Ben
Bernanke's decision to cut interest rates in
September will probably be used as the leading
example in the "what not to do" classes for
central bankers in decades to come.
Besides focusing too much on a single
piece of data - the August headline payroll
decline of 4,000, he was also accused of paying
too much attention to the wishes of Wall Street
moguls. As it turns out, even as stock markets
jumped significantly in
September, the original
headline for August jobs was actually erroneous.
Announcement of the September payrolls last Friday
saw an upward revision of the August number to a
positive 89,000 jobs, along with a substantial
rise of 110,000 in September. That sent bond
yields higher around the world, and probably
caused billions of dollars of losses across Asia,
where central banks hold a bulk of their
countries' reserves in US Treasury bonds.
Investors rejoicing about the rise in
global stock markets though must stop and think
about their gains in the context of other asset
prices, such as gold. When used as the benchmark,
ie, index prices as a function of gold prices,
America's stock markets are actually down around
9% this year, rather than being up 10% as people
report. For much the same reason, the Hong Kong
stock market is up "only" 20% this year, rather
than the 45% gain that newspapers report using
simplistic index calculations.
In effect,
the rise in nominal stock market values shows a
lack of confidence in monetary policy by investors
who are looking to re-leverage their portfolios in
order to avoid inflation. This is an important
point that is not always appreciated by central
bankers - investors behave in relation to expected
price changes, rather than observed variables.
Thus, even in places where interest rates are
being kept steady, when investors expect a rise in
inflation, their view of the real cost of
borrowing changes, ie, it becomes lower. Reduced
cost of borrowing, in their minds, would then
equate with higher borrowing.
Look at this
from the perspective of savers, and the view is
much the same. When Bernanke cuts interest rates
as he did last month, he reduces the amount paid
to savers each month. Even as their incomes are
reduced, they may find that expenses remain the
same or actually increase. Under this scenario,
keeping money with a bank is not an option, so
investors have to go out and buy assets with
greater chances of appreciation. Now that no one
in the US believes in buying houses, they have
gone back to chasing stocks.
This is of
course a wonderful cycle. Confronting the dotcom
bubble in 2000, former Federal Reserve chairman
Alan Greenspan cut interest rates aggressively, in
effect encouraging speculation on home ownership.
Now that house prices are falling after the boom
went just a bit too far, his successor has
attempted the same medicine but this time to favor
stock markets. Many companies are now trading at
multiples that are similar to those observed in
1999, just before the dotcom bubble broke.
Inflation springs eternal Across
various non-G7 countries, often referred to by the
dubious label of "emerging markets", the increase
in observed inflation has been strong. Financial
websites estimate average inflation in these
countries at over 5%, from under 4% just last
year. What is more important though is the figures
that are not published - namely food price
inflation, which now runs at over 10% in major
emerging countries. Breaking down the components
of price increases shows that meat and poultry are
the main contributors of food inflation across
Asian countries such as China, Taiwan, Korea,
Indonesia, the Philippines and Malaysia.
One of the greatest frauds perpetuated on
modern monetary policy was pulled by the US
Federal Reserve about 30 years ago, when the oil
crisis of the 1970s led to the abandoning of fuel
prices as an input for the calculation of
inflation, along with other volatile components
that were removed over the period, such as food
and house rents. The new measure, called "core"
inflation, in effect is useful for people who
don't eat, drive or live in houses. Other than
Dick Cheney, I cannot think of any American who
fits this description.
But I digress. The
rule of thumb for central banks is that they can
control only two out of the following three: money
supply, interest rates and currency values. In
Asia, most banks are wedded to controlling
currency values due to politically-inspired pegs,
and also have a habit of setting interest rates
due to their need to corral bank profitability
that is driven by the gap between borrowing and
lending rates. For more on the subject of how
banks make money, and where Asian currency
policies fit into the picture, I refer readers to
a recent article (1).
As a result of
frequent intervention in the currency and interest
rate markets, Asian central banks lost control of
their money supply a while ago, with the most
extreme failure being observed in China. The
resulting storms of liquidity going through their
financial systems have caused massive asset
bubbles to build up - whether it is stock markets
in Shanghai, houses in Chengdu or office blocks in
Beijing, the effects of China's central bank, the
Peoples Bank of China, losing control of its money
flows are there everywhere. In addition,
skyrocketing prices have also caused a seismic
shift in Chinese consumption - which extends from
luxury items such as mobile phones to mundane
daily items such as pork.
Food prices have
gone up due to America's poor handling of
environmental issues (2), which has helped to push
up the cost of corn and with it, the prices of
meat-related products. Chinese people have always
associated the consumption of meat with
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