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23-06-2013, 11:14 PM
Reining in liquidity proves a high-wire act
• BY
AVID UREN
• From:The Australian
• June 24, 2013 12:00AM
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Source: The Australian
AFTER years of bathing their economies in a flood of liquidity, the central banks of the US and China appear to have decided that it is time to take a cold shower.
Markets were shocked last week by Federal Reserve chairman Ben Bernanke's revelation that he expected the program of bond purchases to have wound down completely by the middle of next year and that this schedule could be accelerated if the economy improved faster than expected.
There was an expectation that the jump in bond rates around the world since May, when he first canvassed "tapering" bond purchases, would lead to some softening in the Fed's rhetoric.
Instead Bernanke shrugged off the rise, commenting: "If interest rates go up for the right reasons -- that is, both optimism about the economy and an accurate assessment of monetary policy -- that's a good thing."
China's markets had expected the People's Bank of China to act to ease a squeeze on liquidity that has pushed short-term rates up dramatically over the past two weeks.
Despite interbank rates spiking to 30 per cent and rumours of banks facing acute cashflow problems, there has been no officially confirmed intervention, though there were reports of intervention on Friday.
An editorial in the state-owned China Securities Journal last week declared that authorities must control growth in the money supply.
"We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth," it said.
The Chinese government has also shown no signs of acting to offset the slowing in economic activity.
There have been no announcements of new infrastructure spending or easing of restrictions on property investments.
The policy tightenings are occurring at very different points of the economic cycle in the two big economies.
The US economy is recovering, with growth picking up, while China is seeking an orderly deleveraging with slower growth.
Both are concerned that financial stability will suffer if excessively loose monetary policy is allowed to continue for too long.
Just as China's stimulus-fuelled growth helped to sustain the world economy while the US and European economies slowed after the financial crisis, so too would US growth help to offset a slowdown in China.
However, the effects on Australia are not symmetrical.
In the Asian financial crisis in the late 1990s, the devaluation of the Australian dollar and an improvement in exports to advanced nations offset the collapse of exports to regional trading partners.
Asia's share of Australia's exports fell from 56 to 46 per cent, while exports to OECD nations, excluding Japan, rose from 35 per cent to 44 per cent.
However, the passage of 15 years means that Asia now takes 74 per cent of Australia's exports while the OECD excluding Japan is only 21 per cent, so there is less scope for US strength to make good any weakness from China.
The US stance is hedged.
Bernanke says that if the economy does not evolve in line with Fed forecasts, then the bond purchases will continue.
He has denied that the Fed is acting out of concern that its policy is creating asset bubbles, noting last month that the rise in share values this year reflected improving fundamentals.
However, the switch in the Fed's strategy came at a time when the search for yield was reaching frenzied levels reminiscent of 2006-07. This was particularly evident in emerging markets where countries such as Thailand, The Philippines and South Korea tried to restrain capital inflows. The market for collateralised debt obligations -- the securities that multiplied the losses of the global financial crisis -- was starting to mushroom again.
The Chinese strategy is more opaque. A statement from the State Council -- China's cabinet -- last week said a "prudent monetary policy" would be maintained, keeping credit available in priority sectors while constraining it for sectors facing excess capacity and guarding against "regional and systemic risks".
On both monetary policy and economic policy more broadly, the new Chinese administration appears to be pushing the case for economic reform ahead of palliative stimulus. HSBC's well-regarded chief China economist Qu Hongbin cites the recent comment from Premier Li Keqiang that reforms would be accelerated to create opportunity for consumption and investment, while there was little further room to stimulate the economy with government investment.
There is concern that rapid credit growth is producing diminishing returns in economic output. In the March quarter, there was about 1 renminbi's worth of incremental GDP for every four renminbi of additional credit.
Analysis by ratings agency Fitch shows that including lending by both banks and non-bank institutions, credit has risen from the equivalent of $US9 trillion to $US23 trillion in the five years since the financial crisis, with the credit-to-GDP ratio rising from 75 to 200 per cent.
About a quarter of credit is in forms other than bank loans, with the big growth being in so-called wealth management products.
Various reasons are postulated for the credit crunch, including capital outflow responding to the higher US dollar and the June 30 reckoning by banks of their minimum deposit to loan requirements.
There has been some suggestion that investors in the banks' off-balance-sheet wealth management products are becoming reluctant to roll over their funds, leading to a cash squeeze.
The central bank has the ability to provide as much liquidity as it wants, so whatever the reasons, the rise in inter-bank rates is partly the result of the central bank holding back, presumably to restrain credit growth.
RBS foreign exchange strategist Greg Gibbs says that if non-performing off-balance-sheet products are coming back on to the banks' books, there is not much that liquidity operations can do about it.
"The most likely scenario is that the banks will be now much more cautious who they either lend to directly or facilitate lending to via off-balance-sheet products. In which case growth in China is likely to slow further. As the economy slows we will learn more how capable the economy is carrying its current debt load."
Peking University finance professor Michael Pettis says it will be difficult to achieve a smooth deleveraging.
"The problem is that when debt levels have got so high, and it's more debt that keeps the existing debt afloat, you absolutely have to stop the process but it's very difficult to stop the process in an orderly way."
Tightening monetary policy is always the high-wire act for central banks. It carries the risks that that bad debts will be exposed and that markets will overreact, snuffing out growth.
