The instability in central bank divergence

Mohamed El-Erian

February 26, 2014

A careful reading of recent policy statements in advanced economies points to an intriguing possibility: after being forced into quite a similar stance, individual central banks will try to implement more differentiated monetary policy approaches. The driver is greater evidence of multispeed economic growth. The challenge is for other components of economic policies to support the more differentiated set of central bank policies. And what is fundamentally at stake is the much-desired shift from policy-induced growth to genuine self-sustaining private sector engines.

The best place to start this analysis is with the insightful remark made by Martin Wolf back in October 2010. Writing in the Financial Times, Mr Wolf correctly projected that “the US is seeking to impose its will, via the printing press. The US is going to win this war, one way or the other: it will either inflate the rest of the world or force their nominal exchange rates up against the dollar.”

First through quantitative easing 2 and then “Operation Twist” and “QE3”, the US Federal Reserve’s prolonged reliance on unconventional monetary policy confronted country after country with a difficult choice: to either tolerate a significant exchange rate appreciation – thereby risking competitiveness, jobs and, in some cases, domestic financial stability – or follow the Fed in loosening monetary policy.

Nowhere was this dilemma greater in the advanced economies than in Japan, which experienced a sharp currency appreciation in the context of an already prolonged period of inadequate economic growth. The dramatic policy shift that occurred in late 2012 has turned the Bank of Japan into one of the most aggressive users of its balance sheet to boost the economy.

In countering the appreciation of its currency, the BoJ has transitioned to a very expansionary policy stance. Moreover, based on recent signals from Haruhiko Kuroda, its governor, the BoJ may also find that, by the end of this year, it is among the last central banks voluntarily pursuing a hyper-accommodative stance.

Notwithstanding moderating inflation, and having already stopped its QE operations, the Bank of England will likely come under growing pressure during this year to signal a further reduction in policy accommodation; and to do so by changing its “forward guidance” regarding the maintenance of a floor on interest rates. In the process, it will likely be leading western central banks on the “rate normalisationpath starting next year.

For its part, and absent a major economic slump, the Fed will complete its full exit from QE by the end of this year. But, unlike the BoE, it will not be signalling any impending interest rate move in the first part of 2015. Instead, it will likely strengthen its forward guidance by replacing its simple unemployment threshold with more holistic measures of the labour market and a more explicit inflation floor.

The European Central Bank will likely come third in this line-up, led by the BoE at one end and the BoJ at the other. Specifically, it is unlikely to join its American and British counterparts in gradually removing either price or quantity accommodation. Indeed, to do so would strengthen further the single European currency at a time when the eurozone is only modestly existing recession. But it will also resist joining Japan as a massive implementer of QE
Instead, the ECB is likely to opt for some type of “credit easing” as a means of supporting the flow of credit to rationed companies and individuals – an action that will attract significant media attention but is unlikely to dramatically change economic conditions on the ground.

The prospects for this more varied mix of central bank policies is, at least for now, consistent with underlying trends in real and nominal gross domestic product in each of the economies. But its viability can only be ensured if other components of the overall economic policy stance evolve appropriately in supporting the still-elusive (and much-needed) shift to more sustainable private sector-led growthstarting in the UK where the government is eager to rebalance the economy from consumption and housing to exports and investment.

Absent such comprehensive policy support, and given the unbalanced and still-fragile state of the advanced world’s growth engines, this attempt at central bank policy differentiation could well lead to significant currency realignments and a more general risk of financial market instability. The result of which would likely force central banks into renewed policy convergence, or what Michael Spence, the Nobel Prize-winning economist, once labelled a “non-cooperative co-operative game”.

The writer is the outgoing chief executive and co-chief investment officer of Pimco

Taming Europe’s Banks

Michel Rocard

FEB 25, 2014

Newsart for Taming Europe’s Banks

PARIS Last month, the European Commission unveiled its much-anticipated blueprint for banking reform, aimed at reining in risk-taking by the European Union’s largest banks. But the proposal has met significant resistance, with some warning that it would erode European banks’ competitiveness, and others arguing that it is inadequate to mitigate banking risks effectively. How this debate unfolds will have profound implications for the EU’s future.

