Last updated: June 25, 2013 7:38 pm

Careless talk may cost the economy
By Martin Wolf
If the Fed had been more prudent, premature tightening might have been avoided
An Ingram Pinn illustration of US Federal Reserve chairman Ben Bernanke

Since the beginning of May, monetary policy has undergone a substantial tightening. This has taken the form of a rise in the yield on the bonds of highly rated governments. The yield on 10-year US Treasuries rose by 88 basis points between May 2 and the end of last week, to 2.51 per cent.

This is a clear tightening of monetary conditions: a rise in these yields lead to rising borrowing costs for the private sector. It is, however, not clear that it is deliberate: longer-term bond yields are not an explicit target for monetary policy.

Moreover, part of the reason for the jump in rates is rising confidence. But talk of taperingUS quantitative easing is also a factor. It is hard to manage a policy whose effects depend on expectations. But it must be done better: this tightening is premature.

That is surely not how it would appear to the Bank for International Settlements, whose annual report calls for an early end to loose policies: “Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets. Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks.”

Government bonds and inflation rates


This is central bank bromide. Worse, it is hard to understand how the BIS thinks its recommendations add up across the world economy. In essence, it suggests that the private sectors should run bigger financial surpluses, as heavily-indebted agents repay debt, while governments should run smaller deficits. Unless one assumes that advanced countries will run vast current account surpluses with the rest of the world, this is a plan for a depression. The BIS does not even consider the possibility that monetary policy has been ineffective because it is competing with the fiscal tightening the BIS has recommended.

At least three further points stand out. First, the two crisis-hit economies that have made greatest use of unconventional monetary policy – the US and the UK – are also the least affected by structural rigidities so there is no moral hazard there.
Only sadists can argue that supportive monetary conditions have cushioned southern Europe against the need to reform.

Second, it ignores the fact that one of the reasons for failure to reduce debt faster is economic weakness caused by the austerity it supports. Third, core inflation is low and falling in the US and eurozone. Rapid tightening risks tipping these economies into outright deflation – a risk the BIS does not even mention.

Indeed, in a critique of the Federal Open Market Committee’s latest policy statement, James Bullard, president of the Federal Reserve Bank of St Louis, argues that the FOMC “should have more strongly signalled its willingness to defend its inflation target of 2 per cent in light of recent low inflation readings”. He is right: the Federal Reserve’s forecasts show core inflation at or below 2 per cent up to and including 2015.

Second, he argues that “the committee’s decision to authorise the chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed”. It should have waited “for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement”. I agree.

If the Fed had been more careful, this premature monetary tightening might not have happened. As it is, the fall in prices of the world’s most important financial securities could materially damage recovery, as it lowers prices of riskier assets across the world, not least in emerging countries. Gavyn Davies highlights the dangers of such a correction, citing Warren Buffett’s remark that we only discover who is swimming naked when the tide goes out.

The BIS argues that if yields were to rise by 3 percentage points across the maturity spectrum in the US, mark-to-market losses would be more than $1tn, or almost 8 per cent of GDP. Losses elsewhere would be even bigger.

Financial shocks are possible, as “carry trades”, in which investors have borrowed short to lend long or borrowed in low-interest currencies to lend in higher-interest ones, unwind sharply. Indeed, one of the reasons why policy makers must be careful is that investors in such trades know how vulnerable they are to a rush for the door. They will flee as soon as they fear others may do so, creating a big danger of self-fulfilling panics (see charts).

The challenge in unwinding current policies is not technical. As Fed chairman Ben Bernanke explained in February 2010, exit from QE and bloated central bank balance sheets is technically straightforward. Since the Fed pays interest on reserves, it can even raise short-term rates before QE is reversed. Furthermore, such an exit is desirable, provided it occurs only when the recovery is in place.

There are three true challenges. The first is proper management of expectations. This may be too late now. But the right way to proceed, as Mr Bullard has argued, is to stress only conditions, not timetables. Nobody knows when the conditions for tightening will emerge, because nobody knows how the economy will perform.

The second challenge is to address the vulnerability of the financial system – especially the systemically significant parts – to big declines in prices of safe-haven bonds. This is purely market risk, not credit risk. That can be managed by a mix of lower leverage and, if necessary, regulatory forbearance. It is unlikely that markets would cease to fund systemically significant financial institutions that have only mark-to-market losses on safe-haven government bonds. Yet the authorities will need to have plans to address such an eventuality.

