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2 Davos: Pointless
pontificators By Chan Akya
A casual investor enjoying strong returns
from global asset markets, in other words pretty
much everyone these days, would have been left
fairly confused with the verbiage spewed by
participants at the annual Davos jamboree, whose
collective concerns might well have represented
another planet entirely. A closer read of the
different pontificators suggests that policymakers
are simply unhappy at their reduced importance in
the new global economy. Much like those of a
jilted suitor, their complaints can be categorized
under "sour grapes", and this is in
no
way a reflection of the facial resemblance of some
of the elderly speakers to raisins.
It is
a matter of some concern to central bankers around
the world that bond yields have simply not reacted
much to the continued rise in inflation and
economic growth. Even with oil prices rising for
the past few years, economic growth has failed to
taper off, particularly in the emerging economies
of China and India. This is notable because these
economies are energy-inefficient, that is, they
use more energy per additional unit of output than
the more advanced European and US economies. With
prices going up, it would have been reasonable to
expect that their demand for such energy would
cool down, but that has not happened.
Western policymakers made two major
mistakes in this assessment. First, the underlying
assumption that economies have to generate a
profit from every marginal unit of output is
plainly wrong. This is especially so when the
behavior of non-market economies like China is
considered. The Communist Party needs to have
economic growth to pull off the greatest
development program in history. Thus while the
next widget from the production line may not make
a profit, the process of producing it allows the
hiring of new workers from the countryside,
building new factories and collecting taxes from
all the activities. That allows the widget itself
to make a loss, although as I noted in previous
commentaries, someone eventually has to pay for
those losses. [1, 2]
The second mistake
that policymakers made was to look at market
indicators in a closed system, ie, from the narrow
textbook perspective so beloved of mediocre
economists who invariably end up in government. In
this case, the trade deficit of the United States
and falling bond yields proved to be two sides of
the same coin, as countries with trade surpluses
with the US bought its debt obligations. That is
the reason rising economic growth has not led to
rising bond yields for the US, or indeed even
Europe.
Herein lies the quandary for
policymakers. Their actions in terms of moderating
economic growth and related factors such as
inflation are to a large extent offset by the
ability of a larger group of investors simply to
crowd them out. In other words, as long as
investors keep buying securities, yields will
remain low, even if the central banks continue to
push up nominal interest rates. As I have written
previously, this also represents a subsidy that
exporting nations pay back to consumers. Think of
it as like a bulk buyer's discount at a sale.
Dinosaurs on display For
reasons as yet unclear to me, the World Economic
Forum in Davos, Switzerland, appears to attract
more than its fair share of such policymaking
dinosaurs. Rendered impotent in the face of
significant changes to the market's key variables,
policy wonks are instead left frothing at the
mouth, discussing vague notions of risks. The
usual bromides about investors overpaying for
assets is as old as the first central banking
conference.
As central bankers, and indeed
all politicians, see themselves as the solution to
society's ills, they have a neurotic need to
worry. Indeed, it is this very habit that
guarantees their jobs. Think about it: if central
bankers walked around proclaiming that all markets
were fairly priced and all banks well run, the
most obvious follow-up question from the assembled
public would be: Why then do we need you, chaps?
The point, of course, is that global
economies do not really need central bankers, at
least not in their current form. Markets have
taken over their job by helping to price risk but,
more important, in redistributing risk. The
primary function of central bankers, which is to
maintain a stable and functioning banking system,
has thus been rendered obsolete because the very
practices that lead to banks failing, such as the
over-concentration of risk, have now been largely
addressed by the markets.
Take as an
example the savings-and-loan crisis in the US,
which ensnared a number of larger banks and caused
a systemic issue at the time mainly because these
institutions were overexposed to certain
categories of assets that declined sharply in
price
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