According to Michel Barnier, the EU commissioner spearheading the reform effort, the proposed measures – including regulatory authority to divide banks’ riskier trading activities from their deposit-taking business, and a ban on proprietary trading by the largest banks – would enhance financial stability and protect taxpayers. But the draft regulation falls far short of the recommendations made by a high-level expert group in 2012, which included an impermeable wall between banks’ speculative-trading business and their retail and commercial banking activities.

Nonetheless, many claim that Barnier’s proposal goes too far. Perhaps the strongest reaction came from Bank of France Governor Christian Noyer, who called the proposalsirresponsible and contrary to the interests of the European economy.”

The positions taken in this complex debate do not align neatly with the traditional left-right political spectrum. Barnier is a center-right Frenchman recommending more public control over private banking activities. (Indeed, stricter banking regulation has been endorsed by all.) And, while Noyer’s position at the central bank makes him independent, he is championing banking-sector autonomy in a country led by a left-wing government. What is at stake is Europe’s capacity to avoid another financial meltdownone that could be even more devastating than the 2007 crisis.

Of course, to some degree, a capitalist system will always be vulnerable to shocks and crises. The question is how to respond to them to minimize the fallout, while bolstering the system’s resilience.

In 1929, a crisis among speculating capitalists prompted poorly conceived and excessive reactions, leading to a deep and prolonged depression. Less than four years later, US President Franklin D. Roosevelt’s newly elected government passed the Glass-Steagall Act, which prohibited commercial banks from trading securities with clients’ deposits.

By forbidding investment banks from holding cash deposits, Glass-Steagall helped to support more than a half-century of financial stability after World War II. Thistogether with the gold exchange standard, which ensured that credit did not exceed the economy’s productive capacitycontributed to sustained global economic growth.

Everything changed in 1971, when US President Richard Nixon, unable to contain the fiscal deficit resulting from spending on the Vietnam War and expanded social-welfare programs, abolished the dollar’s direct convertibility to gold. The resulting exchange-rate, interest-rate, and commodity-price volatility continues to this day.

The financial sector has since made every effort to design instruments that protect against price fluctuations, to transform private debt into tradable financial securities, and to gain access to speculative markets. But these efforts were conducive to fraud and delinquency, and thus spurred a wave of new financial crises – in Europe in 1992, in Asia in 1997, and in Russia in 1998as well as a recession in Europe and the United States in the early 2000’s.

Two other destabilizing developments emerged in the last quarter of the twentieth century: a strong incentive to use debt to prop up demand, and a shift toward financing public debt through private institutions at market prices, under the pretext of fighting inflation. These trends boosted public-debt burdens, while flooding the global financial system with liquidity generated by private banking activities that were unconnected to transactions in the real economy.

As a result, by 2006, global liquidity amounted to more than twice the value of world GDP. Add to that the American financial sector’s untenable subprime and securitization activities, and it is not surprising that the next two years brought the global financial system to the brink of outright collapse.

To prevent the crash from triggering another Great Depression, governments intervened with massive taxpayer-funded bailouts, causing public-debt burdens to swell further, reaching unsustainable levels in many developed economies. Making matters worse, the US, the United Kingdom, and Japan began implementing quantitative-easing policies that is, they began printing money – in an attempt to sustain GDP growth.

Through all of this, governments have strengthened bank regulation only slightly, leaving key issues like liquidity creation, exposure to derivatives, and tax avoidance largely unaddressed. Today, 98% of the $750 trillion in global liquidity is in speculative markets. Like all bubbles, this one is bound to burst.

The European Commission has acknowledged the danger, declaring that the only way to mitigate it is to separate the real economy from speculative markets by preventing banks from being involved in both. But, according to Noyer, such a move would not work in the eurozone, where banks’ profits depend largely on their risky activities. If those activities move to the UK, the eurozone economy will suffer considerably.

From a short-term perspective, Noyer’s position is largely correct. But the profits that would be lost remain lower than the potential costs of another major financial crisis. The eurozone’s member states should never again have to face such costs.

