become more open about its intentions.
At the same time, they appeared eager to signal that they would not follow the Fed in preparing for a gradual withdrawal of economic stimulus.
Mario Draghi, the president of the European Central Bank, based in Frankurt, said at a news conference that crucial interest rates would “remain at present or lower levels for an extended period of time.” Until Thursday, the bank had steadfastly refused to pin itself down on future policy.
“It’s not six months,” Mr. Draghi said. “It’s not 12 months. It’s an extended period of time.”
Mr. Draghi also said that the central bank was signaling a “downward bias” in interest rate policy, meaning further cuts were possible or even likely.
Only hours earlier, Mark J. Carney, who became governor of the Bank of England on Monday, made a similar break with tradition. The British central bank said in a statement that any expectations that interest rates would rise soon from their current record low level were misguided.
With their promises of easy money stretching toward the horizon, the central bankers offered more certainty to investors at a time when tensions in Europe are rising again. So-called forward guidance is considered one of the tools available to central banks, but it was one the European Central Bank and the Bank of England had not used before.
European markets reacted positively to the announcements, with the FTSE 100 in London closing 3.1 percent higher and the Euro Stoxx 50, a benchmark of euro zone blue chips, climbing 3 percent. (Markets in the United States were closed for the Fourth of July holiday.) The euro fell sharply, a development that was probably not unwelcome at the European Central Bank, since a cheaper euro makes European products less expensive in foreign markets, feeding exports. The British pound also fell.
Mr. Draghi said it was a coincidence that his central bank and Bank of England introduced forward guidance on the same day. Both left their main interest rates at 0.5 percent and did not announce any other policy moves. It was a day for talk rather than action.
This is the very market-comforting strategy that has worked in Canada and the United States over the past few years, but the Bank of England had to date refused to play ball. What investors and entrepreneurs alike should find troubling is that the ECB claimed that it was just a coincidence that both institutions chose the same day to introduce this well-worn policy tool.
For Governor Carney and Mr. Draghi to have arranged the timing and coordination of their wise interventions makes sense, given the stagnant economic situation across Europe, and the essential insolvency of many banks in the Southern Euro zone. For it to have happened by chance, or to pretend that it isn’t part of a strategy to adopt Mr. Carney’s Canadian tactics across Europe and the U.K. during his first week in the U.K., should trouble all of us.
A full swing was in order. The left hand and the right hand need to act in unison, and should be proud to do so. The ball will never get out of the rough, otherwise.
Yes, a success. A success in convincing people to acquire more debt by keeping interest rates artificially lower than the market would otherwise keep them for a long period of time. It was tried in the late 90’s and we ended up with a bubble. Tried in the early to mid 00’s and we ended up with another, larger, bubble. It is being done again right now to an extent that hasn’t been tried since 1920’s Germany, but this time it will work. Just ask everyones favourite Goldman employee.
My biggest curiousity is why these Central Planners never mention the word “deleveraging.” Is it because they don’t want it to happen on their watch? Is it because the Central Banking model of capitalism only works when asset prices go up? Is it because the mere suggestion that we are in for a period of difficulty that might last 20 years would be enough to rattle the markets and disturb their hope for a wealth effect miracle?
Every day we follow this path the world gets deeper and deeper in trouble. When we find ourselves in a hole, we are supposed to stop digging. Instead we’ve gone out and bought a caterpillar on the credit card. You suggest that Southern Europes banks are effectively insolvent, what about Deutsche Bank’s $50 trillion, that is
in derivatives. They net out to a mere 770 billion, but what happens when one side can’t pay?
We can see where all this is headed very easily because Japan was here 20 years ago. They now have a debt/gdp ratio of 240%. A third of their tax revenue is used up by debt interest service, and their average interest rate on that debt is 0.7%. Mr. Abe declares he wants inflation of 2%. Assuming no one is dumb enough to buy 10 year bonds at 0.7% when inflation is at 2%, what happens to their debt service costs when their interest costs triple? Hint: its not good.
Mr Carney was lucky to have the Canada job when he did. I’m sure he is a very competent manager but one look at the Toronto, Montreal, Vancouver, or Ottawa skylines tell you exactly what he has done here. The amazing thing is that he could have looked anywhere else in the world to see the consequences of a property bubble but either didn’t care or believed inflating the debt bubble was the most prudent course of action at the time.
Quite simply we live in a world that equates debt growth with GDP growth. In 1980 total credit market debt owed to GDP was about 160% in the US. In 2007 it peaked at 377% and has now pulled back to about 350%. In 1929 it peaked at 260%. The drop of 27% we’ve experienced has left more than 47 million American’s on food stamps, presumably because they don’t have enough money to feed themselves. We need to drop another 90% to get back to a level that in the past was so large it caused the great depression.
There are only 2 ways out of this. Prolonged inflation or a collapse, similar to what we started in 2008 before the market was taken over by Central Bankers. There are no other options because the path we are on is unsustainable. I’ve been told by very smart people that the Central Bankers understand this but I’m not sure it is going to matter.
Or maybe I’m just crazy. Either way I will sleep okay at night with my gold.
But it’s funny.