The case for keeping US interest rates low

Martin Wolf

After nearly seven years of zero interest rates, the inflation of which critics warned is invisible

©David Sparshott
How close is the US Federal Reserve to normalising monetary policy? This was the question addressed by Stanley Fischer, vice-chairman, at the Jackson Hole Symposium. So will the Fed raise interest rates this month? On that, I can only guess — and that guess is no. Another question is whether the Fed should raise rates this month. My answer to that is also no.
In itself a rise might seem unimportant. The Fed’s intervention rate has been 0.25 per cent since December 2008. One must doubt whether a jump to 0.5 per cent would be significant. After all, the Bank of England’s base rate has been 0.5 per cent throughout the crisis. This point is correct, but too limited.

Any increase would be significant: first, it would indicate the Fed’s belief that the policy can be “normalised” after almost seven years of post-crisis healing; second, it would indicate the beginning of a tightening cycle.

One of the reasons for believing the latter is that this is how the Fed has historically behaved: the last such cycle began with rates at 1 per cent in June 2004 and ended with rates at 5.25 per cent two years later.

Without doubt, beginning a tightening cycle for the first time in more than 11 years would be a significant moment. It would also signal more than an immediate rise in rates.

The likely destination and speed of travel are also enigmas because the US economy is not behaving normally. After nearly seven years of zero interest rates, the inflation of which critics warned is invisible. This is not normal.

For the same reason, the correct timing of that first tightening remains uncertain. Yes, US unemployment is down to 5.1 per cent. And, yes, the private sector has added 13.1m jobs over 66 months.
Martin Wolf 1

But core inflation is firmly under 2 per cent, inflation expectations are well under control and nominal gross domestic product is growing steadily at around 4 per cent. Little of this suggests an urgent need to tighten. An inflation-targeting central bank is not forced by the data to move now.

A broader perspective than this is needed, especially because any first tightening is so significant. A necessary condition for making this move is confidence that it will not need to be reversed in the near future. But it is impossible at present to have such confidence.

This is particularly important when interest rates are near zero. It would be desirable to move above this level to create room for manoeuvre in future. But, if the prospect of persistent tightening weakened the economy, the Fed might be forced back to the lower bound in worse circumstances. As Andy Haldane of the Bank of England has put it, “The act of raising the yield curve would itself increase the probability of recession.”
Martin Wolf 2
The decision on when to raise rates, then, has to be seen as one of risk management under asymmetric pay-offs: if the Fed is too late, inflation might rise; if the Fed is too early, it might diminish future room for manoeuvre. Given the strength of the dollar, which is likely to last, and recent market turmoil, the balance is clear: it is necessary to be more confident than now that the tightening cycle would prove sustainable.
In addition, the view that low real interest rates are a long-term feature of the world economy looks quite plausible. Events in China suggest the condition could even worsen. In fact, these ultra-low rates seem to be the lowest rates ever. Yet, if real rates and inflation remained so low, nominal interest rates would remain exceptionally low, too.
Martin Wolf 3
Some worry that low rates are somehow unnatural. Arguing in this vein, the author William Cohan insists that: “Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth.” But: money is not like any commodity. It is a state monopoly for whose creation the central bank is indeed responsible. The central bank does determine short-term rates.
Mr Cohan is not alone. Plenty of people have wanted tighter monetary policy for years, for one reason or another. Some focus on quantitative easing more than on low short-term rates, believing it is sure to lead to high inflation in the end. But belief that the expansion of central bank balance sheets ensures a surge in credit and spending is wrong. The presumed link between bank reserves and lending can be managed.

The most powerful central bank in the world is considering whether to raise its record-low interest rates for the first time in nearly a decade. Even before the US Federal Reserve makes a move, the effects are reverberating throughout the global economy. Our project explores how.

A more sophisticated view is that of the Bank for International Settlements. It believes that monetary policy should be targeted not at equilibrium in the real economy, but at equilibrium in the financial sector. Thus, one should be prepared to tolerate prolonged cyclical unemployment over the medium term, in order to prevent a build-up of damaging financial excesses over the longer term. This raises two big questions. First, does anybody know what monetary policy would stabilise our financial casino? Second, what is the point of a deregulated financial system that creates such profound dilemmas? It surely makes better sense to cage it, instead.
In sum, central banks should continue to focus on stabilising the real economy, though more needs to be done to curb financial excesses. Meanwhile, as an inflation-targeting central bank, the Fed has no strong reason to start a tightening cycle right now. And, when it does start, rates will not reach previous cyclical highs. Our world is not normal. Get used to it.

The West’s Refugee Crisis

What happens in the Middle East doesn’t stay in the Middle East.

A photograph of Syrian woman Rehan Kurdi holding her son Aylan is pictured next to a bouquet of flowers outside the home of Rehan's sister-in-law Tima Kurdi in Coquitlam, British Columbia September 3, 2015.
A photograph of Syrian woman Rehan Kurdi holding her son Aylan is pictured next to a bouquet of flowers outside the home of Rehan's sister-in-law Tima Kurdi in Coquitlam, British Columbia September 3, 2015. Photo: Reuters

The photograph of 3-year-old Aylan Kurdi, who drowned trying to flee to Greece with his brother and mother, has focused the world on Europe’s Middle Eastern refugee crisis.

Demands for compassion are easy, but it’s also important to understand how Europe—and the U.S.—got here. This is what the world looks like when the West abandons its responsibility to maintain world order.

The refugees are fleeing horror shows across North Africa and the Middle East, but especially the Syrian civil war that is now into its fifth year. Committed to withdrawing from the region, President Obama chose to do almost nothing. Europe, which has a longer Middle Eastern history than America and is closer, chose not to fill the U.S. vacuum.