Michel Rocard, former First Secretary of the French Socialist Party and a member of the European Parliament for 15 years, was Prime Minister of France from 1988 to 1991.

Markets Insight

February 24, 2014 6:06 am

Time for central banks to step back

Focus should be on building a more robust financial system

Central banks have been on the back foot recently. The Federal Reserve has been criticised for its tapering strategy. Forward guidance in the US and UK has become a little discredited

Higher policy rate expectations are played down but are no longer an academic issue. The European Central Bank’s unused lender-of-last-resort policy tool for sovereign governments may have been rendered unusable.

Controversially, perhaps, we should welcome these developments. They could help us to stop obsessing about the capacity of central banks alone to address our economic challenges, and, more generally, to focus on building a more robust financial system.

There are no constants in central banking, and we should embrace the opportunity for change. Under Bretton Woods, central banks had to obey the rules dictated by fixed exchange rates. After 1971, they made up their own rules, until the necessity of fighting inflation. In the credit boom, they were part of the flawed consensus that economies would be self-correcting if only low, headline inflation targets were respected.

Since 2009, central banks have occupied the dominant role in economic policy making, driven partly by circumstance and partly by governments’ withdrawing from the sharp end of economic management.

We have ended up with a chronically unbalanced policy infrastructure that is liable to compromise our ability to cope with the next economic downturn or crisis. It is appropriate, therefore, for central banks to step back a bit.

The Federal Reserve’s quantitative easing exit strategy will sometimes sit awkwardly alongside short-term economic trends, and may again be blamed for financial instability in emerging markets. However, the Fed’s strategy to normalise monetary policy in keeping with its economic judgment is fundamentally right. Spillover effects into emerging markets are best addressed via central bank swap facilities if needed, and by the agreement of G20 governments on best practice policies designed to strengthen emerging countries’ resilience.

We also know that forward guidance does not have the “scientificproperties that were on the tin. It turns out, in fact, to be quite a woolly concept, as both Fed chairwoman Janet Yellen and Bank of England Governor Mark Carney have acknowledged.

Tenuous link

It was always tenuous to link nominal policy rates to real, labour market phenomena such as unemployment, especially when employment and participation rates, wages and hours worked are structurally in transition for demographic and technological reasons. We cannot be sure what a given level of unemployment actually means nowadays. Central banks will have to judge the glide path back to appropriate policy rates under new economic circumstances, but addressing those circumstances is the responsibility of governments.

The ECB’s Outright Monetary Transactions (OMT) programme is now subject to a future ruling by the European Court of Justice, but the German Constitutional Court also deemed it to be constitutionally illegal in Germany, and outside the capacity accorded to the Bundesbank. However these issues are resolved, the OMT programme may not be usable, and would in any case amount to much less than Mr Draghi’s whatever it takes within our mandate”. Perhaps it no longer matters, given that the current convergence of bond yield spreads is more related to deflationary conditions.

This makes QE by the ECB a much bigger call, economically, but arguments will rage about the meaning of the ECB’s mandate for price stability, what constitutes monetary financing of governments, and who bears the ultimate fiscal risk in the event of loss.

The ECB has an unequivocal mandate concerning lending to banks and improving the transmission mechanisms of monetary policy, but politics have undercut its capacity to perform other key functions. Perhaps, though, this will help Europe acknowledge that only governments can address the problem of asymmetric economic adjustment.

Time to call time

These developments in advanced economies suggest it is time to call time on fallible central banks. Unorthodox monetary policies have served their purpose but their legacy is increasingly one of politics, limitations and unintended, negative consequences. Instead, we need to deploy a wider array of policy tools, not least government policies that prioritise high levels of employment and training, more robust income formation, and a ‘long-termism’ that requires corporate and fiscal governance reform.

Central banks should not be accountable for economic outcomes that lie outside their remit. Their primary function should be financial stability, including the management of goods and asset price inflation, of narrower banking structures, and of international monetary transmission effects.

