Wednesday, January 21, 2015

An Honest Assessment from the Head of India's Central Bank

Whenever we find an article from a credible source outside the US, we are interested in featuring it here. It is easy to only focus on US media sources if you live in the US. But many times you can get a perspective that comes from outside the US that is valuable to listen to. 

In this article in Project Syndicate, Raghuram Rajan (Governor of the Central Bank of India) gives a very honest assessment of where things stand in the ongoing economic battle around the world. The article is worth the time to read and consider. Please click the link above and read the full article. Below a few quotes from the article and then a comment.


Bracing for Stagnation

"As 2015 begins, the global economy remains weak. The United States may be seeing signs of a strengthening recovery, but the eurozone risks following Japan into recession, and emerging markets worry that their export-led growth strategies have left them vulnerable to stagnation abroad. With few signs that this year will bring any improvement, policymakers would be wise to understand the factors underlying the global economy’s anemic performance – and the implications of continued feebleness."

"In the words of  Christine Lagarde, the International Monetary Fund’s managing director, we are experiencing the "new mediocre." The implication is that growth is unacceptably low relative to potential and that more can be done to lift it, especially given that some major economies are flirting with deflation."

Conventional policy advice urges innovative monetary interventions bearing an ever expanding array of acronyms, even as governments are admonished to spend on “obvious” needs such as infrastructure. The need for structural reforms is acknowledged, but they are typically deemed painful, and possibly growth-reducing in the short run. So the focus remains on monetary and fiscal stimulus – and as much of it as possible, given the deadening effects of debt overhang.

And yet, the efficacy of such policy advice remains to be seen. It is worth noting that the Japanese checked each of these boxes over the last two decades: They held interest rates low, introduced quantitative easing, and launched massive debt-financed spending on infrastructure. Few would argue that Japan has recovered fully from its malaise.
An emerging narrative might better explain why stimulus efforts have been unsuccessful: As former US Treasury Secretary Larry Summers has argued, the world economy may be going through a sustained period of "secular stagnation."
. . . . .

"Today, debt is making it difficult for developed countries to resume pre-2008 growth rates, let alone restore the levels of GDP that would have been attained if the subsequent Great Recession had not happened. Meanwhile, industrial countries’ overall debt/GDP ratios are continuing to grow."

"In emerging markets, slow growth in the advanced economies has shut down a traditional development path: export-led growth. As a result, emerging markets have had to rely once again on domestic demand. This is always a difficult task, given the temptation to over-stimulate."

"The abundance of liquidity sloshing around the world – the result of developed countries’ ultra-accommodative monetary policies – has made the task more difficult still, as the smallest sign of growth in an emerging economy can attract foreign capital. If not properly managed, these flows can precipitate a credit and asset-price boom and drive up exchange rates."

. . . . .

"But, overall, there is a palpable sense of gloom in the developed world, a feeling that growth is unlikely to take off in the foreseeable future. If secular stagnation persists, these countries will have to undertake painful structural reforms, figure out how to restructure their promises (debts, social-security commitments, and pledges to keep taxes low), and distribute the resulting burden."
My added comments:

This article is filled with topics that we have talked about on this blog and that most certainly relate to the potential for monetary system change. The first thing to say is that this seems like a very open and honest assessment that the central bank easy money policies may not really be solving any problems. Instead they may just "kicking the can down the road". Mr. Rajan notes that the efficacy of the easy money polcies "remains to be seen". He goes on to use Japan as an example of a nation who has tried it for long time without success.

He adds later that the "abundance of liquidity sloshing around the world" can "precipitate a credit and asset-price boom and drive up exchange rates." We have covered all this here on the blog and listed warning after warning from both the IMF and BIS about "asset bubbles" from the various QE policies. He also notes that none of this is solving the debt overhang problem and that "industrial countries overall debt/GDP ratios are continuing to grow."

I am struck by the sense of gloom in this article coming from a highly regarded Governor of India's central bank. Usually, central bankers prefer to paint as rosy a picture as possible to the public. This article leaves you with that nagging sense that something is just not right that we have talked about here, despite US media efforts to portray a recovery being underway. It's a surreal feeling we have noted on here a few times.

We are seeing more and more signs that the problems in the global economy may be starting to overwhelm the central banks ability to manage them. The disaster that overwhelmed the Swiss National Bank was a very visible sign. But here we have a highly regarded central bank governor sounding as if there is not much hope that things are going to improve any time soon and openly questioning easy monetary policies.

All we can do here is attempt to make readers aware of all these issues and encourage them to stay alert and think about a plan to prepare for tough times should we encounter them. What we have learned in this past week is that even central banks can wave a white flag of surrender when no one is expecting it. This article seems to suggest there may be more white flags coming.

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