Tuesday, July 15, 2014

The Tale of Seven Banks

There once were seven central banks (that I follow), that each had an economy and an actively traded currency, and all was well in the world. Fast forward through a global financial crisis to today and the world economy is recovering, being led by the US.

The US economy being shepherded by the Federal Reserve, is doing OK. Growth is slow but steady, and inflation, as monitored by the Fed, is trending below its long-term averages. Both the previous Fed Chair Bernanke, and the current Fed Chair [and Bernanke disciple], Janet Yellen, have stated that the Fed will be willing to accept inflation above its long-term trend as long as employment and GDP lag behind.

The Bank of Canada is dancing to a similar tune, as wages and other drivers of core price inflation in Canada remain stymied. The same can be said for the Bank of England, and the Bank of Japan where again inflation targets are quantified by the central banks and reflected in their monetary policies . Wages in the US are not increasing because of slack in the labor markets, but that problem is slowly fixing itself. In the United Kingdom, wages are not increasing for a similar reason, but, they are however, dealing with real estate prices that are growing faster than incomes (especially in London) being driven by foreign buyers. The Bank of Japan is in the process of undoing almost 20 years of economic stagnation, and price deflation. Prices, wages, and interest rates have been falling since the early 1990s, but now monetary and fiscal policy are both being aligned to support the intended shift in the macro-economy.

The remaining three banks are the Reserve Bank of Australia, the European Central Bank, and the Swiss National Bank. Each one with its own set of ‘personal’ problems to contend with. In Australia, the issue is the slowdown in Chinese growth in manufacturing, for which Australia exports the bulk of the raw materials it mines. The slowdown is rippling through the Australian labor market which happens to be heavily weighted in the [you guessed it] mining sector. On the European continent, Germany is starting to show signs of exhaustion as its customer -- the rest of Europe -- is not doing so well. The other major players including France, Italy, and Spain and some minor ones are focused on government bond yields while economic growth stagnates and prices fall. In Switzerland, where money goes to hide when there is risk afoot on the continent, the Swiss National Bank has to guard its economy against capital flight from the Euro area to their little haven.

Each of these banks has ended up in a unique position, stemming from global rebalancings due to half a decade plus of emergency monetary policy, but none more precarious than the Fed. Central Bankers around the world are taking their cues indirectly from the Fed; as Chinese domestic consumption is not yet able to replace the shortfall in US consumption. The rest of the world is waiting for someone to step up and buy. Europe needs time to find a new economic equilibrium, as debt and low productivity work their course, while the US, who is on a similar path just has a head-start and a more resilient economic base.

Central Bankers were able to co-ordinate monetary policy stimulus in response to the global financial crisis; but the panic was universal. The timing of the undoing is not so universal now that it’s safe to call an end to the crisis. The Banks must now normalize their policies and let the (somewhat) free markets get back to the tedious work of setting prices from wages, to interest rates, to gold, and real estate.

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