We would all be better off if central banks were reassuringly vague in carrying out monetary policy, rather than firm in holding out economic hostages to fortune. The price may be slightly more animated yield curves, and more volatile market interest rates, but in the bigger scheme of things, this would be no bad result.

George Magnus is a senior independent adviser to UBS, and former chief economist of UBS

Copyright The Financial Times Limited 2014

viernes, febrero 28, 2014



02/25/2014 12:31 PM

Yanukovych's Fall

The Power of Ukraine's Billionaires

By Christian Neef in Kiev

Photo Gallery: The Role of the Oligarchs

The protesters in Kiev were largely responsible for the fall of the Ukrainian president. But his way out of office was paved by two of the country's most powerful oligarchs. Made rich by Viktor Yanukovych, the pair made early preparations for his departure.

Nobody told Ukrainian parliamentarian Yuri Blagodir that you had to be physically fit to be a representative. But last Thursday, the ability to run fast suddenly became a key skill. Just before 10 a.m., the parliament in Kiev was finally assembling in an effort to find a way out of the spiraling chaos that had gripped the country. Then came the order to clear the building.

Gunfire rang out, explosions shook the government quarter and special police and secret service units rushed to the scene. The opposition, it was said, intended to storm the parliament and the seat of government.

Blagodir, 40, ran up the street along with the other parliamentarians, away from the city center and away from the parliament building. They felt like they were running for their lives -- a pack of representatives being hunted by the people they represented.

It was afternoon before they returned to their workplace and the greatly anticipated special session only began at 5 p.m. For Yuri Blagodir, the session was of particular importance. Just a day earlier, he had still been a member of the Party of Regions, the governing party led by President Viktor Yanukovych.

Thursday was to be the first day of his new political life. A day prior, he had posted the following on his website: "The events of the last three months have shown that the official response to the crisis can only lead to civil war and the disintegration of the state." He joined three other Party of Regions members in renouncing their membership. A day later, 10 more representatives turned their backs on Yanukovych and huge numbers of functionaries across the country did the same.

It marked the beginning of the rapid end of Yanukovych's grip on power. It was his worst-case scenario: By the end of the day on Thursday, a third of his parliamentarians had abandoned him.

The reason was clear. Civil war no longer seemed merely a theoretical possibility. Snipers had opened fire on protesters in the city center, killing dozens with shots to the head, neck or chest. Over 50 people were killed on the streets of Kiev that day -- a day which was supposed to be one of mourning for the protesters who lost their lives that Tuesday. In total, according to Ukrainian authorities, 88 people died in the conflict last week.

An Understanding with the Oligarchs

As government loyalists and protesters battled it out on and around Independence Square, the rest of the city was ghostly silent. The subway was closed, as were shops, restaurants and banks. Only ambulances sped through the city streets. In front of the Radisson Hotel, Polish Foreign Minister Radoslaw Sikorski climbed into a car to drive with his counterparts Frank-Walter Steinmeier, from Germany, and Laurent Fabius, of France, to a meeting with Yanukovych in an effort to re-establish peace.

Parliamentarians, meanwhile, began debating a crisis solution of their own -- even as others were pouring oil onto the fire. The country's secret service head demanded that the battle against the "terrorists" be fought to the bitter end. And former head of government Yulia Tymoschenko, still locked up in Kharkiv at the time, said that the many deaths in Kiev were the result of "negotiations with the dictatorship that were hopeless from the outset." It was essentially a call for a violent overthrow.

Yet by then, it had long since become clear that a solution to the crisis would not be found on Independence Square. Nor would it come from Moscow, Washington, Berlin or Brussels. Rather, it would have to come from parliament -- together with those people who had supported the president. The opposition was faced with the prospect of winning them over in order to establish a political majority.

More than anything, though, the opposition had to reach an understanding with the two men who controlled roughly half of Yanukovych's party: Rinat Akhmetov and Dmitry Firtash, the two most influential oligarchs in the country.