The result has been the worst human catastrophe of the 21st-century. What began as an Arab Spring uprising against Bashar Assad has become a civil war that grows ever-more virulent. Radical Islamic factions have multiplied and Islamic State found a haven from which to grow and expand. More than 210,000 Syrians have been killed, and millions have been displaced inside the country or in camps in neighboring countries.


The conceit has been that while all of this is tragic, the Middle East has to work out its own pathologies and what happens there will be contained there. But by now we know that what happens in Damascus doesn’t stay in Damascus. First came the terrorist exports, recruited by Islamic State and sent back to bomb and murder in Paris and on trains. Now come the refugees, willing to risk their lives fleeing chaos on the chance of a safe haven in Europe.

The lesson is that while intervention has risks, so does abdication. The difference is that at least intervention gives the West the opportunity to shape events, often for the better, rather than merely cope with the consequences of doing nothing. As difficult as the war in Iraq was, by 2008 the insurgency was defeated and Iraqis were returning to Baghdad. Only after Mr. Obama withdrew entirely from Iraq and ignored Syria did Iraq deteriorate again and Islamic State advance.

Europeans who dislike an America they think is overbearing should note what happens when the world’s policeman decides to take a vacation and let the neighbors fend for themselves. In the modern world of instant communications and easy transportation, the world’s problems will wash up on the wealthy West’s shores one way or another. If Europe isn’t prepared to handle nearby crises, militarily if necessary, be prepared to accept the refugees.

On that latter point, Europeans are by and large generous people who want to help refugees.

German Chancellor Angela Merkel has shown leadership in accepting refugees in her country and trying to work out a plan to propose a quota system for the rest of Europe to apportion the asylum claims now besieging the front-line states of Greece, Hungary and Italy. Germany is expected to take 800,000 this year.

Aylan Kurdi’s death might also finally shame more governments into action. Prime Minister David Cameron announced on Monday that Britain is abandoning its refusal to bear a heavier load and will resettle up to 20,000 over the next five years. One good idea would be to open processing centers closer to where the refugees start their journeys. But without a clear commitment from states to accept more, the temptation of asylum seekers to resort to human traffickers will remain great.

Yet it’s also true that years of bad economic and fiscal policy mean that Europe is now far less able to cope with refugees than many assume. Europe is unable to police its maritime borders effectively, which is why so many human smugglers are using Mediterranean routes. That’s a function of its long-term underinvestment in naval and coast-guard assets. Collective European spending on defense amounted to some $250 billion in 2014, a $7 billion decline from a year earlier, and it’s going down year after year.

Absorbing refugees also requires a robust economy that Europe hasn’t had in years. Most refugees want to go to Germany, but even Germany is growing at a mere 1.6% annual rate.

Unemployment looks low (4.7%) but the labor force participation rate is very low, about 60%, according to World Bank figures. For the rest of Europe, the ability to absorb a refugee influx is even worse.

Without economic reform to produce a growth economy, migration on the current scale is going to strain Europe’s welfare state and further encourage the rise of extreme anti-immigration parties like the National Front in France, Golden Dawn in Greece, Jobbik in Hungary and the Pegida movement in Germany. It will also begin to threaten such pillars of the modern European Union as its Schengen policy that allows passport-free travel and migration. Schengen has been a crucial economic safety valve that allows young people in particular to move for economic opportunity when their native country is in recession.


All of which underscores that the migration crisis is far more than a humanitarian issue. By all means Europe needs to do more to end the immediate human suffering. So does the U.S., which could in particular accept Syrian Christians who are targeted for extinction by Islamists.

But the larger problem is the retreat by Europe and America from promoting, and if necessary enforcing, a world order built on Western ideals. The migration crisis shows that this failure will eventually compromise Western ideals at home as well as abroad. 

Midweek Briefing -- The U.S. Dollar: A Safe Heaven in Perception Only

Dear OI Reader,

Jim Rogers just made a few heads spin.

In a recent interview, he said in no uncertain terms that the U.S. dollar is no safe heaven.

Then, in the same interview, he also made very clear that his LARGEST investment position is being long the U.S. dollar.

However, while Rogers seems to be contradicting himself, there is a method to his madness. Today we’ll take a look at Rogers’ latest move, and a look at the bigger picture shaping up in the U.S. dollar.

Here’s the story…

Fools Float the Dollar

Jim believes that there is more turmoil coming for global financial markets. As that happens, Rogers expects investors to continue to flee to what they think is a safe haven… that being the U.S. dollar.

What Rogers is doing can only be classified as a trade, not an investment.

An investment is based on sound underlying fundamentals. You make an investment because you believe the market has mispriced the value of a particular asset and believe that eventually price and value will coincide.

A trade is based on playing the greater fool theory. Rogers owns the U.S. dollar because he believe its future price is not going to be determined by its true intrinsic value, but rather by the misplaced belief of market participants (great fools) who think it is a safe haven.

I expect that he is probably right and the U.S. dollar will at some point in the near future be stronger than it is today. I also believe that at some point this party is going to end.

The Reaction to a Yuan Devaluation -- Much Ado About Very Little

The Chinese “devaluation” rattled global markets in August. I’m afraid I don’t see this move as being nearly as dramatic as the market has taken it to be or the media made it out to be.

For some context on the size of this Chinese “devaluation,” have a look at the graph below. Next to the movements of virtually every other currency in the world, the weakening of the yuan looks pretty minor.

Global Currencies vs. the U.S. Dollar

Global Currencies vs. the U.S. Dollar

Source of image: Oanda

Over the past two years, the yuan has weakened against the dollar by 3.28%.

The Japanese yen has dropped 20.73%.

The euro is down 18.36%.

My Canadian loonie has slid 27.73%.

The Australian buck has declined 31.32%.

Those moves are in the currencies of the most stable countries. Within the BRIC, nations, the Brazilian real is down 62.1% against the dollar and the ruble is down 102.53%.

