By Yilmaz Akyüz
GENEVA, Oct 22 2013 (Columnist Service)

Five years into the crisis, growth in the U.S. is still below potential, Europe is struggling to pull out of recession and major emerging economies are slowing rapidly after an initial resilience during 2010-2011.

Longer-term prospects are not much brighter largely because the key problems that gave rise to the most serious post-war crisis – income inequalities, external imbalances and financial fragilities – remain unabated and have indeed been aggravated.

The world economy suffers from an under-consumption bias because of low and declining share of wages in the gross domestic product (GDP) in all major advanced economies including the U.S., Germany and Japan, as well as China.

Yilmaz Akyuz

Still, until 2008-2009 the threat of global deflation was avoided thanks to consumption binges and property booms driven by credit and asset bubbles, particularly in the U.S. and the European periphery.

The crisis has not removed but reallocated global trade imbalances.

Longer-term global prospects depend a lot on the U.S. due to its central position in the world economy and the international reserves system. It is highly unlikely that the U.S. can move to wage-led growth in the near future.

Nor can it shift to export-led growth. This would require, inter alia, exports to grow faster than domestic demand and the share of private consumption in GDP to fall. This is difficult to achieve since for several decades the U.S. has constantly lived beyond its means thanks to its “exorbitant privilege” as the issuer of the central reserve currency.

Thus, a key question is if the U.S. would be inclined to go back to “business as usual” and allow credit and asset bubbles in search of relatively rapid growth. This is closely connected to its exit from the ultra-expansive monetary policy.

Clearly, exit implies not just increased policy interest rates but also the normalisation of monetary policy – the federal funds rate to become again the main instrument of policy, a significant contraction in the size of the balance of the Federal Reserve (Fed) sheet and the volume of excess reserves that depository institutions hold at the Fed, and a large shift of the Fed’s asset composition back to short- and medium-term Treasuries.

A strategy that the Fed should gradually exit from the quantitative easing (QE) 3 but maintain low policy rates for several more years in order to support growth and use macro-prudential regulations to limit systemic risks appears to be enjoying considerable support.

However, it may not be easy to engineer such a process without jeopardising financial and macroeconomic stability. Uncertainty abounds because there are not many historical precedents for exit from extended periods of zero-bound interest rates and QE.

Even a gradual return of the Fed balance sheet to “normal” size and composition may result in a considerable hike in long-term rates even if policy rates are kept low for an extended period. The prospects for exit from the QE3 in the coming months have already pushed up the yield on the U.S. 10-year Treasury bond to almost 3 percent in August 2013 from around 1.60 percent in May.

If concerns about financial instability and the effectiveness of macro-prudential measures come to dominate, the Fed may be obliged to exit rapidly. This would result in a hike in short- and long-term interest rates and give a major shock to the financial system as in 1994.

It would result in slower growth and a stronger dollar. Too rapid an exit and re-pricing of substantially increased stock of debt could even cause a hard landing in the U.S. by leading to large losses for bondholders and depressing private spending.

These dilemmas arise in large part because of excessive reliance on monetary policy to combat recession and the reluctance to use fiscal expansion and debt restructuring to stimulate aggregate demand.

The normalisation of monetary policy in the U.S. will also cause problems for emerging economies. Despite occasional complaints about the “currency war” entailed by liquidity expansion in several major advanced economies simultaneously, the policy of ultra-easy money has generally been benign for emerging economies.

It has been a major factor in the sharp recovery of capital inflows after the sudden stop caused by the Lehman Bank collapse in September 2008.

Many major emerging economies such as India, Brazil, South Africa and Turkey have come to depend on such inflows as their current accounts started to deteriorate. They have invariably welcomed the asset bubbles that such inflows have helped generate and often ignored the financial fragilities caused by increased exposure to interest rate and exchange rate risks by private borrowers abroad.

Such exposures are on the rise since the beginning of 2012. As funds have started to be withdrawn from domestic securities markets, emerging economies have increasingly relied on international debt contracted in reserve currencies, which reached, in net amounts, 600 billion dollars between the beginning of 2012 and mid-2013.

As the Fed has got closer to ending the QE3 and the long-term U.S. rates have edged up, strong downward pressures have started to build up on the currencies, stocks and bonds of several emerging economies such as Brazil, India, South Africa and Turkey, which were widely seen as rising stars only a couple of years ago.

And the longer-term prospects of the eurozone are even less encouraging than the situation in the U.S. Deleveraging and recovery are likely to remain extremely slow in the periphery and many countries cannot expect to recuperate the output losses incurred after 2008 for several years to come.
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Quantitative Easing (QE) has been favourable to developed countries, stimulating local investment and exports. Credit: Bigstock.

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO , Jun 25 2013 (IPS)

It took world leaders some time to realise that the financial crisis initiated by the collapse of the subprime mortgage segment of U.S. financial markets in 2007 would not exhaust its effects in an ordinary recession.

