With politicians in the U.S. and Europe abrogating responsibility for getting their zones of the world economy growing again, the task falls by default to central bankers. Yet they are standing pat for fear of being left spent in the event the feared second dip of recession materializes.
Economists have been cutting their global and national economic growth forecasts in recent months, but leading central banks have taken only relatively modest steps to stimulate economies. To deploy a cliche, they may have been talking the talk. They are not walking the walk. This week:
- the ECB left its benchmark interest rate unchanged at 0.75%. Last week, its president, Mario Draghi, promised to do “whatever it takes” to preserve the euro;
- the Bank of England, which last month announced an increase of £50 billion ($78 billion) in its quantitative easing (QE) program, held its benchmark interest rate at 0.5%;
- The U.S. Federal Reserve confirmed that it would keep keep its extremely low interest rates (0.0-0.25%) until late 2014.
Meanwhile, in the world of factory floors and customers, the JP Morgan Global Manufacturing Purchasing Managers’ Index (PMI) fell to 48.4 in July from 49.1 in June–edging even further away from the dividing line of 50 that separates contraction from expansion. Like central bankers in China, those in Europe and the U.S. are holding out the hope that the policy actions they have already taken will kick-in in time. That they are now keeping the last of their policy powder dry suggests that they are hoping against all hope.
In the card game 21s, a player can ‘twist’ to get another card from the dealer in the hope of reaching an aggregate face value of his hand of exactly 21. More often it is done in hope rather than expectation. So with the U.S. Federal Reserve’s latest attempt at stimulating the U.S. economy, Operation Twist. Banish the thought that this could be called QE3. After all, the Fed’s second round of quantitative easing did not achieve much in the way of generating additional demand to get the U.S. economy growing at anything but the most sluggish pace. It faces the same uphill battle with Operation Twist, intended to nudge down long-term interest rates as QE2 was intended to push down short-term ones. (Historic footnote: when the Fed tried the same tactic in 1961 it was originally called Operation Nudge)
Operation Twist will work like this: Between now and the end of June next year, the Fed will buy $400 billion dollars in Treasury bonds with maturities of 6-30 years. It will finance these purchases by selling an equal amount of debt with maturity of 3 years or less. In this way it will lengthen the average maturity of its debt holdings but does not need to expand its balance sheet to do so. Creating demand for longer-term bonds should drive down their yield.
Yet the U.S. economy already has very low interest rates by historic standards, and has, by now, had them for some time. It is not the cost of credit that is the issue but the demand for it. Large companies are awash with cash. They have neither the need to borrow, however cheaply, nor, more importantly, for as long as they see no increase in final demand for their goods and services, the appetite to invest that would require borrowings. Similarly with individuals. Mortgages, which are tied to long-term interest rates, are already cheap, for those who can get them, or want them. The housing market in the U.S. is not only battered but frozen. The lack of consumer confidence under the long dark shadow of persistent high unemployment is keeping it so. So neither companies nor individuals are prepared to commit the spending needed for a sounder recovery. Easier monetary conditions won’t make any significant impact on that.
One international criticism of the U.S Federal Reserve’s second round of quantitative easing announced at the beginning of last month was that it would weaken the dollar, and that that was the intention of the Fed to boost the U.S.’s international competitiveness. In the event, the dollar has strengthened over the past month, by 5.2% on the Dollar Index. The economic data out of the U.S. has been more positive and sovereign-debt concerns in Europe have undermined the euro, a key component of the Index. Fed officials, if not American exporters, must be feeling quite chuffed.
The U.S. Federal Reserve is showing a $2.7 billon paper loss on the $29 billion portfolio of bad assets it received from Bear Stearns as part of JPMorgan Chase’s takeover of the investment bank. The Financial Times says this “could fuel the political and public backlash over the use of government funds to rescue financial institutions.” The Fed won’t realize the losses until it sells the assets, which it has said it won’t do for at least two years. But its valuation of the Bear assets gives a measure of the current market value of troubled mortgage-backed securities.