Given how virtually every other nation has had its goods and services go dramatically on sale over the past year and a half, is it any wonder that China got tired of being at a competitive disadvantage?

Therefore, I don’t view China allowing the yuan to weaken modestly as a reason to start running around with my head cut off. Is China’s economic growth slowing? I think most definitely, and that is why China is trying to reduce the competitive disadvantage that was created by its currency not devaluing at all while most others did in a major way.

China’s currency move wasn’t motivated by the yuan’s relationship with the dollar. It was motivated by the yuan’s relationship with all of the other currencies.
What Could Ultimately Be the Undoing of the Mighty Dollar?

The relationship between the strength of the dollar and the prices of commodities could not be clearer.

U.S. Dollar vs. Commodities

U.S. Dollar vs. Commodities

Source: StockCharts

The chart above shows how from September 2012-June 2014, the U.S. dollar index (black) didn’t move around much, and neither did the S&P total commodity index (blue). Then when the dollar went on its tear starting midsummer last year, the bottom fell out of commodities.

For every 1% the dollar strengthens, the prices of commodities seem to drop two-three times as much.

I don’t pretend to fully understand this relationship. Do commodities react to the dollar directly? Or does the dollar react to the fundamental supply and demand factors that influence commodity prices?

Perhaps it is a bit of both.

I suspect that when the incredible strength of the dollar reverses, it is going to do good things for the price of “stuff.” And like Jim Rogers, I do believe that the dollar will reverse course… I just don’t know when.

As Rogers observes, the U.S. dollar is no safe haven. The United States is the largest debtor nation in the world. In fact, despite having significant exposure to it, Rogers describes the dollar as a “flawed” currency. The only thing that is supporting it is that current perception that the dollar is a safe haven.

That sounds like the definition of a bubble.

In 1999, most everyone with any stock market experience knew that technology stocks were incredibly expensive relative to the actual earnings (assuming they had earnings) that these companies could generate. Yet people kept buying them simply because of the perception that they would continue going up.

Just like the U.S. dollar today.

Those technology stocks kept going up until they didn’t. And then they crashed because there were no underlying fundamentals to support anything close to their stock prices.

In 2007, it was not hard to be aware of the fact that U.S. house prices had become completely unhinged from historical norms in relation to average family incomes. Yet people kept buying them, because it was assumed that housing prices would never crash.

That party ended too. Badly.

The ultimate cause of the undoing of the dollar may ultimately come from the rapidly transforming oil market.

For decades, the U.S. has been the most important customer for the world’s major oil-exporting nations. Truly, this is the basis of today’s “petrodollar” -- a multi decade dollars-for-oil relationship between the U.S. and the Middle East.

Now with U.S. oil production having soared and long-term demand growth likely to be nonexistent, America’s importance to those major oil producers has diminished.

The important future customers for oil exporters are found in the fast-growing and highly populated Asian nations. These are the countries that are going to be thirsty for oil in the coming decades and provide the market for exporting nations.

Since that is the case, the need for the Saudis and other exporters to have their oil priced in U.S. dollars has diminished greatly.

It doesn’t take a rocket scientist to figure out what happens to demand for U.S. dollars if the Saudis start accepting Chinese yuan in exchange for their exports. And you can bet that Russia (the other major exporter) would enjoy nothing more than reducing the U.S. importance in the oil and financial markets.

Next month, China is expected to launch its own global crude oil contract that will NOT be priced in U.S. dollars… it will be priced in yuan. All of a sudden, the idea that the U.S. dollar could be bypassed in oil market transactions seems very real. Indeed, this could be the end of the petrodollar as we know it.

The U.S. dollar will remain strong until it isn’t. The timing on that is unknown, but markets can change much faster than expected.