"The two knew that, were Yanukovych to fall, they would be the biggest losers. That is why they did everything to prevent the radical solution sought by the protesters on the Maidan," says Vadim Karasev. Karasev was an advisor to President Viktor Yushchenko, who came to office following the 2004 Orange Revolution only to lose it a short time later due to deep differences with his one-time ally Tymoshenko. Currently, Karasev heads up one of Ukraine's most important think tanks.

Our meeting with Karasev took place in an empty café at the Premier Palace Hotel, across from where Kiev's Lenin monument stood until it was pulled down by radical nationalists in December. "If Yanukovych had attempted to solve the crisis with violence, he would have lost, but the oligarchs would have too," Karasev says. "Tymoshenko would have replaced him immediately and then we would have seen a repeat of what happened after the Orange Revolution: the dispossession of the rich. But all of Ukrainian politics depends on them. The men who became rich thanks to Yanukovych want guarantees for their holdings."

Pulling Strings

Akhmetov and Firtash: Those two names have repeatedly surfaced in Kiev in recent weeks. But they have been careful to stay out of the spotlight and declined interview requests. It was reported over the weekend that they were both in London. Still, they both have been busy pulling strings in recent weeks.

Akhmetov is the more important of the two. The 47-year-old is worth $15 billion and is head of the holdings company System Capital Management, which controls more than 100 companies with some 300,000 employees. They include metallurgical and pipe factories, banks, real estate firms, mobile phone enterprises and a large media company. He is the de-facto ruler of Donbass, the home of Ukrainian heavy industry, and owns the football team Shakhtar Donetsk. He is also among the leaders of Yanukovych's Party of Regions.

In recent weeks, Ukrainian protesters have staked out houses of his in both Donetsk and London. They held up signs reading: "Just one phone call from him and the killing will stop."

Only once did Akhmetov show himself to the protesters. He drove up in his Mercedes and told them that he was prepared to talk. The worst for him, he said, would be if he "could no longer walk through Donetsk and breathe Ukrainian air." Akhmetov, who started "at zero" 25 years ago, as he likes to emphasize, didn't want to belong to the losers.

He comes from a poor mining family. "We lived in just 20 square meters (215 square feet) and had no toilet or sink at home," he has said. But then, at the beginning of the 1990s, following the collapse of the Soviet Union, he made his first million trading coal in the mining city of Donetsk.

Nobody knew him at the time. He only entered the spotlight when Akhat Bragin, who was president of the Shakhtar football team at the time, was assassinated in an explosion during a game in 1995. Bragin was the godfather of Donetsk.

Akhmetov had had business dealings with Bragin and became his successor at Shakhtar. Just before, he had founded his first bank in Donetsk. He later said that he became rich via "a few risky deals immediately after the disintegration of the Soviet Union."

A short time later, the former automobile mechanic Viktor Yanukovych, previously convicted of robbery and assault, was named head of the Donetsk regional government. A business relationship developed between him and Akhmetov -- one which ultimately blossomed into a friendship. When Yanukovych became head of government in Kiev in 2002, Akhmetov's career looked to be on the rise.

The Rise

The budding oligarch of course went on to back Yanukovych's 2004 presidential candidacy. But when he failed -- after seeking to ride Russian support and clumsy electoral fraud to the presidency, and touching off the Orange Revolution in the process -- things began looking grim for Akhmetov as well. The country's new leadership, under Yushchenko, began confiscating parts of his steel conglomerate, accusing him of having obtained them illegally.

Then, in 2005, he was accused of involvement in economic crimes and police began raiding his properties and offices. He fled to Monaco and stayed there for a time, avoiding the unpleasantness at home. Ultimately, though, he returned and became a key sponsor of Yanukovych's Party of Regions. When Yanukovych finally did become head of state in 2010, the future looked bright for Akhmetov.

The second oligarch, Dmitry Firtash, 47, followed a similar path to his riches. After serving in the army, he became a fireman and began his business career with a deal that profited him $50,000: In Hong Kong, he traded 4,000 tons of evaporated milk from Ukraine for cotton from Uzbekistan.

Later, he went to Moscow where he lived in the Rossiya Hotel in Moscow, located across from the Kremlin. It is where Soviet businesspeople gathered and while there, he got to know key players in the Turkmen natural gas industry. He quickly entered the trade, receiving natural gas in exchange for foodstuffs.