For most of 2007 and 2008, government authorities, especially in the U.S., argued, rightly, that subprime mortgages were a relatively small segment of the U.S. financial system, concluding – wrongly, as it turned out – that the crisis could be easily contained through the use of conventional policy instruments at the disposal of the Treasury and the Federal Reserve.

In fact, the crisis spread out to other segments of U.S. financial markets and, in September 2008, with the bankruptcy of Lehman Brothers, it spread out to most of the rest of the world.

As domestic financial sectors in the countries hit by the shock waves were engulfed by their own crises, credit supply contracted and the financial crisis was transformed into an economic crisis, with falling output and rising unemployment.

The realisation that the crisis was deeper than most analysts expected initially led governments to react through implementation of anti-cyclical macroeconomic policies. Expansive fiscal and monetary policies were implemented, in one form or another, not only in the U.S. and Western European countries, but also in many developing economies in 2008 and early 2009.

The collapse of output and employment in the developed economies was contained and the ghost of a disaster like that of the early 1930s was, at least temporarily and at least for some countries, exorcised.

At this point, economic policy debates in the richest economies suffered a reversal.

Output was still lower and unemployment much higher than before the crisis both in the U.S. and in Europe. Nevertheless, the debate switched from real problems to fiscal balances. Conservative groups, ranging from the lunatic extreme right of the Tea Party in the U.S. to the moralising posture of northern European governments led by right wing parties or coalitions, prevented the further use of fiscal policy to raise output and to create jobs.

It is a fascinating discussion as to why this happened, but there is no room in this commentary to explore the question. The fact is that aggressive expansionary fiscal policies have become politically unacceptable even while output is low (or even falling, as is the case with many European countries, and not only the “peripheral” ones) and unemployment is growing. Under these conditions, the only instrument left to try to increase market demand and to stimulate production was monetary policy.

Monetary policy, traditionally, impacts the economy through variations of interest rates. The interest rates under the control of monetary authorities like the U.S. Federal Reserve or the Bank of England, for instance, were, however, already very low, near zero.

There was not much conventional monetary policy could do to compensate for the lack of a rational expansionary fiscal policy. It was in this context that quantitative easing (QE) policies were formulated in the U.S., U.K. and more recently in Japan, while the European Central Bank struggles with itself to determine what should be its policy. QE policies are simply initiatives to funnel money into the economy in amounts great enough to facilitate the expansion of the supply of credit for private borrowers, both firms and consumers.

It may be too soon to assess whether they worked as expected or not. Of course, the developed economies where these policies were implemented are still struggling with the crisis and its developments. A generous reading of these policies is often based on a counter-factual: things are not that good yet, but they would be much worse if those policies had not been applied.

For developing economies, the impact is certainly ambiguous. On the one hand, accepting the assumption that without QE policies developed countries would be in a much worse situation than they are now, it is better than nothing.

If output had contracted further in those economies, trade would be even lower nowadays, creating balance of payments problems for many developing countries.

On the other hand, from the point of view of developing countries, monetary easing is certainly not the ideal way to support output and employment.

QE increases money supply at the same time that it reduces domestic interest rates in the developed economies. In a world of free capital flows, as is mostly the case now, this means that a large part of this liquidity will flow out of the country that created it.

In part, although governments deny it, this is precisely what they expect: capital outflows devaluate the currency of the country practicing QE, so it will have two stimuli for the price of one: lower interest rates stimulate domestic production and investment, and devalued currencies stimulate exports.

Of course, for developing countries the impact is exactly the opposite: they receive too much foreign liquidity, their exchange rates tend to become overvalued, reducing exports and stimulating imports.

Deficits in the balance-of-payments current account tend to emerge, but it is easy to finance them since there is so much liquidity in the world.

Until, of course, QEs are discontinued and borrowing countries will find out, as they did many times in the past, that foreign debt accumulated to the point of leading them to a crisis.

Would it be better not to have developed countries practicing QE? Well, governments in these countries had to do something and monetary policy was the only instrument left after right wing parties prevented them from using fiscal policy.

Expansionary fiscal policies in those countries, however, would be much better for developing economies because they expand their domestic economies without undervaluing their currencies. Fiscal expansion, in contrast to monetary expansion, is not a beggar-thy-neighbour type of policy.

There is evidence now that the Federal Reserve expects to stop QE3 relatively soon. QE had some deleterious impacts on developing countries, as just argued, but its reversal is also full of risks.

It is possible that interest rates will rise too much and too quickly, creating serious problems for those countries and firms that borrowed more in this period.

Increased volatility itself, because of the uncertainties such a change in direction engender, is a problem, scaring investors and depressing production and investment. To expand the economy to get out of a depression is the correct attitude, but QE was an instrument that definitely contributed to increased short and medium term risks of the macroeconomic situation.

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By Roberto Savio
ROME, Apr 24 2013 (IPS)

For a long time it was a given that while Europe was based on defending a more just society, with social values and solidarity, the United States was based on the glory of individualism and competition, and anything public was considered “socialist”.