Keep looking through the windshield,

China Confronts the Market

Jeffrey Frankel

chinas leadership

CAMBRIDGE – China’s current economic woes have largely been viewed through a single lens: the government’s failure to let the market operate. But that perspective has led foreign observers to misinterpret some of this year’s most important developments in the foreign-exchange and stock markets.
To be sure, Chinese authorities do intervene strongly in various ways. From 2004 to 2013, the People’s Bank of China (PBOC) bought trillions of dollars in foreign-exchange reserves, thereby preventing the renminbi from appreciating as much as it would have had it floated freely. More recently, the authorities have been deploying every piece of policy artillery they can muster in a vain attempt to moderate this summer’s plunge in equity prices.
But some important developments that foreigners decry as the result of government intervention are in fact the opposite. Exhibit A is the August 11 devaluation of the renminbi against the dollar – a move that invoked for US politicians the old adage, “Be careful what you wish for.” The devaluation – by a mere 3%, it should be noted – reflected a change in PBOC policy intended to give the market more influence over the exchange rate. Previously, the PBOC allowed the renminbi’s value to fluctuate each day within a 2% band, but did not routinely allow the movements to cumulate from one day to the next. Now, each day’s closing exchange rate will influence the following day’s rate, implying adjustment toward market levels.
The authorities probably would not have moved when they did had it not been for growing market pressure for a depreciation that could help counteract weakening economic growth. In fact, bolstering growth might have been the primary motivation for the country’s political leaders, even as the PBOC remained focused on advancing the longer-term objective of strengthening the market’s role in determining the exchange rate.
But the two motivations are consistent: market forces would not be placing downward pressure on the renminbi if China’s economic fundamentals did not warrant it. The American politicians who demanded that China float its currency may have anticipated a different outcome – somewhat unreasonably, given that market forces reversed direction in mid-2014 – but one can hardly blame the Chinese for taking them at their word.
To be sure, China remains far from embracing a free-floating currency, let alone a fully convertible one, which would require further liberalization of controls on cross-border financial flows.
Unification of onshore and offshore markets is more important than a floating exchange rate in determining whether the International Monetary Fund will include the renminbi in the basket of currencies used to determine the value of its reserve asset, the Special Drawing Right. Much commentary on the subject has underestimated the importance of the criterion that the currency be “freely usable.”
Nonetheless, many are fretting that China’s exchange-rate adjustment has triggered a “currency war,” with other emerging economies devaluing as well. But, more than a year after the economic fundamentals swung against emerging markets (and especially away from commodities) and toward the United States, this adjustment was due. Though the Chinese move likely influenced the timing, other devaluations would have inevitably taken place. Warnings about competitive devaluations are misleading.
Exhibit B in the case against attributing financial developments in China to government intervention is the stock-market bubble that culminated in June. According to the conventional wisdom, the authorities consistently intervened not only to try to boost the market after the collapse, but also during its year-long run-up, when the Shanghai Stock Exchange composite index more than doubled. The finger-wagging implication is that Chinese policymakers, particularly the stock-market regulator, have only themselves to blame for the bubble.
There is undoubtedly some truth to this story. It seems clear that the extraordinary run-up in equity prices was fueled by a surge in margin financing of stock purchases, which was legalized in 2010-2011 and encouraged by the PBOC’s monetary easing since last November. Likewise, there was plenty of support for the bull market in government-sponsored news media, for example.
But what many commentators fail to note is that China’s regulatory authorities took action to try to dampen prices over the last six months of the run-up. They tightened margin requirements in January, and again in April, when they also facilitated short-selling by expanding the number of eligible stocks. The event that ultimately seems to have pricked the bubble was the China Securities Regulatory Commission’s June 12 announcement of plans to limit the amount that brokerages could lend for stock trading.
This is precisely the kind of counter-cyclical macroprudential policy that economists often recommend. But, whereas advanced economies rarely implement this advice, China and many other developing countries do tend to adjust regulation, including reserve requirements for banks and ceilings on homebuyers’ borrowing, counter-cyclically.
One could criticize the Chinese regulator on the grounds that the effect of its moves to increase margin requirements did not last long; or one could criticize it on the grounds that its moves caused the recent crash. But, either way, these measures were intended to stem the rise in market prices, rather than to contribute to it.
This is not a trivial point. Nor is the fact that the PBOC’s interventions in the foreign-exchange market over the last year have aimed to dampen the renminbi’s depreciation, not add to it.

Given this, it is facile to blame China’s problems on government intervention.

The deadly disunity of the Europeans

Wolfgang Münchau

A quota system is too crude and politically as unsustainable as fiscal transfers among countries

Europe’s multiple crises share a common theme. Whether we are talking about banks, sovereign debt or, as now is the case, refugees, the EU finds it hard to act. What we have is a classic collective action problem, of the kind described by Mancur Olson, the political economist, in the 1960s. People have a common interest in acting but fail to do so because vested interests get in the way. Even the harrowing pictures of the dead young boy will not resolve the collective action problem. All it will do is to produce visible hyperactivity.

The three crises share another common theme: each one of them is virtually intractable if you look at it from a micro perspective, from the vantage point of a Greek bank or Budapest East train station. But if you look at immigration from an EU-level perspective, the picture is much more nuanced.
The EU has 500m inhabitants. Setting aside refugees, net immigration — the difference between those coming into and those leaving the EU — was 539,000 in 2013, about 0.1 per cent of the total population. Net immigration was higher in 2010, when it stood at 750,000.
The UN refugee agency (UNHCR) puts the number of refugees and migrants who crossed the Mediterranean at 300,000 between January and August, compared with 219,000 for the whole of 2014. If you extrapolate this year’s number to the whole of 2015, you get to around 450,000, an extra 230,000 people compared with last year.
These numbers do not capture the whole story: many immigrants, from Syria in particular, use land routes. Net immigration this year may thus well end up being the highest in recent years, but still tiny compared with the EU’s total population. Net immigration including refugees is clearly rising. Still, this is not an immigration crisis. It is a collective action crisis.

Its solution would be straightforward in the presence of a central authority empowered to take decisions. But this is not how the EU works. It works through co-ordination and harmonisation — through fiscal rules, banking regulation and neighbourhood policies. But none of them prevented the crisis, and none of them helps solve it. The problem was never a lack of rules or policies. It was the simple fact that certain things in life cannot just be co-ordinated.

Nor are member states big enough to act on their own — not even Germany. Angela Merkel is, for once, on the right side of the argument. But Germany does not have the capacity to absorb all the EU immigrants. Viktor Orban, Hungary’s populist prime minister, produced a good rendition of the mindset that gives rise to collective action problems. He said last week this was not a European crisis, but a German crisis, since all the refugees wanted to go to Germany.

Germany, I would add, acted in a similarly cavalier fashion during the eurozone crises.

The collective action problem is nobody’s fault in particular. It is hard-wired into the system. The EU’s job is not to prevent financial crises, or to save children from drowning in the Mediterranean Sea. Its job is to run market integration programmes, or negotiate complicated trade agreements.

When there is a crisis outside its narrow reservation, its instinct is to forge a political compromise. This is how we ended up with the rescue umbrella for the eurozone, and an ineffective bank resolution regime. The proposed quota system for immigrants is drawn up in the same spirit.

Angel Ubide from the Peterson Institution in Washington attributes the failure of the eurozone’s banking union to a primacy of co-ordination over mutualisation. I think this gets to the core of the problem. Instead of mutualising, or sharing, risks, EU member states only share procedures and follow common rules. But the risks remain within member states. There are many areas where this approach is pragmatic and sensible. A sudden spike in immigration is not one of them. A quota system is far too crude, and politically as unsustainable as fiscal transfers between countries. Such policies breed resentment, and ultimately fail. In a quota system you do not kick cans down the road, but people.