He too advanced quickly. He bought a chemical factory in Estonia and later purchased an Austrian firm which specialized in natural gas transportation. In 2004, he joined the Russian gas company Gazprom in opening the company RosUkrEnergo, which specialized in transporting natural gas to Western Europe.

It was this company which later put him at odds with the Orange Revolution: A dubious 2009 deal between Prime Minister Yulia Tymoshenko and her Russian counterpart Vladimir Putin ruined Firtash's business. He and Tymoshenko became bitter enemies.

When Yanukovych ascended to power, it was good for Firtash as well. He expanded his empire and today, with his media conglomerate Inter Media Group, controls several television channels.

There are, of course, differences between Akhmetov and Firtash. For one, Firtash is worth less than a billion dollars, in contrast to the monumentally rich Akhmetov. Furthermore, he works closely with partners in Russia whereas Akhmetov's business empire is more focused on Europe. But the two have divided the political playing field between them and they control their country's political scene as though it were a business joint venture. Key positions, whether in ministries or in parliament, are all occupied by their people. Yanukovych's economics minister, for example, came from Akhmetov's team while the deputy prime minister, in charge of natural gas issues, answered to Firtash. It is a loveless marriage of convenience, but it has held.

'Hard to Believe'

In the last parliamentary elections, Akhmatov filled roughly 60 spots on the Party of Regions list with his people while Firtash chose 30. That is how politics in Ukraine is done: Whereas Putin took power away from the oligarchs in Russia, they are still at the controls in Ukraine.

The pair came to the conclusion well before the current crisis that Yanukovych would not be around for much longer. They began carefully looking around for alternatives. Akhmetov, for example, had always gotten along well with Tymoshenko, in contrast with Firtash, and began supporting Arseniy Yatsenyuk, who took over the leadership of her Fatherland alliance when she was incarcerated. Firtash, for his part, backed Vitali Klitschko's party UDAR.

"In reality, Firtash early on placed people in Klitschko's UDAR Party, a former head of secret service, for example," says Vadim Karasev. "The contacts were made via the head of the presidential office."

"It may sound hard to believe," Karasev says, "but Firtash was looking for an alternative for the eventuality that Tymoshenko was released and claimed the right to the presidency. It would have been advantageous were Klitschko already there, as a puppet of Firtash."

That's how Akhmetov and Firtash built up options for a possible future without Yanukovych. When the protests broke out on Independence Square in November and both oligarchs saw how obstinately Yanukovych reacted, they began to distance themselves. It was clear to both of them that if worse comes to worst, and the West imposed sanctions on Ukraine, their businesses would be the first to be affected.

Akhmetov made it known that he was in favor of negotiations between the government and the opposition. Firtash also quickly called for a peaceful resolution of the conflict, emphasizing that people on both sides of the barricades were Ukrainians.

Letting Yanukovych Fall

Last Tuesday's bloody conflicts tipped the scales. On Wednesday both Akhmetov's and Firtash's TV stations changed their coverage of Independence Square: Suddenly the two channels, Ukraina and Inter, were reporting objectively on the opposition. The message of the oligarchs was clear: We're letting Yanukovych fall.

And in parliament -- where the majority party had barely budged a millimeter in the past weeks -- the mood suddenly changed: Suddenly they were looking for a compromise after all. It became clear on Thursday what this would mean: the forming of a broad coalition, the return of the old constitution and, with it, a reduction of the presidential powers as well as an accelerated presidential election.

Friday was a cheerful day, with bright blue skies. There was still sporadic gunfire but on Independence Square it was hard to believe that, just a few days earlier, people had been gunned down there.

Shortly after noon Yanukovych addressed the people as though he were still calling the shots. He declared that he would "initiate" new elections, constitutional reform and the formation of a new government with national support

Then, things began moving very fast. On Friday evening, parliament got back its full former powers, dismissed the hated interior minister and ultimately Yanukovych himself and smoothed the way for the release of Yulia Tymoshenko.