Axel Merk: Are central banks a destabilizing force?
How the hell did something this sensible get into the Financial Times?
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By Axel Merk
Financial Times, London
Monday, January 19, 2015
Few pity the speculators who lost money when the Swiss franc surged last Thursday after the Swiss National Bank removed the ceiling it had imposed versus the euro since 2011. However, the ensuing rout in currency markets suggests central banks may have become a potentially destabilising force.
SNB president Thomas Jordan said Swiss companies had years to prepare for the removal of the currency peg. The opposite is the case: the mere existence of the peg in the first place discouraged Swiss businesses from hedging their currency risk; now the SNB has pulled the rug from under them. Talking to folks in Switzerland, some describe it as a feeling of betrayal.
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It may be a mistake to think the SNB's actions are an isolated event: The threats emanating from central banks go much further.
With regard to investments, central banks the world over have made risky assets appear relatively safe. Risk premia have been compressed. In plain English, complacency is rampant. It is obvious now that investors were complacent about the risk of the SNB abandoning the peg. But what about stocks and bonds worldwide?
In recent years, both asset classes have risen against a backdrop of low volatility, a measure of complacency. This means when central banks try to disengage from their extraordinarily accommodative policies, risk premia ought to rise again: fear may come back to the market. All else equal, as volatility rises, asset prices must re-price lower. That is a problem if much of the economic recovery is based on asset price inflation.
The fallout from central bank asset purchase programmes, or quantitative easing, does not just put investors at risk, but threatens the social fabric and political stability all over the world. Those who own assets and know how to deal with credit might fare well, but those without assets or knowledge suffer. As such, monetary policy is a key driver of the rising wealth gap. Yet the underlying problem that citizens and/or their governments cannot balance their books is not being addressed because central bank action masks the real issues.
Ukraine would not be in its current situation if it were able to balance its books. In the US, increased political polarisation may make it ever more difficult to come up with entitlement reform. In Japan, a populist prime minister is implementing radical policies that include massive quantitative easing. It may not be fair to blame monetary policy for all these directly, but it provides a catalyst that enables the build-up of imbalances.
As the Swiss example has shown, imbalances can correct rather violently.
In that spirit, Mario Draghi, president of the European Central Bank, intends to raise the stakes. The official word is that QE by the ECB, to be announced this week, ought to boost inflation expectations that are currently too low. However, Germany does not need QE because it has already undertaken structural reform, while much of the eurozone needs structural reform rather than QE.
Structural reform would do far more to encourage businesses to make investments than negative interest rates do currently. It will also be hard to boost inflation via QE if banks continue to be inhibited by impaired balance sheets. Lifting sanctions against Russia would also mitigate deflationary forces more than QE. Finally, lower oil prices do much more to boost the eurozone economy than QE possibly could. As Mr Draghi appears committed to proceeding anyway, it appears QE is aimed squarely at debasing the euro, adding fuel to the dynamics outlined.
In contrast, many anticipate the US Federal Reserve will raise interest rates this year, resulting in extreme bullish positions on the US dollar. Since last summer, the dollar has rallied in tandem with US stock and bond markets, suggesting foreigners are chasing performance in the US. However, it implies the dollar may not be the beneficiary in a "risk-off" environment.
Looking longer-term, although current budget deficits have come down, it is hard to see how the US can afford positive real interest rates for an extended period given its entitlement obligations. Even if rates gradually rise in the US, real interest rates are not expected to turn positive any time soon. Not surprisingly, gold has been moving higher.
When Fed chairwoman Janet Yellen says the Fed will be patient, what she is really saying is: Please continue to be complacent.
Axel Merk manages the Merk Funds.
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