The real alternative, in the long run, is not between co-ordination and mutualisation, but between separation and mutualisation. Those who support further European integration will be in a position to make a powerful argument that only the EU is in a position to solve the crises. The debate will not be about a transfer of power from the capitals to Brussels. It will be about whether we empower the EU with tasks that nobody else can handle and whether we give it the necessary financial resources.

I fear this is not going to happen for a long time — for two reasons. The less important one is that the likes of Mr Orban will be among those to take the decision. The deeper reason is that Europeans are not yet desperate enough to accept the Logic of Collective Action, the title of Olson’s 1965 book.

Yields vs Stocks and The Fed

By: Ashraf Laidi
US Flag Change in Nonfarm Payrolls (AUG)
173K217K245KSep 04 12:30
US Flag Change in Manufacturing Payrolls (AUG)
-17K5K12KSep 04 12:30
US Flag Change in Private Payrolls (AUG)
140K204K224KSep 04 12:30
US Flag Unemployment Rate (AUG)
5.1%5.2%5.3%Sep 04 12:30
US Flag Average Hourly Earnings (AUG) (m/m)
0.3%0.2%0.2%Sep 04 12:30
US Flag Average Hourly Earnings (AUG) (y/y)
2.2%2.1%2.2%Sep 04 12:30
The widely anticipated US August jobs report headlined with a disappointing 173k increase in nonfarm payrolls (lowest since March). The silver lining was in the 44k upward revision of the previous two months and the decline in the unemployment rate to fresh seven-year lows of 5.1% from 5.3%. The decline 41K decrease in the labour force was too small to reduce the participation rate, which remained unchanged at 62.6%.

Average hourly earnings rose by a 5-month high of 0.3% m/m and 2.2% y/y in August. Both series are above their 3-month average, but they remain far below their 2007 highs of 0.6% m/m and 4.0% y/y. Some economists deem the rates as disappointing given the notable increases in minimum wages.

Are both the establishment and household surveys strong enough? Fed hawks require continued evidence of tightening labour markets at a time when the inflation mandate remains undershot. The evidence was obtained in the unemployment rate but not in non-farm payrolls.

Renewed decline in energy prices will further drive inflation below the Fed's goal while jobs continue to offer low-paying employment.

Don't forget the Fed's other goal

Aside from the Fed's goal price stability and maximum employment, its3rd goal is to preserve financial system stability. A 10% decline in most US indices off their highs is no tragedy, neither is a 16% decline in Germany's Dax-30 or a 26% plunge in the Hang Seng Index. But tightening of financial market conditions becomes an issue when the borrowing environment becomes treacherous. We're not only talking about energy debtors, but all-sector high yield debt, which is at its worst measure since 2011 when using 10-year junk spread.

Asian corporate spread is also on the rise. After reaching 8-month highs back in January, Asian spreads are back up near 7-month highs. USD-based debt gone turned highly expensive is part of the problem. Relying on demand from a slowing China is another.

Fed's 1998 Backtrack

For those who claim the Fed is and should be focused on domestic issues and ignore China, think again.

In spring 1998, the Fed was mulling a rate hike as US GDP growth was at 14-year high s and CPI was stabilizing. But as the 1997 emerging market route spiralled into a crisis from Brazil to Russia and Hong Kong in 1998, the Fed was forced to cut rates in Sep, Oct and Nov of that year.

The collapse of LTCM also helped. Today, US growth remains subpar and the exogenous risks are considerable.

SPX and SPX?10-Year Yield Ratio Chart

Back in the US, financial market stability is not exactly an ocean of calmness. But the rise in high-yield spreads and escalation in the VIX will grow more notable.

Finally, the uncharacteristically high level of US 10-year yields relative to the recent declines in US equity indices raises the following question: "If China were not selling treasuries to prevent CNY declines, then how low could yields be?" And if stocks continue to plummet (expect another 7% from today's close in US indices), then the relative relationship between indices and yields should reveal less tightening.

The above chart highlights the declining SPX/Yields ratio, suggesting that it's a matter of time before yields catch-down with stocks, regardless of whether the Fed raises rates or not. Earlier in the year, stocks were seen as too high relative to yields. Things have changed, but this too, will be temporary.

Russia flirts with Saudi Arabia as OPEC pain deepens

Kremlin energy tsar says OPEC may have to ditch its low-price policy within months. But Russia needs to cut output quietly too

By Ambrose Evans-Pritchard, Cernobbio, Italy

A company handout photograph shows the oil production platform at the Sakhalin-I field in Russia, partly owned by ONGC Videsh Ltd., Rosneft Oil Co., Exxon Mobil Corp. and Japan's Sakhalin Oil and Gas Development Co

Gazprom's revenues are likely to drop by almost a third to $106bn this year Photo: Bloomberg News
The OPEC oil cartel cannot withstand the pain of low crude prices indefinitely and may be forced to abandon its pugnacious bid for market share within months, Russia's chief energy official has predicted.

Arkady Dvorkovich, the deputy prime minister, said OPEC producers are suffering the ricochet effects of their attempt to flush out rivals by flooding the world with excess output.
"I don't think they really want to live with low oil prices for a long time. At some point it is likely that are going to have to change policy. They can last a few months, to a couple of years," he told The Telegraph.
Saudi Arabia took a fateful decision last November to crank up production to record levels despite a glut of 1-2m barrels a day (b\d) accumulating in global markets, hoping to halt the advance of US shale and kill off high-cost projects in the Arctic and deep off-shore waters.
Opec newWorkers adjust a valve of an oil pipe as smoke rises from burning excess gas in Zubair oilfield in Basra  Photo: REUTERS

Riyadh has made it clear that it will not cut output to shore up prices unless non-OPEC producers share of the burden. This essentially means Russia, the world's biggest producer.

Mr Dvorkovich, the head of Russia's economic and energy strategy, said his country was in constant talks with OPEC in order to bring about a "more rational policy" but was coy on whether the Kremlin would break the impasse and strike a deal with the Saudis.