Roberto Savio, founder and president emeritus of the Inter Press Service (IPS) news agency. Credit: IPS

One of the main accusations of the last electoral campaign in the U.S. was that Barack Obama had an unspoken design to transform the U.S. into another Europe, beginning with healthcare reform.

Well, it’s time for an update – the defenders of market fundamentalism are now in Europe.

At the last meeting of Ministers of Finance on Apr. 9, the freshly-appointed U.S. Treasury Secretary Jacob J. Lew tried to convince Europeans to lessen their commitment to austerity as the best medicine for economic problems. The U.S. Treasury, together with the U.S. Federal Reserve, has launched a policy of economic stimulus, with concrete success.

Every month, the Federal Reserve alone is putting 80 billion dollars into the bond market. Incidentally, Japan is doing the same, on an even greater scale. Lew was met with a firm rejection: the best way to achieve growth in the long term (contrary to any evidence) is to cut deficits and reassure the markets, even at the cost of higher unemployment and social misery in the short term.

Europe’s most powerful minister, Germany’s Wolfgang Schauble, said: “Nobody in Europe sees this contradiction between fiscal consolidation and growth. We must stop this debate, which says that you have to choose between austerity and growth.”

He was echoed by the president of the European Union, Herman Van Rompuy: “There is no room for complacency. The European economies have a high level of debt, deep structural medium-term challenges, and short-term economic headwinds that we need to confront.”

"Share traders [are] both more reckless and more manipulative than psychopaths"
These short-term economic headwinds are the daily reality of all the countries of Southern Europe. Suffice it to point out that youth unemployment has climbed to 22 percent across Europe (Spain is close to 47 percent) to see that we are wasting a generation, which will have no access to a future pension or a house. Like it or not, a study by the International Labour Organisation (ILO) foresees that the generation now entering the labour market will retire with a pension of only 640 euro per month. Is that a sustainable society?

The reaction of British Prime Minister David Cameron to his country’s loss of Triple A status, was to reaffirm even more his commitment to austerity, including reductions in education and health spending. He conveniently used the funeral celebrations for former British Prime Minister Margaret Thatcher, the forerunner of the dismantling of the welfare state, to place himself as the heir of the Iron Lady: TINA, There Is No Alternative.

Meanwhile, we now have the data for Cyprus. It is widely accepted that it will lose at least two percent of its gross domestic product (GDP) in the coming months and the social impact will be dramatic. Soon, it will be obliged to ask for another bailout.

But under the new formula imposed by Germany, which is to make bank investors and depositors pay for the bailout, they have already lost 60 percent of their money. It will be interesting to see how Germany will find a way for a new bailout.

The Bank of Cyprus has already sold all its gold reserves. What will they now extort, the sale of houses? This is what is widely rumoured will be asked for in Spain and Italy, where citizens would pay a one-off amount and bank depositors would be taxed on their deposits as a condition for any European money.

At the same time, Germany sits comfortably on its trade surplus with Southern Europe, which has reached, according to the OECD, the magical amount of one trillion euro. And the bailouts to Greece, Portugal and Ireland were directed towards reimbursing bad German bank investments.

Yet, the situation of the banks and the volume of toxic titles they still possess are unclear. A number of figures circulate: what it is agreed is that banks still need money to stabilise. The case of Bankia in Spain is emblematic. The government has poured in 72 billion dollars, more than what it cut in health and education. Have the banks become wiser and less speculative now that they know that they will be bailed out anyhow?

The latest news from Wall Street is revealing. The banks that created risky amalgams of mortgages and loans – the so-called derivatives, which created the immense disaster that ignited the present crisis (with the added contribution of European bank speculation over sovereign titles) – are creating exactly the same instruments of risky speculation. Forgotten is the last crisis five years ago. In the last quarter alone, banks have issued 33.5 billion dollars in bonds backed by commercial mortgages and proven disastrous speculation is back, just like collateralised debt obligations.

The reason is simple. Unless banks are put back to the pre-Clinton era when deposit banks were rigidly separated from investment banks, all the money that goes to the banks will go first to speculation, which has a higher return (and if anything goes wrong the state will bail them out again), and then to deposits and loans, which have a much smaller return.

So, the traders specialised in those derivatives are being hired back by the banks.

Two experienced forensic experts working for a Swiss university have devised computer simulation and intelligence tests to measure the egoism of 28 professional financial traders, and to check their willingness to cooperate with others. They discovered that the share traders were both more reckless and more manipulative than psychopaths. Thomas Noll, a psychiatrist and a prison administrator, told Germany’s ‘Der Spiegel’ that the “more egoistic” traders “were more willing to take risks than a group of psychopaths who took the same test”.

What surprised the researchers was the competitive attitude of the financial traders, which had a destructive edge. Instead of being business-like and aiming to reach the highest profit, explained Noll, “it was most important to the traders to get more than their opponents, and they spent a lot of energy trying to damage their opponents”.

How many crises do we have to bear before regulations eliminate risks from the banks and they are confined to the world of speculation? Or, in other words, before regulations isolate normal citizens from traders who are not wired like us?

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