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What’s next? Helicopter money? – Gregor Logan

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Greece is facing debt repayment deadlines again and so is ‘renegotiating its debts’ with the EU (a euphemism for borrowing even more). The last time this happened in July 2012 Mario Draghi, president of the European Central Bank, said in an unscripted off the cuff remark “within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. These few words have been credited with saving the Euro, or at least prolonging its agony, as confidence returned to financial markets and the cost of debt in Greece, Italy and Spain fell dramatically, allowing Greece to roll over its debt.

The world relies on ever more experimental monetary policy because after the Global Financial Crisis in 2008 governments of the developed world had accumulated too high levels of debt and ongoing deficits to introduce classical Keynesian reflationary fiscal policies of tax reduction and higher government spending.

Since the early 1990’s central banks have been tasked with controlling inflation as their primary policy aim. This has been interpreted as 2% is good, but above or below 2% requires monetary contraction or expansion. When zero interest rates proved insufficient to generate more than anaemic growth and hence the required 2% inflation, the central bankers introduced further monetary stimulus in the form of bond buy back’s, now termed Quantitative Easing or QE. First introduced in the US, it was followed with varying levels of speed and enthusiasm by the UK, Japan and Europe.

This has enabled the global economy to enjoy so-so economic growth of 2% or so, but has only been possible because consumers and corporates have returned to spending tomorrow’s income today and in the process run up considerably larger debts than before the crisis; debts which in many cases are only affordable because of the prevailing very low interest rates. It has also fuelled the much debated rise in asset prices and consequent divergence in wealth.

Many think all this is simply storing up a bigger crisis for the future. Nor has it addressed the major imbalances in the global economy — characterised as the developing world exporting cheap goods and low paid workers to the developed world and in the process deflating consumer prices, lowering the cost of borrowing and encouraging the propensity for Western consumers to borrow and spend.

In Japan, the central bank has done so much QE there are fears they may have run out of ammunition. In the US, Donald Trump has said the previously unthinkable by a politician and suggested the Government should pay back its national debt with discounts. You might write that off as another attention seeking maverick quote, but he is merely voicing what many are thinking.

In our press ‘helicopter money’ is widely talked about as the next step — but only one that will be taken in extremis — just like QE before it. Helicopter money is when central banks print money for the government to spend as it chooses or transfers are simply made to individuals to spend, typically within a specified time frame so the money cannot be saved. There are recent precedents. In 1999 Japan gifted shopping coupons with a six month life to families and the elderly and in 2008 US taxpayers received a one-off gratuitous rebate of $300.

I think this begs two important questions. The first was prompted by Mario Draghi in 2012 when he prefaced his remarks with ‘within our remit’: Just how far does the remit of a central banker go? Is it continuously assessed, and if so by whom and why don’t we hear or see evidence of it? I ask this question because in many ways they now appear to be acting as unelected governments, determining — not just implementing — economic policy, often seemingly and regrettably on the hoof.

The second question is why will helicopter money work after zero and now negative interest rates combined with QE have been insufficient to cure our perceived economic ills and may even, as some commentators suggest, be storing up yet more trouble for the future? Why will it not be just another short-term boost that fades with time leaving us back where we were but with even more debts created by fiat money?

Financial markets have placed huge confidence in the ability of central bankers to ‘do what it takes’. With fading global growth, government bond yields already low or negative, even in high debtor nations like Greece, and equity valuations at the upper end of their historic levels, a pretty big rabbit is going to have to come out of someone’s hat sometime soon.

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.

Stock market vigilantes put the Fed between a rock and hard place – Gregor Logan

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I was surprised the Fed actually went ahead and raised rates in December — but not surprised by the negative reaction of global stock markets. I sympathise with the Fed’s predicament. There were already obvious signs of distress in the junk bond market, continuing weakness in emerging market economies and currencies and growing evidence of economic slowdown in western economies. However, the asset price bubbles in stock and real estate markets continued to inflate, taking markets to historically elevated valuations and giving the, perhaps, false impression that all was well in underlying economies. This view was helped by strong employment numbers in the US and improving employment trends elsewhere in western economies.

The need to ‘normalise’ rates appears to have been thought appropriate to give the central bankers some policy options should economic activity turn down again. The US economic recovery was already one of the longest post war, albeit one of the most anemic, and should it turn down due to some unforeseen shock there would have been precious little the Fed could do with ZIRP still in place and their balance sheet already inflated from past QE.

The big question is of course what happens now. To answer that question I think we have to put where we are today into context. Since the financial crisis, global government and corporate debt has risen faster than GDP to levels way above where they were in 2008. Despite this, bond yields have fallen due to the combination of ZIRP and QE. This in turn has allowed stock markets to rise far faster than corporate profits, in part because price earnings ratios are a reciprocal of interest rates — but also because there was no reasonable alternative for large institutional investors.

Inflation has been absent, with many economies experiencing disinflationary if not deflationary tendencies, despite the best efforts of central bankers. The collapse of commodity prices has exacerbated this trend. Emerging market economies have been weakening for some time despite currency depreciation, whilst the western economic recoveries are not yet clearly self-sustaining. Most leading, and some coincident, economic indicators are already suggesting a continuation of the weakening trend; for example, global shipping rates as measured by the Baltic Dry Index are down nearly 50 percent over the last year.

All of which confirms the economic and financial world was in a pretty precarious state to cope with a rate rise. Only 0.25 percent, and you might reasonably respond, but it was also a doubling of rates after many, many years of ultra-low rates and build-up of debt to pay for ever higher asset prices.

The Fed’s resolve is clearly being tested. It appears we have stock market vigilantes pushing prices down to encourage the Fed to not raise further and perhaps even reverse the rate rise. This puts moral hazard back on the agenda, and a further postponement of the evil hour when debts have to be repaid and stock prices decline to more reasonably reflect the level of underlying earnings.

Was the ending of QE equivalent to the first rate hike? – Gregor Logan

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Last week I wrote an article for The Market Mogul about the impact that any Federal Reserve interest rate rise might have on the global economy, and when it might happen. Some people have said that the decision to hold rates in September indicated that the Fed were worried about growth prospects.

But see it another way: I think the ending of quantitative easing should be seen as the equivalent of a first rate rise, and I think in time this will also be recognised in the market. It is from this date that we should start to calculate the impact on the economy and asset prices, not when the Fed finally do raise rates. I think this has already been reflected in the weakness in emerging market economic growth, stock markets and commodity prices.

Read more on The Market Mogul by Gregor Logan >

It’s time for the political parties to start talking about QE – Gregor Logan

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3450968469_98f9b65c4c_bEarlier this month I wrote an article about quantitative easing for online magazine Medium. In the article, I argued that in the run-up to the election the major political parties had not spent enough time debating the challenges of unwinding QE after 7 May.

Too much time has been spent discussing fiscal policy, which, while important, is much less pressing. It is time the political parties said quite clearly how they are going to manage this deleveraging process.

Read this article by Gregor Logan on Medium >

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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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