"Our consultations do not imply directly that we are going to see any coordinated action. Perhaps 'yes', perhaps 'no', most likely 'no'," he said, speaking at the Ambrosetti forum of world policy-makers on Lake Como. "We are sending signals to each other."

Russia insists that it cannot switch off output as easily as the Saudis, given the harsh weather in the Siberian fields, a claim dismissed by OPEC as a negotiating ploy.
Nor can the Kremlin order Russian drillers to slash production without under-cutting its insistence that these oil groups are genuine companies, answerable to their shareholders. Yet there are subtle ways of achieving the same outcome.

Russian secret service 'murdered six Red Cross nurses' The Kremlin, Moscow  Photo: CORBIS

The head of Russia's oil giant Rosneft, Igor Sechin, has been the right-hand man of president Vladimir Putin for more than twenty years. The company is 70pc state-owned. "If Putin wants to cut, of course he can do it. Everybody knows that, " said one OPEC veteran.

Mr Dvorkovich hinted that output cuts could be on the way. "We are not going to cut supply artificially. Oil companies will act on their own. They will look at market forces and decide whether to invest more or less," he said.

"If prices stay low it is in the nature of oil companies to stabilise production, or even to cut production. The government will not decide on the behalf of oil companies what to do," he said.
Adnan Shihab-Eldin, the former secretary-general of OPEC, said the oil cartel is in "bad shape" and may have to rethink its current strategy. "Can OPEC really afford to the policy started in November of letting the market determine prices," said at the Ambrosetti forum.

Mr Shihab-Eldin said US shale drillers have proved remarkably resilient, slashing costs from $70 a barrel to nearer $50 through new technology and a switch to higher-yielding "sweet spots". The rig-count has halved but production has hardly fallen.

He said OPEC will make a hard-headed decision over how best to extract maximum revenue, ditching its current policy if it does not pay. "Keeping market share at any price is not an ideology for OPEC," he said.

Russia is in deep crisis. The economy has contracted by 4.6pc over the last year. The rouble has halved against the dollar since mid-2014, falling pari passu with the price of Brent crude. While this provides a shock-absorber of sorts, it makes life much harder for Russian firms struggling to repay $12-15bn a quarter in external dollar debt.

These companies are largely shut out of global capital markets by Western sanctions, forcing them to rely heavily on the Russian state for dollar liquidity. Yet the central bank is trying to conserve its foreign reserves. The treasury itself failed to sell all its bonds at an auction last month.

Russia's strategic embrace with China has so far failed to produce much beyond warm words.

A $400bn gas deal signed in May 2014 has run into trouble as the Chinese haggle hard over prices and stall on $55bn of financing for the construction projects. Hopes for a second pipeline to China from West Siberia have come to little.

An informal 'super-OPEC' with Russia would control roughly 45pc of the global oil market, roughly equal to OPEC's glory days in the 1970s. Industry experts say the Saudis might consider a deal if Russia offered a gentleman's agreement to trim its 10.7m b\d output by 500,000.

Eventually, this may happen by default. The main Russian wells in Western Siberia are Soviet vintage and depleting at a rate of 8-11pc a year. Sanctions have paralyzed new investments in the Arctic and the Bazhenov shale basin.

Saudi Arabia is also in some trouble, and lacks Russia's industrial depth and strategic strengths. Riyadh's foreign reserves have fallen to $661bn from $737bn over the last eleven months.

The Saudis still have an ample cushion but are running a budget deficit of 20pc of GDP to cover their social welfare spending and military expansion. They must either drain reserves at a pace of $12bn a month, or issue debt.

One foreign policy veteran said it is mystifying what the Saudis really intend to do under the new regime of King Salman. "They have gone from being the most predictable of countries, to the most unpredictable," he said.

The Russians and the Saudis have powerful reasons to co-operate on energy policies. Until now they have been on opposing sides in Syria, poisoning everything. This may be changing. King Salman has been invited to visit Moscow as the thaw in relations deepens.

Mr Putin is building up Russia's troop presence in Syria but he has also sent shockwaves through Damascus by backing some form of "power-sharing" in the country, a sign that Bashar al-Assad's days may be numbered.

The contours of a realpolitik entente between Saudi Arabia and Russia are emerging, with major implications for the global oil markets and the world economy.

Mr Dvorkovich said the Kremlin would stand behind its long-standing ally for now. "There are many people who still support Assad, We're not going to put anyone aside, except the terrorists," he said.

Father of the euro fears EU superstate by the back door

Professor Otmar Issing has warned against handing over control of tax and spending before a democratic political union has been established

By Ambrose Evans-Pritchard, Cernobbio, Italy

8:59PM BST 06 Sep 2015

Otmar Issing, member of the executive board of the European Central Bank

Otmar Issing believes Germany would be better off staying in the euro Photo: AFP

The euro’s founding father has warned that Europe’s latest plan for an EMU-wide finance ministry is a dangerous attempt to smuggle through political union, and breaches the basic tenets of modern democracy.

Professor Otmar Issing, the chief architect of monetary union through its early years, said it would be “dangerous” to transfer control over tax and spending to the EU federal level before full political union has been established first on democratic foundations.
Such a quantum leap in the constitutional structure of Europe – effectively the creation of an EU superstate, with a parliament comparable in power to the US Congress – is unthinkable in the current political atmosphere.
It would require referenda across Europe, and a two-thirds majority in both houses of the German parliament. “The chances of political union are close to zero,” he said, speaking at the Ambrosetti forum of world policymakers on Lake Como.
If Europe were to jump the gun and force the pace of integration, this would lead to a rogue plenipotentiary with unbridled powers over sensitive issues of national life. “It is hard to see how it could be given democratic accountability,” he said.
Prof Issing, a towering figure in the pre-EMU Bundesbank and the European Central Bank’s first chief economist, said control of budgets must for now be left to national government and sovereign parliaments that are genuinely answerable to their own peoples. “Political union cannot be obtained in the European Union by the back door. It is a violation of the principle of no taxation without representation, and represents a wrong and dangerous approach,” he said.

