What’s going wrong with the global monetary policy? Nothing, really, except for the economic reality.
Let me explain. In a forthcoming article I will be highlighting the channels through which monetary policy deployed in recent years (a combination of extremely low lending rates, negative in many cases deposit rates, massive asset purchases or QE) have contributed to increasing markets and economic volatility, whilst achieving preciously nothing in terms of lifting up economic growth.
Here, let’s consider what I shall term the ‘extreme impotency’ of monetary policy in the age of a structural debt crisis.
Lessons from the ECB
Earlier this month, ECB did something remarkable. Prior to its March meeting, the ECB has hyped markets expectations for a dramatic monetary expansion (as pre-flagged here: http://trueeconomics.blogspot.com/2016/02/28216-ecb-in-march-thaw-or-spring.html). On the day of the announcement, the ECB actually exceeded markets expectation as I noted here: http://trueeconomics.blogspot.com/2016/03/14316-t-rex-v-paper-clip-of-draghi-and.html and de facto threw in the entire kitchen sink of monetary policies at the fire. This had no real effect.
The ECB forced through extraordinary measures:
- Already negative interest rate on ECB’s main deposit facility were pushed down from -30 to -40 basis points.
- ECB’s monthly bond purchases (the so-called QE programme) were expanded by 1/3rd from EUR60 to EUR80 billion a month, and the time frame for QE was not cut shorter, staying at March 2017 end-date. Better yet (or rather worse), Mario Draghi said the deadline might be extended, if required.
- ECB expanded the range of assets it is buying to include “investment-grade, non-bank corporate bonds” - a measure that will be deployed from June on, reflective of tightening supply in sovereign bond markets and of the ‘kitchen sink’ approach to policy.
- Then, there is an expansion of the T-LTROs universe to introduction of four new targeted long-term refinancing operation facilities with a maturity of four years. The TLTROs are ECB loans to banks designed - so it says on the tin - to help them increase liquidity. Which is, as pure bullshit goes, pure bullshit - there is no shortage of liquidity in the banking system. If there was one - ECB will not be having negative deposit rates. Instead, there is a perceived shortage of lending from that liquidity. Or in simple terms: not enough debt is being issued. So to help banks lend, the ECB promised that those banks where net lending exceeded a benchmark, the interest rate charged by the ECB on TLTRO loans can be set as low as the ECB deposit rate facility rate of -0.4%. In other words the ECB will actually pay banks to issue the loans.
Notice one simple regularity: all measures deployed by the ECB in March and indeed all measures deployed by the ECB across the entire QE are designed to do one thing and one thing only. They are designed to create more debt in the system that has been imploding from too much debt ever since the start of 2008. The ECB is, therefore, curing drug addiction by massively increasing supplies of more pure grade cocaine. If before the ECB started acting the system was sloshing around privately intermediated debt with higher associated costs, now it is being primed by low cost liquidity from the ECB.
The monetary party should have turned into a total rave by now. It did not. Primarily because the financial drug addicts have already over-dosed, so new shipments of the monetarists’ white gold are simply no longer capable of doing much. Just how bad things are? Amidst announcing its most recent ‘blanket bombing with cash’ approach to monetary policy, ECB also lowered its growth projections for the euro area, from 1.7% y/y real GDP growth to 1.4% for 2016. You really can’t make it up: as Mario Draghi bragged about ECB’s valiant efforts to boost economic growth, and as he promised even more of the same, his own forecasters were telling us that none of it is working.
No one in the markets is actually believing anything the Central Bankers say anymore
Bonds investors are refusing to sell bonds (something that should have happened if anyone trusted Central Banks on their promises to deliver higher inflation). Banks shares remain in the same pattern of volatile trading with no one having a faintest idea as to profitability of the paper they are shifting. Asset prices are rising, but they are not rising for real assets (hedges against potential inflation). Banks lending, meanwhile, is getting more questionable. Larger corporate borrowings are funding increasingly higher volumes of shares buybacks (see post here http://trueeconomics.blogspot.com/2016/03/19316-shares-buy-backs-horror-show-of.html). While ECB prints cash, households and SMEs continue to struggle with legacy debts, so that demand for new loans is simply not there no matter how low the interest rates get.
