Central bank cash glut risks 'monetary anarchy'
London, February 29, 2012
The scale of money printing in the West has become so massive that the world may fall prey to "monetary anarchy", with traces of bubbles appearing everywhere.
At least that's what some critics see in the latest round of cash pumping by major central banks.
It is also an eerily reminiscent of 2011, when similarly generous monetary easing sparked higher oil prices, slowed the recovery and stoked speculative hot money flows into vulnerable emerging markets.
The European Central Bank alone is expected to lend another half trillion euros or more of super-cheap money to banks on Wednesday, following Japan and Britain which have already injected fresh cash. The Federal Reserve has promised to keep interest rates low until 2014 and act further if needed.
There is a sense of deja-vu in financial markets. Just like the last time a wave of money was pumped into the world financial systems in 2011, crude oil - fuelled also this time by Middle East tensions - has jumped 15 per cent this year.
As a result, riskier assets such as equities are already coming off new year highs. Rising emerging market currencies are forcing some central banks there to intervene.
The scale of money creation since the onset of the global credit shock can be seen in the size of central banks' balance sheet expansion.
JP Morgan says G4 central bank balance sheets have more than doubled since 2007 to 24 per cent of combined gross domestic product and will reach 26 per cent this year.
"We have Monetary Anarchy running riot, where the elastic band between the real economy and the current liquidity-fuelled markets is stretched further and further beyond credulity," Bob Janjuah, head of tactical asset allocation at Nomura, noted.
He said bubbles were visible in all asset classes because central bank balance sheets are at the core.
"If/when the current cycle implodes, central banks which have seen explosive balance sheet growth will add to the problems, rather than being able to act as credible lenders of last resort," he said.
"Real assets are relatively attractive. But I am going to wait for this current central bank bubble to burst before going all in. The end of the bubble will be signposted by either monetary anarchy creating major real economy inflation or by a deflationary credit collapse."
Kicking off its second bout of quantitative easing in late 2010, so-called "QE2", the Federal Reserve announced a $600 billion programme to buy bonds.
The Bank of Japan raised its asset buying and lending scheme to 55 trillion yen in October 2010 and spent a record 8 trillion yen to the currency's ascent, pumping more cash in the process.
Also in October, the Bank of England expanded the size of its asset purchase programme to 275 billion pounds. Last month, it raised it again to 325 billion.
While markets got an initial boost from this, the effect was short-lived partly because rising oil prices eventually chilled spending. And aggravated commodity and food-price inflation forced emerging economies to step up monetary tightening.
Taking stocks as a guide, the MSCI all-country world index rose 18 per cent between October 2010 and April 2011, only to fall more than 26 per cent from there to September.
Since then, it has gained nearly 25 per cent, mainly on the ECB's three-year, cheap loan programme.
However, the negative consequences of cheap money may not have been all visible, because headlines and prevailing sentiment were dominated by the intensifying euro debt crisis.
"We saw what happened last spring when the Fed printed money - QE2 - amidst a commodities price shock: commodity prices surged further and US consumption faltered as a result," said Stephen Jen, managing partner of SLJ Macro Partners.
"As Greece (debt worries) recede into the background for now, oil enters as the next potential threat to the global economy. The truth may be that oil had already been a threat, but investors were just too pre-occupied with Greece to notice."
Today, a renewed wave of yield-seeking capital inflows is starting to push some emerging economies to act again despite forecasts for an overall slowdown in the world economy.
For example, Colombia raised its key interest rates twice this year to control inflation and slow consumer credit growth. Brazil has been intervening in the currency market to curb a currency rally and keep local manufacturers competitive.
Data from fund tracker EPFR shows global emerging markets equity funds absorbed $18.5 billion this year, compared with outflows of over $13 billion in the same period last year.
Goldman Sachs says the latest round of liquidity injection - which it calls "competitive" monetary easing - may create a problem for emerging markets again.
"With output much closer to potential and inflation at or above policymakers' range of comfort, any stimulative leakage from a bout of monetary easing in the DM world is much less welcome," it said.
"Policymakers are forced to choose between allowing exchange rate appreciations that may be too rapid and accepting domestic overheating, which has its own negative ramifications." - Reuters