Prof Issing is a towering figure in the pre-EMU Bundesbank
Prof Issing is a towering figure in the pre-EMU Bundesbank  Photo: Reuters

Prof Issing was making a clear allusion to the American Revolution and the events that led up to the English Civil War in the 1640s, two great struggles triggered by a monarchical assault on the parliamentary power of the purse. The early democracies of Europe were all rooted in legislative control over spending.

The proposals for an EMU finance ministry emerged in a paper by the heads of the Commission, Council, Parliament, Eurogroup, and ECB in June, a document known as the “Five Presidents Report”.

It will start with an advisory European fiscal board and a strategic investment fund with enhanced powers, clearly a finance ministry in embryo. It will graduate towards a “euro area Treasury” from 2017 onwards, anchored in the EU treaties.

The report says that the new machinery will be established on a “lasting, fair and democratically legitimate basis”, and is in many ways a soul-searching admission that the EMU project has gone badly wrong, leading to bitter divisions.

Yet critics warn that the EU is once again putting the cart before the horse. They point to the same fundamental errors that have led to perma-crisis in monetary union and spawned populist revolts across much of the EU.

Prof Issing has always been open to an authentic United States of Europe similar to the US federal democracy. What he objects to is a deformed halfway house where supra-national bodies take decisions behind closed doors.

The euro may survive “for a period” under its current structure, but it will break apart if the principles of monetary union are permanently violated. “Pacta sunt servanda (Agreements must be kept),” said Prof Issing.

Delivering on the Promise of 2025

Keynote Address by Christine Lagarde
Managing Director, International Monetary Fund
W-20 Summit

September 6, 2015, Ankara, Turkey


Good morning–Günaydin [Gew-nahy-din].

Thank you, Dr. Türktan, for your generous introduction.

[Mr. President / Mr. Prime Minister,] Mr. Deputy Prime Minister, Madam Ambassador: I am delighted to be here for this inaugural gathering of the Women’s 20—the W-20.

Today’s launch is timely. At their summit meeting last November, the G-20 pledged to reduce the gap in women’s labor force participation by 25 percent by the year 2025—which would have the benefit of creating an estimated 100 million new jobs for the global economy.

That was The Promise of 2025. Today, I want to focus on how to deliver on that promise.

Certainly, it represents a major challenge. But with so much attention focused on gender equity—by the post-2015 Sustainable Development Goals this year, and by the G-20’s pledge from last year—we clearly have a unique moment of opportunity.

We must seize it.

Why the 2025 Promise Matters

By the latest estimate, there are more than 3½ billion reasons why gender equity matters. And if those are not enough, let us reflect a little more why this issue is so important.

As I have said many times before, women’s empowerment is not just a fundamentally moral cause, it is also an absolute economic no-brainer. What do I mean by that?

First, we know that empowering women boosts economic growth. For example, we have estimates that, if the number of female workers were to increase to the same level as the number of men, GDP in the United States would expand by 5 percent, by 9 percent in Japan, and by 27 percent in India.1

These estimates, while of course tentative, are significant and large enough to be taken seriously. This applies particularly to countries where potential growth is declining as the population is ageing.

Second, getting more women into secure and well-paid jobs raises overall per capita income. For Turkey, it has been estimated that gender parity in employment could increase per capita income by 22 percent.2 The same kind of gains are also possible for many other countries.

Third, greater gender equality not only raises absolute income, it also helps to reduce income inequality. A forthcoming paper by our staff examines this relationship by comparing a so-called Gender Inequality Index to measured income inequality. The results have been quite striking—it suggests that a boost to education and employment chances for women could lead to improvements in income equality of a magnitude that historically took decades to achieve.

And forth, female empowerment can reduce poverty. The Food and Agriculture Organization, for example, has estimated that giving women the same access to farming resources as men could increase agricultural output in developing countries by up to 4 percent—lifting over 100 million people out of hunger.3

So, to sum up, boosting growth, raising overall incomes, reducing inequality, and tackling poverty: that is why the promise of 2025 is so important.


We all recognize, however, that setting a goal and achieving it are two very different propositions. To deliver, we need decisive, sustained, and collective action.

This is where the W-20 can make a difference: reminding the G-20 of their commitment—and holding them to account.

The IMF supports this effort. In recent years, as you may know, we have strengthened our work on the macroeconomic effects of gender gaps.

This has included new research, for example, on women’s role in the economy and legal barriers to female participation. Perhaps even more importantly, we are now looking to apply this research in our policy advice to our member countries.

So the IMF stands with the W-20. On which key policy areas should we focus to help deliver on the G20 promise?

Three Key Policy Areas for Women’s Economic Empowerment

Over the course of a woman’s life, there are numerous opportunities to support her empowerment. I will highlight three critical junctures:

•Going to school—education;

•Getting a job—working; and

•Having a family.

Let me touch on each one:

1. Education

Turning first to school, let me begin by quoting Aung San Suu Kyi:

“The education and empowerment of women throughout the world cannot fail to result in a more caring, tolerant, just and peaceful life for all.”

Indeed, opportunities in the classroom have ramifications that are wide-reaching and long-lasting.

At an individual level, for instance, we know that one extra year of primary school boosts a woman’s earning potential by 10 to 20 percent. One extra year of secondary school boosts her earning potential by 25 percent.4

At a country level, Turkey’s own experience with girls’ education is instructive. The proportion of Turkish women with graduate degrees who have jobs is very high—it exceeds 70 percent. At the opposite end of the scale, however—where there is illiteracy—just 17 percent of women can find work.5 Indeed, it is estimated that adding one year of preschool education in Turkey could increase female labor force participation by 9 percent.6

The message is clear: girls’ education is probably the single best investment a country can make.

