Page 1 of 4 CREDIT BUBBLE BULLETIN Weber's invaluable insight
Commentary and weekly analysis by Doug Noland
Europe is again showing heightened fragility, while US equities post a big first-quarter. The Cyprus fiasco has brought a number of important issues to the fore. It doesn't seem an inopportune time to be reminded that the Germans just have a different view of how economic systems function, and this difference has been on increasing display.
Anyone who has even casually studied ''Austrian'' economics certainly appreciates the stark contrast to American economic doctrine. Over the years, as our economic thinking and central
bank policies have evolved ever more radically, I have looked to grounded German central bankers for sound doctrine and analysis (along with a little sanity).
I recently noted a 2004 CBB, ''Issing v Greenspan''. It was written in the midst of overheated mortgage finance and the emergent Alan Greenspan / Ben Bernanke doctrine of ignoring asset bubbles (focusing instead on ''mopping up'' strategies in the event one burst). Analysts with an ''Austrian'' bent saw rather obvious dangers in the Federal Reserve's policy of accommodating credit and speculative excess, asset inflation and the misallocation of resources throughout the economy.
Back in '04, I excerpted from a speech from Otmar Issing, chief economist at the Bundesbank and European Central Bank, including an insight that is even more pertinent today: ''Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous... ''
The Bundesbank decisively won that debate, although the Fed has fought hard to rewrite history. Now we've reached another critical juncture in economic history, with the Federal Reserve having evolved to a policy of directly inflating asset markets. One would have thought that by now the American doctrine of inflationism would have been discredited. Instead, our central bank has become only more radical, with its US$85 billion monthly printing in a non-crisis environment. Many central banks around the world have followed suit, with the Bank of Japan now about to aggressively expand its printing operation.
The upshot has been highly speculative and inflated securities and asset markets around the globe. Meanwhile, the Germans have been under heightened attack for bucking the ultra-easy ''money'' craze. They denounce unrestrained borrowings and mounting debt levels. They see myriad financial and economic imbalances and deep structural problems on a global basis.
From the German perspective, they see no substitute to financial, economic and policy reform. The Bundesbank has protested ''money financing'' of European sovereign debt and, more specifically, the open-ended ''Draghi Plan'' market backstop. Anecdotes over the years have suggested that Bundesbank officials view US monetary policy with increasing alarm. With this in mind, I will this week highlight Insights from Axel Weber, UBS chairman, and former ECB Council member and Bundesbank president. If Mr Weber had not resigned from the ECB in protest over the bank's bond purchases, he might today have Mario Draghi's job as head of the ECB. I believe his comments are in line with those at the Bundesbank and perhaps German policymakers more generally.
On a seminar panel with chairman Bernanke, former Treasury Secretary Larry Summers, and the Bank of England's Mervyn King, Mr Weber spoke this week at the London School of Economics (LSE). Seemingly intent on providing colorful material for future historians, Bernanke stated ''because stronger growth in each economy confers beneficial spillovers to trading policies, these policies are not ‘beggar-thy-neighbor' but rather ... ‘enrich-thy-neighbor' actions.'' Fortunately, Weber came prepared to share valuable insight.
From Mr Weber: ''Now, I've changed sides (from being a central banker), so to say. I'm now in the private sector, which is getting a lot of flack now, especially having been stabilized largely through public intervention. So I feel a bit along the side... having left office, I can speak more freely. And what I'm going to do here is basically pour some water into the wine.
''I think what we heard a lot here was central banks are frequently entrusted with more and more tasks. They get more and more tasks and therefore they need more and more instruments. My point is there is some expectation management in order here, because as central banks obtain a larger core role in the economy, we do have to see the downside: what this could potentially mean. And therefore this expectation management is important.
''It's important to have that expectation management on unintended consequences - or side effects of monetary policy. And it's also important for the new roles that central banks are now getting more and more into, and that is a role in the supervisory world - a role in financial stability, a key player in financial markets that increasingly deals with banks from all angles. And that gives them a special responsibility. And I think it also heightens the risk that central banks, if they get it wrong, they could get it wrong across a number of issues.
''Let me start very briefly... with just giving you a very brief view on what I think are the key issues now. The question of lessons learned... we're not really out of the woods yet. And so it may be a bit too early to draw some lessons learned. But my view is that global financial sentiment, while it has improved from last summer, and while there are some overall signs of a more stable and improving macro economic backdrop, better financial conditions and a pickup of investment is unfolding - this may be a period where the Cypriot developments that we've just seen over the past few days are a timely reminder that there still remain high-risks. And the handling of complexity and of stabilizing banking systems and stabilizing euro area problems is still out there. And maybe the mood that we've seen improve was good, maybe too good - and maybe too good to be true.
''So, I am still of the view that, in a sense, I fear the recent rally in financial markets that we've seen could be a misleading signal. It is more driven by exceptionally expansionary monetary policy - in the belief that on both sides of the Atlantic we could avoid some disasters. But, basically, the underlying progress in the economy hasn't really made a meaningful forward leap. The big policy issues on fiscal policy, on structural policies, on reforms are largely untackled and a fundamental rebound of economic activity is not yet clearly in sight.
''And we have to continue to remind ourselves that stabilizing growth and moving to a more sustained momentum has to occur against a backdrop of a hugely elevated debt position and deficits in most of the major countries that are unprecedented for post-war history.