The third challenge is to manage the global consequences. The likely result of a credible exit will be a shift towards assets in the recovering high-income economies. For emerging countries that should be welcome, in the medium run. But they need to ensure that their financial systems, too, can cope.

We should look forward to a world of higher long-term interest rates on safe-haven bonds. But we should not need to enter that world yet.

Policy makers need to speak softly about exits. But the regulatory stick must be big enough to ensure the economy copes when it comes.

Copyright The Financial Times Limited 2013.


Updated June 26, 2013, 5:59 a.m. ET

Ruchir Sharma: How Emerging Markets Lost Their Mojo

Investors have once again come to see state companies as slow-witted giants, prone to overinvest and overbuild.


Chad Crowe

Emerging economies have lost nearly $2 trillion in stock-market value since the global financial crisis hit in late 2007. The full blame for this meltdown, and then some, can be placed at the door of their state-owned companies, which account for a third of these economies' roughly $9 trillion market capitalization.
Over the past five years, the value of private companies in emerging economies—including Brazil, Russia, India and China, as well as Mexico, Indonesia and Turkey—has remained broadly stable. Meanwhile, the value of state-owned companies (defined here as companies with a government ownership stake of at least 30%) dropped by more than 40%. Today there is only one state company (PetroChina) among the 10 most valuable companies in the world, down from five in 2008.

These losses suggest that the global markets don't buy the conventional wisdom of the postcrisis years when magazine covers heralded "The Rise of State Capitalism" and books forecast "The End of the Free Market." Most of these forecasts started with China, which responded to the growing financial crisis by pushing state-owned banks to lend to priority industries at cheap rates. Beijing also directed state-owned firms to lend and invest aggressively, and otherwise expand state control over the corporate sector.

When China escaped the global recession relatively unscathed, it emboldened governments in emerging markets from Russia to Brazil to follow the Chinese example, and many are still promoting state capitalism. They may be forced to reconsider. Investors have been voting with their money and exiting their markets. But it isn't only stock prices that are in decline. Lower profits for state-owned companies mean less money for the government and lower productivity growth for the broader economy.

During the mid-2000s, a rising tide of liquidity was flowing out of the U.S. and Europe, and investors began indiscriminately bidding up the stock prices of emerging-market companies, private and state-owned. Betting that rising demand from China would continue to drive up prices for industrial commodities, investors poured money into any company involved in energy or raw materialsindustries often controlled by the government in the emerging world.

All this changed after the crisis. Investors refocused on profitability, and they have once again come to see state companies as slow-witted giants, prone to overinvest and overbuild. According to our research at Morgan Stanley Investment Management, investors now value government-run companies at about half the price of private firms in the same industry, from banking to telecoms.

World-wide, investors are also shifting money to technology from commodities. This helps to explain why the U.S.—a center of tech innovationnow accounts for nine of the 10 most valuable companies in the world. Meanwhile, state-owned companies in the emerging world aren't being able to keep pace. Technological innovation has never been a forte of bureaucrats.

Not so long ago many governments in the emerging world also saw state companies as sluggish behemoths, burdening their economies. In the 1990s, many began selling off companies they owned, hoping that private ownership would raise corporate profitability and national productivity—and often it worked. In China, reform of state-owned enterprises helped sustain the "economic miracle" there with the government laying off millions of inefficient workers and bringing in more professional management to help run some of its largest companies.

By the following decade, however, the privatization craze was over, discredited by botched attempts in nations such as Russia, where privatization turned into a fire-sale of valuable state assets to rich oligarchs. Meanwhile, the runaway boom in emerging markets was making growth look easy for state and private companies alike.

Now, with investment flowing out, emerging nations need to return to the path of reform, including privatization and reduced government control over the economy. In the past few years, the profitability of state companies has also been slipping, and now revenue growth is falling fast. Interestingly, China appears to be leading the way in recognizing the need for change.