• BY
AVID UREN • From:The Australian
• June 24, 2013 12:00AM
• Increase Text Size
• Decrease Text Size
•
•
Source: The Australian
AFTER years of bathing their economies in a flood of liquidity, the central banks of the US and China appear to have decided that it is time to take a cold shower.
Markets were shocked last week by Federal Reserve chairman Ben Bernanke's revelation that he expected the program of bond purchases to have wound down completely by the middle of next year and that this schedule could be accelerated if the economy improved faster than expected.
There was an expectation that the jump in bond rates around the world since May, when he first canvassed "tapering" bond purchases, would lead to some softening in the Fed's rhetoric.
Instead Bernanke shrugged off the rise, commenting: "If interest rates go up for the right reasons -- that is, both optimism about the economy and an accurate assessment of monetary policy -- that's a good thing."
China's markets had expected the People's Bank of China to act to ease a squeeze on liquidity that has pushed short-term rates up dramatically over the past two weeks.
Despite interbank rates spiking to 30 per cent and rumours of banks facing acute cashflow problems, there has been no officially confirmed intervention, though there were reports of intervention on Friday.
An editorial in the state-owned China Securities Journal last week declared that authorities must control growth in the money supply.
"We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth," it said.
The Chinese government has also shown no signs of acting to offset the slowing in economic activity.
There have been no announcements of new infrastructure spending or easing of restrictions on property investments.
The policy tightenings are occurring at very different points of the economic cycle in the two big economies.
The US economy is recovering, with growth picking up, while China is seeking an orderly deleveraging with slower growth.
Both are concerned that financial stability will suffer if excessively loose monetary policy is allowed to continue for too long.
Just as China's stimulus-fuelled growth helped to sustain the world economy while the US and European economies slowed after the financial crisis, so too would US growth help to offset a slowdown in China.
However, the effects on Australia are not symmetrical.
In the Asian financial crisis in the late 1990s, the devaluation of the Australian dollar and an improvement in exports to advanced nations offset the collapse of exports to regional trading partners.
Asia's share of Australia's exports fell from 56 to 46 per cent, while exports to OECD nations, excluding Japan, rose from 35 per cent to 44 per cent.
However, the passage of 15 years means that Asia now takes 74 per cent of Australia's exports while the OECD excluding Japan is only 21 per cent, so there is less scope for US strength to make good any weakness from China.
The US stance is hedged.
Bernanke says that if the economy does not evolve in line with Fed forecasts, then the bond purchases will continue.
He has denied that the Fed is acting out of concern that its policy is creating asset bubbles, noting last month that the rise in share values this year reflected improving fundamentals.
However, the switch in the Fed's strategy came at a time when the search for yield was reaching frenzied levels reminiscent of 2006-07. This was particularly evident in emerging markets where countries such as Thailand, The Philippines and South Korea tried to restrain capital inflows. The market for collateralised debt obligations -- the securities that multiplied the losses of the global financial crisis -- was starting to mushroom again.
The Chinese strategy is more opaque. A statement from the State Council -- China's cabinet -- last week said a "prudent monetary policy" would be maintained, keeping credit available in priority sectors while constraining it for sectors facing excess capacity and guarding against "regional and systemic risks".
On both monetary policy and economic policy more broadly, the new Chinese administration appears to be pushing the case for economic reform ahead of palliative stimulus. HSBC's well-regarded chief China economist Qu Hongbin cites the recent comment from Premier Li Keqiang that reforms would be accelerated to create opportunity for consumption and investment, while there was little further room to stimulate the economy with government investment.
There is concern that rapid credit growth is producing diminishing returns in economic output. In the March quarter, there was about 1 renminbi's worth of incremental GDP for every four renminbi of additional credit.
Analysis by ratings agency Fitch shows that including lending by both banks and non-bank institutions, credit has risen from the equivalent of $US9 trillion to $US23 trillion in the five years since the financial crisis, with the credit-to-GDP ratio rising from 75 to 200 per cent.
About a quarter of credit is in forms other than bank loans, with the big growth being in so-called wealth management products.
Various reasons are postulated for the credit crunch, including capital outflow responding to the higher US dollar and the June 30 reckoning by banks of their minimum deposit to loan requirements.
There has been some suggestion that investors in the banks' off-balance-sheet wealth management products are becoming reluctant to roll over their funds, leading to a cash squeeze.
The central bank has the ability to provide as much liquidity as it wants, so whatever the reasons, the rise in inter-bank rates is partly the result of the central bank holding back, presumably to restrain credit growth.
RBS foreign exchange strategist Greg Gibbs says that if non-performing off-balance-sheet products are coming back on to the banks' books, there is not much that liquidity operations can do about it.
"The most likely scenario is that the banks will be now much more cautious who they either lend to directly or facilitate lending to via off-balance-sheet products. In which case growth in China is likely to slow further. As the economy slows we will learn more how capable the economy is carrying its current debt load."
Peking University finance professor Michael Pettis says it will be difficult to achieve a smooth deleveraging.
"The problem is that when debt levels have got so high, and it's more debt that keeps the existing debt afloat, you absolutely have to stop the process but it's very difficult to stop the process in an orderly way."
Tightening monetary policy is always the high-wire act for central banks. It carries the risks that that bad debts will be exposed and that markets will overreact, snuffing out growth.