Davos leaders uneasy over glut of easy moneyReuters . Davos, Switzerland
The world is awash in easy money, with consequences that are starting to worry some central bankers and business leaders at the Davos World Economic Forum, though so far inflation fears seem overdone.
With developed world government finances constrained by huge debts and deficits, central banks have pumped trillions of dollars into the system to try to revive sluggish economies, combat deflation and prop up weak banks.
The Fed, the Bank of England, the Bank of Japan and to a lesser extent the European Central Bank have strayed far from traditional inflation fighting to take into account objectives such as reducing unemployment, raising nominal GDP, and ensuring the smooth functioning of the sovereign bond market.
In pursuit of these goals, they have taken unconventional steps such as keeping interest rates well below the inflation rate, buying government bonds and mortgage-backed securities and providing long-term liquidity to banks at near zero rates.
Indeed, the Japanese central bank is now actively trying to create more inflation because prices are obstinately stagnant.
On Tuesday, the BoJ announced its most radical effort yet to end years of economic stagnation, after weeks of relentless pressure from new Prime Minister Shinzo Abe for a greater push to lift the economy out of recession.
In a joint statement with the government, the BoJ said it would switch to an open-ended commitment to buying assets next year and double its inflation target to 2 per cent.
Central banking purists, especially in Germany, with its history scarred by hyper-inflation, worry that the guardians of sound money are losing their independence to governments and will find it hard to get the genie back into the bottle.
The leading hawk on the ECB’s Governing Council, German Bundesbank chief Jens Weidmann, who cancelled his appearance at Davos, warned on Monday that central banks were being bullied by governments and it could lead to currency wars.
‘Already alarming violations can be observed, for example in Hungary or Japan, where the new government is interfering massively in the business of the central bank with pressure for a more aggressive monetary policy and threatening an end to central bank autonomy,’ he said in a speech in Frankfurt.
‘A consequence, whether intentional or uninentional, could moreover be an increased politicisation of exchange rates.’
Within the Federal Reserve, dissident Richmond Fed president Jeffrey Lacker has been warning for months that the UScentral bank’s stimulus actions risk a surge in inflation after this year.
Management consultancy Bain & Co said in a report that the most immediate effect of a world awash with capital has been ‘to paralyse, confuse and distort investment decisions’.
Large financial flows were creating dangerous pockets of excess capital in some places, while simultaneously cutting off access in other places. At the same time, big institutional investors like pension funds face large gaps between the returns they will need to meet payouts and what markets will generate.
‘Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles,’ it said, pointing to big risks for economies and businesses closely linked to commodities.
The US central bank embarked on a third round of asset purchases in December that are meant to spur growth and pledged to keep rates near zero until the unemployment rate drops to 6.5 per cent, as long as inflation expectations remain in check.
US unemployment was 7.8 per cent last month, and Fed Chairman Ben Bernanke made clear last week he is in no rush to tighten monetary policy. Speaking on January 14 in Ann Arbor, Michigan, he said ‘the worst thing the Fed could do would be to raise interest rates prematurely’.
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