Since taking office in March, Chinese Premier Li Keqiang has been talking about the need for a "self-imposed" revolution to reduce his government's power and promote "market mechanisms" for growth. In the West, many commentators still marvel at how China appeared to dodge the global recession by implementing a huge half-trillion dollar stimulus program in 2009. But in China the evolving view is that the funds were misdirected to wasteful projects like unneeded steel and aluminum plants. The state-run Xinhua News Agency has even been running editorials about how another stimulus would be self-defeating.
Clearly, China's leadership recognizes that its state enterprises failed to make productive use of the surge in government-directed bank lending after 2009. Indeed, according to my firm's research, since then the return on equity of those enterprises has fallen to below 6% from 10%.

To get their mojo back, governments in emerging markets would do well to also count the mounting costs of state capitalism and start cutting back the role of the state, and putting more of their state-owned companies in private hands. Otherwise, these companies will keep destroying wealth, and undermining the economic growth prospects of emerging nations.

Mr. Sharma is head of emerging markets at Morgan Stanley Investment Management and author of "Breakout Nations: In Pursuit of the Next Economic Miracles" (Norton, 2012).

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Getting Technical


Charts Suggest Gold Will Bounce


With Fed taper talk roiling the markets, stocks continued their dead-cat bounce but gold broke down yet again. Don't get enamored with either trend.

Stocks continued to rebound off the recent drubbing triggered by the Federal Reserve's hints that it may cut back its bond-buying program. Meanwhile, gold can't seem to get out of its own way.
But this week's stock-market strength and this year's gold weakness are both running into problems. Let's start with stocks.

There is no denying that the Standard & Poor's 500 snapped its rising trend from last November's important low (see Chart 1). With last week's losses, the index set in place a series of lower highs and lower lows to define a short-term bearish trend.

Chart 1

Standard & Poor's 500

The question now is whether this is a corrective pause or the start of something worse. I have presented evidence here over the past few weeks that supports the latter case. However, even as stocks are still set up for lower prices, basic technical analysis only looks for another few percentage points to the downside.

If and when the current bounce ends, a downside target of 1,520-1,535 is reasonable, bringing the total correction from May to roughly 10%. The index traded at 1,600 Wednesday afternoon.

Why that level? That is the level at which the index bounced off its trendline in April. It is also where the rising trendline from October 2011 will be in a few weeks. And the 200-day moving average is also rising at a pace to reach that zone at the same time. The combination of support features is indeed compelling.

On the bullish side, there is always a chance that the market made its low this past Monday. However, we need proof in the form of technical breakouts above several features, including the 50-day moving average, currently at 1,619. Better yet, a move above the June 16 high of 1,654 would convince the most stubborn bears to change sides. That is a long way to go from today's trading, however, so it is not a practical yardstick for active traders.

Gold, on the other hand, is a total mess. The brutal bear market from 2011 offered many false hopes, some of which did get the better of me. It actually accelerated to the downside with the April 2013 debacle, and last week I wrote that sentiment was so bearish that it could be a contrarian signal that the worst was over (see Getting Technical, "No Relief in Sight," June 20).

It wasn't.

But even with Wednesday's latest decline, sentiment remains at extreme bearish levels, according to the Daily Sentiment Index survey of traders compiled by veteran trader Jake Bernstein at

And now the SPDR Gold Trust (ticker: GLD) is closing in on the downside target I mentioned in last week's column at 118 (it traded at 119 Wednesday afternoon). This target was based on the height of the April-June triangle pattern projected down from last week's breakdown point.

Making this an even more compelling target is that it is also the target for the break of the much larger triangle pattern formed between July 2011 and April 2013 (see Chart 2).

Chart 2

SPDR Gold Trust

Because the percentage changes involved in long-term patterns can be large, I used a chart with log scaling, which is similar to percentage-change scaling. The height of the pattern projected down from the breakdown point in percentage terms is also in the 118 area.

Gold is in a serious bear market, but all bear markets do eventually come to an end. Still, catching falling knives is a dangerous game to play. As stocks may have seen a dead-cat bounce after falling so sharply, gold may experience a dead-elephant bounce since it has fallen so brutally this year.

But if ever there were a time that price action, momentum, cycles and sentiment are coming together, it is now for gold. Picking up a coin or two with a long-term time horizon may be a good idea.

Michael Kahn, a longtime columnist for, comments on technical analysis at A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Getting Technical

MONDAY, JUNE 24, 2013

Emerging Markets: More Pain Coming


Stocks, bonds and currencies in emerging markets have plummeted in recent weeks, and the charts suggest they have farther to fall.