''Now, from a former central banker's perspective, in my view, and I'd like to chime in very briefly on the discussion about the externality that is produced by quantitative easing policies. I fully agree with what was said here about the conduct of these policies and about sort of how it impacts on exchange rates. But there might be one dimension that I'm quite concerned about. And that is that the impact of quantitative policies seems to be larger in terms of impacting currencies if they're conducted through quantitative purchases rather than short-term interest rate policies, probably because they very directly impact on the security markets which they deal with.
''And, therefore, while domestic currency weakness isn't an expected desirable outcome, from the perspective of the central bank that's easing monetary policy via asset purchases, the impact on the foreign exchange value of currencies does not create any overall global demand. It just redistributes demands away from appreciating currencies. And in that sense, the quantitative impact of those policies operating through quantitative easing seems to be stronger - and is leading to a debate whether global distortions emanating from one country and impacting on the other are really an issue that can be dealt with...
''Monetary policies that have been easing over the crisis period had been adequate, in my view for a large part, into 2010. As of recently going forward, I think central banks are going to be much more pressed about giving clear answers to the questions of what an orderly exit from these policies will look like. We've known this for some time: central banks cannot resolve deeper structural issues. They can provide funding.
''This will buy time, but sustainable growth really needs to be emerging from serious policy reforms. And in that sense, there is a necessary debate whether some of the quantitative easing policies that have bought time have really bought time in the sense that this time bought was used wisely by policymakers to do the right reforms. Or, whether an unconstrained policy of that type doesn't really over time start setting the wrong incentives and actually delays the relevant action. It has side effects also in terms of financial market stability. We're seeing that in many areas, and I think central banks really need to weigh very carefully whether continuing on these policies will not down the road produce bigger problems. ''
During Q&A, a question from an LSE student: ''My question, I think, touches upon Larry's [Summers] sentiments. So I'd like to know from each of you, what do you feel is the purpose of economic growth and prosperity. I personally believe it's to better and improve people's wellbeing. But feel free to disagree with me. And how could we better leverage economic growth and prosperity to achieve that wellbeing, particularly over, say, the next 20 or so years... ''
Weber: ''One of the concerns I have with the current excessively loose monetary and fiscal policies is there is a set of generations that isn't around the table. So I think a lot of what we're seeing now is basically trying to achieve a dynamic in the economy that is unsustainable long-term, and therefore will come at the detriment of future generations. And, therefore, I'm quite concerned that keeping monetary and fiscal policies very loose for an unsustainable long period of time might generate some growth numbers that we see now that look good for current generations but actually come at the expense of future generations.
''So, I'm quite concerned about the inter-temporal aspect here, whether we're really trying to counter something that we look at as being cyclical. But if it's actually more structural, and we throw a lot of stimulus at it and basically undermine the future. I'm quite concerned about that inter-temporal aspect of what we're doing here in both monetary and fiscal policies.''
Larry Summers responding to the student question: ''I think you got it right when you spoke of allowing people to have higher living standards, more choices in their lives and to live more comfortably. I can't resist taking the opportunity, though, to disagree with the broad spirit of Axel's [Weber] last comment.
''I do not believe that the long-run can be ceded to the avatars of austerity. Yes, I am the father or stepfather of six children. And, yes, on their behalf I am concerned about the possibility of an overly inflationary psychology will develop in my country. Yes, on their behalf, I am concerned that an excessive debt will be placed upon them. But I am vastly more concerned because I care about their long-run future that a slack economy will not provide for them with satisfactory jobs when they leave school. I am more concerned on behalf of their future that they will live in a country with decaying infrastructure that will not permit investment that maintains leadership. I am more concerned on their behalf that inadequate resources forced by countercyclical austerity will stunt the ability of their generation to be educated. I am more concerned on their behalf that excessively austerity-oriented policies will lead to slower economic growth and as a consequence to an ultimately higher debt-to-GDP ratio and more pressure in terms of higher tax burdens in the future.
''Those concerns, which come out of the proper management of current conditions, seem to me to be a larger concern for the long-run than the concern that somehow unstable and overly-expansionary policy - starting from where we are now - will stunt the opportunities that are open to them. Of course, if policy was starting at a different place, I would reach a different judgment. But starting where the United States or much of Europe or much of the industrialized world is today, it seems to me that the risks of profound stagnation are a more pressing concern than the risks of a resurrection of stagflation.''
Larry Summers and Axel Weber are two exceptionally intelligent, learned and highly experienced policy experts. And in their respective responses to a question (about the purpose of economic growth and prosperity) they perhaps provided an historic exchange in contrasting economic views.
The ''American'' view holds that aggressive counter-cyclical monetary and fiscal stimulus spur growth, prosperity and higher standards of living for future generations. ''Keynesian'' policies can propel the economy back to its long-term growth path, in the process ensuring a higher overall utilization of human and other resources. More money equates to stronger demand, investment and economic expansion. More risk-taking equates to higher asset prices, greater wealth and a stronger expansion. There is little downside to expansionary policies with low utilization and minimal inflationary pressures.
And when listening to Mr Summers, I couldn't help but recall Time Magazine's ''Committee to Save the World'' cover back in early-1999 (Summers - at the time deputy Treasury secretary - with then Fed chairman Greenspan and then Treasury secretary Robert Rubin). ''The inside story of how the Three Marketeers have prevented a global economic meltdown - so far.'' I remember vividly how the post-Long-Term Capital Management bailout policy reflation incited a wild speculative run and a rapid doubling of Nasdaq.
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