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What next from central bankers? – Gregor Logan

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I went to see The Big Short recently. What a great movie. I thought it was as good if not better than the book. And interesting timing with financial markets in disarray as fears over Chinese growth, falling oil prices and the Fed’s interest hike take their toll. We await the response of central bankers to the latest equity market weakness. Mario Draghi, Head of the European Central Bank, has hinted at further unconventional stimulus, but given no detail. The Fed has backpedalled fast on their proposed four hikes in 2016. With interest rates already at near zero and fiscal budgets still under strain, further unconventional measures are surely not far off.

A fascinating review of past policy failures and alternative policy options for the future are given in Adair Turner’s excellent book ‘Between Debt and the Devil’ in which, surprisingly for a former Chairman of the Financial Services Authority (FSA) and general establishment figure, he challenges conventional economic and policy wisdom on many fronts. I warmed to him in the first few pages when he describes starting work as Chairman of the FSA in September 2008. He quickly concludes we faced the biggest financial crisis in 80 years and humbly admits “seven days before I started I had no idea we were on the verge of disaster.” He also suggests almost no one else amongst all of the central banks, regulators, or finance ministries, nor in financial markets or major economics departments knew either. I encourage you to read the book to get the full benefit of his intellectual rigour.

In brief, his conclusion is that central bankers’ current desire to stimulate bank lending via low interest rates and QE is misplaced and instead of solving anything is merely adding to the problems we already have. In particular, it helps the wealthy drive up already inflated real estate prices. He goes further by suggesting we may not need private credit growth at all to fuel economic growth. As a result, and to create a much more stable environment commercial bank’s debt equity ratios should be regulated down to much lower levels than even the new post crisis frugality dictates.

In contrast, he seeks to banish the existing taboo (at least on the political right) of high government deficits and suggests rising government debt is okay as long as it is in a controlled fashion and inflation remains low.

As to how we get out of the current impasse of already low rates and high government deficits, he recommends a large dose of Fiat money in the belief that it is an erroneous notion that printing money will lead to harmful inflation. He writes: “To escape the mess created by past policy errors, we sometimes need to monetize government debt and finance fiscal deficits with central-bank money.”

In other words he argues that the mantra of private debt good, public debt bad should be turned on its head with private debt taxed as toxic and public debt forgiven by the vast creation of Fiat money.

If equity markets continue to decline and fears of a global economic recession become mainstream thinking I expect to see some of his suggested policies being more widely discussed and adopted.

Vote of confidence in central bankers – Gregor Logan

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Equity markets have rallied over the last week as central bankers in Europe and the US have opined on interest rates. Firstly Mario Draghi at the ECB kept rates on hold but more encouragingly said more QE was a possibility after the current programme concluded. Markets might have been concerned at this admission of potential economic frailty but instead chose to be grateful for the possible extra boost to liquidity. Similarly Janet Yellen at the Fed kept rates on hold and this time left open the possibility of a rate rise in December this year, in contrast to last month’s concerns about ‘international headwinds’ suggested no move till into next year.

This is similar to the stance suggested by Mark Carney to the annual meetings of the IMF and World Bank that it remains a possibility that UK rates may rise this year.
Meanwhile the economic news has continued to confirm a modest slowdown in growth and pretty much a complete absence of any inflationary pressures.

Clearly the central bankers continue to think it better to allow the unfortunate consequences of low interest rates to prevail over the risk that tightening too soon will choke off the still modest economic growth.

Most commentators are agreed that low interest rates and QE have been a major contributor to growing wealth inequality as asset prices, both tangible and intangible, have been boosted. The decline in bond yields has hurt pensioners both directly through lower annuity rates and together with other low risk savers indirectly through lower deposit rates.

This has led to greater risks being assumed by both savers and borrowers. For example, the amount of debt required to purchase property with vastly inflated prices by new owners has risen and only been affordable because of low rates. This leaves them vulnerable should either rates rise or prices fall or both.

When asset prices have been rising for a while it is easy to forget the devastating impact on the residual of two big numbers when one or both of them move in the wrong direction.

It leaves a delicate balance for the central bankers to maintain. Possible of course, but past history suggests not one they often get right.

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Welcome to my website. I'm Gregor Logan, an independent management professional with over 35 years of experience in all asset classes, including equities, bonds, property, private equity, alternative assets and bonds. I previously held senior-level roles at MGM Assurance, Pavilion Asset Management and New Star Asset Management.

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