In the U.S., subprime auto loans are now in a securitisation squeeze (see here http://www.wsj.com/articles/subprime-flashback-early-defaults-are-a-warning-sign-for-auto-sales-1457862187). While student loans defaults eased somewhat (down form 2.5% of all loans in 4Q 2014 to 2.3% in 4Q 2015) much of the decline is accounted for by softer loans covenants (see here: http://www.upi.com/Top_News/US/2016/03/17/Report-Student-loan-delinquencies-decline-repayment-on-the-rise/9181458240922/). The 'deleveraged' U.S. households are about to be whacked with healthcare loans markets resting on securitisation model because new debt is good debt until it becomes the unrepayable old debt (http://www.institutionalinvestor.com/article/3538890/banking-and-capital-markets-banking/health-care-loans-offer-possible-remedy-for-high-us-drug-costs.html#/.Vu8pOBIrL_8).
The UK household debt is heading for new highs (http://www.telegraph.co.uk/business/2016/03/17/household-debt-binge-has-no-end-in-sight-says-obr/). Canadian household debt is already there (http://www.theglobeandmail.com/report-on-business/economy/canadians-debt-burden-still-growing-hits-record-in-fourth-quarter/article29172712/). In the U.S., borrowing is rising across virtually all categories (https://www.nerdwallet.com/blog/credit-cards/household-debt-edged-upward-at-end-of-2015/). In Europe, Finland, Spain, Portugal, UK, Sweden, Ireland, Norway, Cyprus, Netherlands and Denmark all have household debt in excess of 100% of GDP.
Meanwhile, negative deposit rates for the banks holding funds with the central banks are hurting banking profitability, costing bank services users in higher fees and higher cost of loans, and dis-incentivising more conservative banks' reserves accumulation.
The real problem, of course, is that the Central Banks are unwilling to face the music. Again, consider the euro area. Here, sluggish demand and weak growth are the key drivers for low inflation. And these drivers themselves are determined by the well-known factors, such as, structural decline in labour and TFP productivity growth, lack of serious competition and free trade across much of services, legacy of pre-crisis debt overhang in household sectors and over-leveraging that has gone on in corporate sector since 2010. Both of these now require restricting legacy debts and/or their partial repayment funded by the ECB. There are also bottlenecks in labour markets, including in areas relating to labour costs, but also in areas relating to skills, workplace practices, wages growth, hours of work demanded, labour force participation, etc.
All of which means that the ECB has been targeting wrong policy objectives using wrong policy tools. And the result is utter and total failure to deliver on its targets. A failure that is equally present for Bank of Japan, and in the longer run - potentially for the U.S. Fed. Let me put this simply: the only functional tool that central banks like ECB and Bank of Japan have is the tool of directly injecting liquidity into debt-burdened companies and households, targeting such injections to either repayments of legacy debts or to building up functional pensions and capex savings buffers. This is much more nuanced than Friedman’s ‘helicopter drop of money’, but it is similar to it in so far as the ‘drop’ must not target debt underwriting intermediaries (banks) and it should not aim to increase issuance of new debt. Instead, it should target balance sheets of households and companies.
The markets know that the Central Banks are out of options, out of depth and out of understanding of what is really wrong with the economy. And, thus, markets are no longer listening to what the Central Bankers say, resting upon the knowledge that the extraordinary policies of the recent past are not a cure of the disease, but the symptom of it: the stronger the Central Bank's signalled commitment to easing, the weaker is the underlying economy, the less likely is the Central Bank's announced policies to have an effect.
Lessons from Japan
Back on January 29th, Bank of Japan announced a convoluted program of differential negative interest rates on deposits.