In technical analysis, there always is a balance to be struck between short-term and long-term conditions. Emerging markets, for example, look ripe for quick snap-back rallies, but investors should leave them to the pros. This camel's back is broken.

Earlier this month, I wrote here that emerging-markets weakness was signaling something bad for global markets (see Getting Technical, "Emerging Markets Send Worrisome Signal," June 10). With the Dow Jones Industrial Average down more than 600 points since thenmost of that coming within the past four days – the emerging-markets signal was indeed accurate.

And even thought the iShares MSCI Emerging Markets Index Fund (ticker: EEM) is down nearly 10% over that span and 18% since early May, this is no time to jump back in. Support remains roughly 4% below Monday's trading, and given the speed of the decline there's a strong possibility of an emotion-driven penetration of that level (see Chart 1).

Chart 1

Emerging Markets ETF


One look at the chart shows this support level to be the bottom of a multiyear-trading range. That means that in four years, the ETF tracking the supposed engine of global growth has gone nowhere.

While we must give support – the bottom of a trading range – the benefit of the doubt, it is very hard to imagine that emerging markets will hit it and suddenly find a long-term floor. A short-term bounce suitable for short-term trading seems to be more in line.

In China, the Shanghai Composite index shed more than 4% last week as short-term interest rates spiked higher. In contrast, the Dow fell by about 1.8%. Then, early Monday, the world got the news that China may not act to prevent a liquidity crisis there and that sent stocks tumbling 5.3% on the day.

While investors can track movements of Chinese stocks via the iShares Trust FTSE China 25 Index Fund (FXI), it does not tell the real story about the trend. The Shanghai Composite itself has not only erased its entire rally from last December's low, but it is on track to trade at its lowest levels since January 2009 (see Chart 2).

Chart 2

Shanghai Composite


Chinese stocks bottomed in October 2008, five months ahead of the Dow, and now prices are not much higher than they were at the end of the 2007-2008 bear market. The cynical question is "what bull market?" Indeed, the economy that was hailed as the new powerhouse has seen its stock market in decline for more than four years.

The term "dead-cat bounce," which comes from the Wall Street saw that "even a dead cat will bounce when dropped from a high enough level" may apply here. A one-month 15% decline can bring out the bottom fishers, and technical momentum indicators do suggest that the market is oversold. But with the trend so solid to the downside there is no reason for investors to speculateat least not until the short-term trend stops falling.

Emerging-markets bonds are not faring any better than stocks. As the benchmark 10-year U.S. Treasury yield jumped higher, prices of bonds of every stripe have gone down in price: Treasuries, junk and municipals. The iShares JPMorgan USD Emerging Markets Bond Fund (EMB) is no exception: It is down 15% since early May, with half of the losses coming in the past four days (see Chart 3).

Chart 3

Emerging Markets Bond ETF


The rising trend from the 2008 financial crisis lows was obliterated on the decline. Such technical damage requires a good deal of time to repair, and as with stocks, this market may experience a "dead-cat bounce."

But the trend is now down and that means investors would be fighting it if they think emerging-markets bonds are cheap. Cheap can get cheaper.

I wrote last week about plunging emerging-markets currencies, such as the Brazilian Real and Indian Rupee. Although too thinly traded for most investors to buy and sell, the WisdomTree Emerging Currency Fund (CEW), a basket of many emerging currencies from across the globe, shows the carnage happening in this marketplace (see Chart 4).

Chart 4

Emerging Markets Currency ETF


Timothy Kelly, Editor-in-Chief of, says emerging-market currencies are getting hit over concerns about global growth. He sees the trend continuing through the summer.

On the charts, the plunge last week followed a month of steep declines and looked eerily similar to the stock market after the crash of 1987. If there is any similarity in the two markets and the sentiment behind their respective moves then we can expect volatility, not rebounding prices, to rule for many weeks to come.

While upside corrections – "dead-cat" or otherwise – are always possible, emerging-markets stocks, bonds, and currencies have all seen significant technical damage. Investors should avoid them until they stabilize and prove that the worst is over.

Michael Kahn, a longtime columnist for, comments on technical analysis at A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.
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