Beyond investment in education per se, there are other ways to boost schooling of girls. Social programs such as cash transfers to poor families can be made conditional on their daughters’ school attendance—as is the case in Bangladesh and Cambodia.7 And strengthening infrastructure—such as roads and sanitation—makes it easier for girls to get to school. A comprehensive approach is required.

The good news is that gender gaps in education are narrowing in many countries. In too many countries, however, they remain significant—including in many emerging markets and developing countries.

If the promise of 2025 is to be met, those education gaps must be closed.

2. Employment

What about the second major policy area: employment?

After receiving an education, a common life event for most women is getting a job. And while having a good education certainly helps women enter the workforce, it is by no means a guarantee of employment.

A number of countries with highly educated women still have low levels of female labor force participation. For example, it is a well-known challenge in Japan.

Japanese women who are currently in their early-30s typically have more than 14 years of schooling behind them—second only to women from New Zealand.8 Moreover, Japanese women on average have completed more years of education than their male counterparts.9 Despite this, the gender gap in labor force participation in Japan stands at 25 percentage points—compared to just over 10 percentage points on average in major advanced economies.10

So yes, education is essential—but it is part of a larger package. What else is needed to help women find work?

First, removing legal barriers is vital. These include obstacles that prevent women from everyday activities—such as opening a bank account and having equal property rights.

Recent IMF research noted that almost 90 percent of countries have at least one important legal restriction that makes it difficult for women to work.11 In half of the countries we studied, when gender equity was constitutionally granted, female labor force participation increased by at least 5 percent over the following 5 years.

The second barrier is women’s pay. Even with the same level of education, and in the same occupation, women earn just three-quarters of what men earn.12 This is by itself a great disincentive for being part of the workforce.

Third, infrastructure can be an obstacle. Without access to basic transport or energy sources, women find it very difficult to work outside the home. In rural South Africa, for example, electrification increased female labor force participation by 9 percent.13

And fourth, there is unequal access to finance. In emerging and developing countries, 70 percent of female-owned small and medium-sized enterprises are either unserved or under-served by financial institutions.14

Increasing financial inclusion for women is an issue that I plan to emphasize at the UN Summit on the Post-2015 Development Agenda later this month. It is crucial to delivering on the 2025 objective.

3. Family

So too is the third broad policy area—which revolves around the special role that women play in family life. As a practical matter, what can be done here?

For one thing, paid parental leave helps to maintain a woman’s connection to the labor market.

Japan, for example, is making significant strides in this area. The government has expanded childcare leave benefits from 50 percent to 67 percent of salary.15 Employers are increasingly playing their part as well—for example, the paternity leave participation rate in one well-known Japanese insurance company reached 100 percent this year.16

This raises a salient point: men—not only as partners, but also as fathers, sons, and brothers—have an important stake in empowering women. Not only does this help their partners, daughters, mothers and sisters to achieve their potential, it also helps build a stronger society for all.

As Amartya Sen put it:

“Women are increasingly seen, by men as well as women, as active agents of change: the dynamic promoters of social transformations that can alter the lives of both women and men.”17

Policymakers and employers can work hand-in-hand to provide affordable and high-quality childcare. Research suggests that cutting the cost of childcare by half could increase the number of young mothers in the labor market by 10 percent.18

Tax reform can also help. In too many countries, the tax system discourages secondary earners—who are often women—from working. Replacing family taxation with individual taxation can reduce marginal taxes on these secondary earners, thereby encouraging women to work.

This package of parental leave, childcare, and a fairer tax system can enable women to combine a job with a family. Along with investing in girls’ education and easing women’s entry into the labor market, it also supports women's economic empowerment.

Conclusion: From Words to Action

The G-20’s pledge to reduce the gap in women’s labor force participation by 25 percent over the next decade holds the potential to empower women in a historic way. More than this, it holds the potential to boost growth, raise overall per capita income, tackle poverty, and reduce income inequality for people all over the world.

In short, this can be a game-changer for the global economy. But the promise can only be fulfilled if words become actions.

We need to work together—the G-20, the W-20, the IMF's 188 member countries—to transform aspiration into reality.

Thank you–Cok tesekkurler [chok te-shek-ular].

1 IMF Staff Discussion Note, Women, Work, and the Economy: Macroeconomic Gains from Gender Equity
2 World Bank:
3 OECD DAC Network on Gender Equality, Women’s Economic Empowerment
4 Daring the Difference: The 3 L’s of Women’s Empowerment
5 IMF Staff Discussion Note, Women, Work, and the Economy: Macroeconomic Gains from Gender Equity
6 World Bank. 2013. Programmatic Concept Note: Turkey: Women’s Access to Economic Opportunities in Turkey Trust Fund
7 IMF Staff Discussion Note, Women, Work, and the Economy: Macroeconomic Gains from Gender Equity
8 IMF Working Paper, Can Women Save Japan?
9 Ibid
10 IMF Staff Discussion Note, Women, Work, and the Economy: Macroeconomic Gains from Gender Equity
11 IMF Staff Discussion Note, Fair Play: More Equal Laws Boost Female Labor Force Participation
12 Daring the Difference: The 3 L’s of Women’s Empowerment
13 Forthcoming IMF Staff Discussion Note, Catalyst for Change: Empowering Women and Tackling Income Inequality
14 Forthcoming IMF Staff Discussion Note, Financial Inclusion—Can it Meet Multiple Macroeconomic Goals?
15 Japanese Ministry of Health, Labor, and Welfare
16 Bloomberg News:
17 Amartya Sen, Development as Freedom
18 IMF Staff Discussion Note, Women, Work, and the Economy: Macroeconomic Gains from Gender Equity