QE2, Pyrrhic Monetary Policy and a Rise in Inequality

Are Central Banks running out of firepower?

And is the second bout of QE or QE2 leading to both an arms race in competitive devaluations and more worryingly, actually accelerating inequalities?

With policy rates close to zero and years of money printing under the snake-oil terminology of "Quantitative Easing", moribund fiscal stances and private sector balance sheets in rehab zone, what more can central banks do to kick start inflation, if not growth trajectories?

No sooner had I suggested that I was against-trend in forecasting a baseline of no change in UK interest rates this year than we're faced with a change in mood music across the developed world and forecasts of more monetary easing or QE and even negative interest rates set by central banks.

Whilst the aim is to get cash to shift to production, investment and consumption by effectively taxing cash balances held by banks, in reality we are seeing plenty of unintended consequences:

1. a greater incidence of financial and asset bubbles as cheap dosh chases higher yields - from property to stocks and financial assets (the short term excluded). This most will go with.
2. this in turn is I would argue actually widening the gap between the haves and the have-nots, be it within countries and globally.
3. for another day...a rise in competitive devaluations: a falling Yen, a falling Chinese currency and others will follow - from SE Asia to commodity producers. 

We hear plenty of research analyses that highlights a global phenomena - from the US through to the emerging economies - of an increasing inequality of wealth creation and ownership to a narrow group of economic players. Be they the kings of Silicon Valley, robber barons in Eastern Europe or the industrial titans of Asia, the pattern is uniform.

Oxfam's recent report came out with stark figures by countries but a headline one that is numbing to review - 1% of the global population have a wealth greater than that of the rest of the 99% in the world. The same conclusion came out broadly in the OECD's recent 2015 paper and notes "Income gaps are even more striking when it comes to the highest earners. In the 1980s, the top 1% of earners commanded less than 10% of total pre-tax income in every OECD country bar one. Thirty years later, their share was above 10% in at least nine OECD countries and above 20% in the United States."

 There are fundamental reasons in terms of basic governance, fundamental democracy and rule of law that explain many of the fissures in developing and emerging economies that prevent citizens from having rights to education, restricted access to financial capital and in some cases, as we see in north Africa and middle East,  access to education but limited opportunities to find employment. But we also see great strides by countries such as China and SE Asia on the back of growth and growth-based economic models.

Rising inequality is somewhat counter-intuitive when we think of the global reforms since the nineteenth century and following the two world wars, the rise and fall of communism and the rise of the welfare model in the post-war period. And whilst it may be less of a relative issue in the EU, rising inequality is a factor that may explain the political counter reactions from the anti-capitalist Occupy Movements in Wall St and the City as well as the drama that is the US election cycle. 

What are the policy lessons?

• The OECD's focus on structural issues - gender, health, education et al - is the classical development tool kit. They are longer term.
• A clear lesson in today's 24-7 world is that interconnectivity is here and exponentially increasing- be it in ideas, news or alas, contagion - financial fear and medical as we witness for the Zica virus. The corollary of this that international co-ordination cannot be ignored - be it in terms of global efforts to tame disease or economies. It also means sector and country risks are subject to a wider set of risks.
• Loose Monetary Policy is ultimately pyrrhic without a looser fiscal stance in an environment, as a century before, to take up slack. 
• Openness to innovation and growth and allied reward for risk takers cannot be compromised - but it needs to be complemented by efforts to ensure equity and fairness so that "everyone eats a bigger slice of a bigger cake"  - moves in the EU to tackle the Googles, Amazons and Cafe Neros of this world on dodgy tax affairs is part of this.

Forecasts, Monkeys (with keyboards) and UK Interest Rates: a case for no change

I was tickled by a comment by the RBS reported in last week's weekend newspapers - who evidently came top in the Wacky Races of would-be forecasters for 2015 for the British economy who used an apt (except perhaps to its number crunchers) riposte about "monkeys with keyboards".

With monkeys of my own in our household, I thought it only fair to get their take on the key forecasts for 2016!

Alas they were too interested in the latest I-Phone and Japanese Animes as target-forecasts than that of something called GDP or seismic developments in the FTSE 100. So we stuck to one indicator...UK interest rates.

With  that UK base rates at 0.25% for the last 7 years and most folk again writing about a definite rate rise this year, the "consensus monkey forecast" at chez nous was a dead-heat: up, down and one flat. I particularly enjoyed the outlier of the forecast for a reduction...(forecaster age 8 mind!). So the average or mean is no change.

Which is essentially my own personal view: ie no change in 2016 with a 70% probability and a 30% chance of a rate increase - and if so, yes by 25 basis points.

Sound UK Fundamentals but plenty of Geo Political and Economic Volatility

The consensus is that UK interest rates will go up later this year and by a quarter of a percent.

The Bank of England typically takes its cue from the trend in US interest rate setting and and the recent rise in the US Feds Funds rate by 0.25% would normally suggest a reaction this side of the "pond". Both the US and UK economies are now in a growth phase, as indeed is much of the EU. But there are lot of downside risks that suggest that the economic take-off in the UK may yet be more subdued than envisaged.

Things are extremely fluid and gittery geo-politically and are not only causing havoc in the financial markets in January but will also pose a sustained and growing risk that the consensus forecasts may not yet have fully factored in further potential volatility and resultant caution on the part of the Bank of England to hold off further monetary tightening, particularly if there will be further deflationary pressure.

Key factors

1. the slow-down and convulsions of the Chinese economy could yet reveal some nasty black holes (quasi-fiscal liabilities) whilst driving a general softening in external demand that will hit SE Asia and in turn is lead to what looks like more than a cyclical depression in commodities - particularly that of the black gold. With China responsible for about a third of global growth in trade in recent years, cooling external demand and in Emerging Markets will together hit external demand for the EU, including the UK.
2. A devaluation of the Chinese exchange rate is now likely and this in turn will continue to mean cheaper Chinese imports in the UK and elsewhere.
3. A Chinese devaluation may set off further devaluations in SE Asia in particular as the Asian tigers seek tor retain competitive edge in the tradeable sector...maybe good for imported inflation into the EU and the UK but also likely to add to FX risks in these countries given the increasing prevalence of dollar borrowing (deja vu late 90s?).
4. With investment houses now rushing to reverse previous gilded forecasts that we were living in a new normal of above USD 100 per barrel just a couple of years back, they are now rushing the other way to come up with ever lower sub-50, 40 or even 30 dollars per barrel. Whatever the macro reasons in terms of underlying demand and supply and alternatives (shale gas) and substitution effects (solar, hydro, wind et al) that explain the decline in the price of hydrocarbons, the fact is that this is clearly a positive external shock and deflationary for the UK. If it is sustained then the deflationary impact will be higher than anticipated - ie imported inflation will be lower.
5. Within the UK the efforts taken by both the fiscal and monetary authorities to cool down the housing market will have a pronounced effect from April 6 when a further 3% transaction tax (Stamp Duty) kicks in for anyone buying an additional property and lending criteria are further tightened by the central bank.

So, as in 2015, I'm forecasting a baseline that UK base rates remain unchanged in 2016.