After the initially positive reaction, the entire game was up: yen rose (instead of falling), and Japan’s terms of trade deteriorated instead of improving. With the negative rates sitting on top of a USD700 billion annual money printing QE programme, yen appreciation was concentrated in two currencies (both the USD and renminbi) which account for most of the Japanese exports. What is more amazing is that following the announcement, Japanese bond yields collapsed (predictably), only to subsequently rise again. The whole market for Japanese Government paper was oscillating like a precarious bubble ready to pop. In this environment, as U.S. is heading for a Fed-declared ‘monetary normalisation’, Government bond yields continue to fall. Meanwhile, in the monetary expansion-minded Europe, German yields are rising, then falling, then rising again. Ditto for Japan. In other words, there is no longer any real connection between monetary policy and markets pricing of Government bonds.
The Central Banks no longer have signalling power left, as the markets have largely stopped listening to the monetary authorities pronouncements. While the Fed has de facto destroyed monetary policy credibility by the way it prepared for, carried out and followed upon its December 15 rate hike, Bank of Japan and the ECB have finished the same off by their kitchen sink efforts at stimulating inflation.
Bill Gross has a neat summary of the state of play: “Instead of historically generating economic growth via a wealth effect and its trickledown effect on the real economy, negative investment rates and the expansion of central bank balance sheets via quantitative easing are creating negative effects… Negative yields threaten bank profit margins as yield curves flatten worldwide and bank NIM’s (net interest rate margins) narrow. The recent collapse in worldwide bank stock prices can be explained not so much by potential defaults in the energy/commodity complex, as by investor recognition that banks are now not only being more tightly regulated, but that future ROE’s will be much akin to a utility stock. Observe the collapse in bank stock prices – not just in the last few months but post Lehman. I’ll help you: Citibank priced at $500 in 2007, now $38 as shown in Chart I. BAC $50/now $12. Credit Suisse $70/now $13. Deutsche $130/now $16. Goldman Sachs $250/now $146. Banking/finance seems to be either a screaming sector ready to be bought or a permanently damaged victim of writeoffs, tighter regulation and significantly lower future margins. I’ll vote for the latter.” (Bill Gross Investment Outlook March 2016)
More of the same v much much much more of the same
Which brings us about to the key question: with monetary policy becoming completely impotent, what can be done to provide a meaningful stimulus to the economies staring at a de facto stagnation (Japan and the Euro area) or the risk of structurally slower growth (the U.S. and much of the rest of the advanced economies)?
The answer depends on what your monetary ideology is.
In the camp of traditional Central Bankers, it is ‘doing more of the same’ with ever widening scope of instruments: when printing money via QE is not enough, go to negative deposit rates and expand QE to all sorts of corporate debt papers. The key premise here is that issuing more debt is the only solution to the debt crisis. The problem with this approach is apparent. There is too much debt in the system already and our (companies and households) capacity to absorb more of it is exhausted.
In the other camp (and I must disclose personal interest here), the view is that given we are faced with the debt crisis, the only answer is to reduce debt or deleverage. This can be done destructively (by engaging in bleeding the economy dry by forcing debt foreclosures and bankruptcies, while simultaneously reducing the cost of debt carry through lower interest rates), or constructively (via structured write-offs of debt and through QE that injects funds directly into companies and households accounts for the purpose of debt write downs). The former approach requires sustained economic contraction over the period of forced deleveraging. The latter approach implies actually healthier balance sheets across the entire economy.
The first camp of ‘traditionalists’ is only now starting to realise that the only way their approach might work is if the Central Banks de facto commit to a perpetual easing (as opposed to temporary). Narayana Kocherlakota thinks same should apply to the negative deposit rates, although one is hard pressed to imagine what quality of assets and capital does he think the banks will hold in the medium term with negative deposit rates.
The problem, however, is that the ‘traditionalists’ - who dominate Central Banks and Government advisory - are still refusing, some 9 years into the crisis, to acknowledge the debt overhang nature of the crisis. Until they do, Central Banks will continue throwing good money at the wrong targets, delivering neither a relief for the real economy nor a momentum for real growth.
