Wednesday, July 30, 2014
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Currency War and Peace

WASHINGTON, DC – Much of the hype surrounding last month’s meeting in Moscow of G-20 finance ministers and central bankers was dedicated to so-called “currency wars,” which some developing-country officials have accused advanced countries of waging by pursuing unconventional monetary policies. But another crucial issue – that of long-term investment financing – was largely neglected, even though the endgame for unconventional monetary policy will require the revitalization or creation of new long-term assets and liabilities in the global economy.

The collapse of Lehman Brothers in 2008 drove up risk premia and triggered panic in financial markets, weakening assets in the United States and elsewhere, and threatening to provoke a credit crunch. In order to avoid asset fire-sales – which would have led to the disorderly unraveling of private-sector balance sheets, possibly triggering a new “Great Depression” or even bringing down the eurozone – advanced countries’ central banks began to purchase risky assets and increase lending to financial institutions, thus expanding the money supply.

While fears of meltdown have dissipated, these policies have been maintained or extended, with policymakers citing the fragility of the ongoing economic recovery and the absence of other, equally strong policy levers – such as fiscal policy or structural reforms – that could replace monetary policy quickly enough.

But several years of ultra-loose monetary policy in the advanced countries has led to significant liquidity spillover abroad, putting excessive upward pressure on higher-yielding developing countries’ currencies. With developing countries finding it difficult to deter massive capital inflows or mitigate the effects – owing to economic constraints, like high inflation, or to domestic politics – the “currency wars” metaphor, coined in 2010 by Brazil’s finance minister, Guido Mantega, has resonated widely.

Moreover, only a small portion of the liquidity created by unconventional monetary policy has been channeled toward households and the small and medium-size enterprises that generate most new jobs. Instead, crisis-affected global financial entities have used it to support their efforts to deleverage and to rebuild their capital, while large corporations have been building large cash reserves and refinancing their debt under favorable conditions. As a result, economic growth and job creation remain lackluster, with the availability of investment finance for long-term productive assets – essential to sustainable growth – severely limited.

Some believe that the elimination of macro-financial tail risks, the gradual strengthening of global economic recovery, and the increase in existing asset prices will eventually convince cash hoarders to increase their exposure to new ventures in advanced economies. But such optimism may not be warranted. In fact, at the recent G-20 meeting, the World Bank presented an Umbrella Report on Long-Term Investment Financing for Growth and Development. The report, based on analysis from various international organizations, highlights several areas of concern.

For starters, banks’ current retrenchment of long-term investment financing is likely to persist. After all, many of the advanced-country banks, especially in Europe, that dominated such investment – for example, financing large-scale infrastructure projects – are undergoing deep deleveraging and rebuilding their capital buffers. So far, other banks have been unable to fill the gap.

Furthermore, the effect of internationally agreed regulatory reforms – most of which have yet to be implemented – will be to increase banks’ capital requirements while shrinking the scale of maturity transformation risks that they can carry on their balance sheets. The “new normal” that results will likely include scarcer, more expensive long-term bank lending.

The World Bank report also points out that, as a consequence of banking retrenchment, institutional investors with long-term liabilities – such as pension funds, insurers, and sovereign wealth funds – may be called upon to assume a greater role in funding long-term assets. But, to facilitate this shift, appropriate financing vehicles must be developed; investment and risk-management expertise will have to be acquired; regulatory frameworks will have to be improved; and adequate data and investment benchmarks will be needed. These investors must focus on the small and medium-size enterprises that banks often neglect.

Finally, local-currency bond markets – and, more generally, domestic capital markets – in emerging economies must be explored further, in order to lengthen the tenure of financial flows. Local-currency government-debt markets have performed fairly well during the crisis, while local-currency corporate-debt markets have played a more modest role as a vehicle for longer-term finance. This suggests that domestic reforms aimed at reducing issuance costs, improving disclosure requirements, enhancing creditors’ rights frameworks, and tackling other inhibiting factors could bring high returns.

Anxiety over unconventional monetary policies and “currency wars” must not continue to dominate global policy discussions, especially given last month’s pledge by G-20 leaders not to engage in competitive currency devaluations. Instead, global leaders should work to maximize the liquidity that unconventional policy measures have generated, and to use it to support investment in long-term productive assets. Such an approach is the only way to place the global economy’s recovery on a sustainable footing.

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  1. CommentedBerlin Goh Pei Lim

    Merely, the antidote or remedy for "Contemporary Monetary Policy" , which is A.K.A. Quantitative Easing is address as "Entitlement Programme of Combating Recession and Economic Growth Induction."(Singapore Government)

    "Entitlement Programme of Combating Recession and Economic Growth Induction."(Singapore Government)
    In short-abbreviation, is EPCREGI. EPCREGI is quite similar to Quantitative Easing.

    Merely EPCREGI, is the process of expanding the Central Bank's balance sheet, hence expansionary to Central bank Money Base, then indulging in monetary transfer to each individual bank account, thus to induce IS curve or AD curve to shift right-wards. Thus with the intension to induce Economic Growth.

    By implementing EPCREGI, one might question the absence of monetary lendings from the Central Bank to Financial Institution.

    It's never an issue. Financial firms analogious to Commercial Bank, can always implement "Surcharge" towards Bank's Client. Hence by "Surcharge", Commercial Bank able to generate Revenue. The result of the effect is considered similar to Lending, by the Central Bank to Financial Firms.

    "Surcharge" can too be implemented to Investment Bank towards their Clients.

  2. CommentedJonathan Lam

    Gamesmkith94134: Currency War and Peace
    “What goes up, it must come down” is known under the law of gravity; it is a simple physics. I think Otaviano Canuto spoke well on the buffer the central banks attempted are void, “as a result, economic growth and job creation remain lackluster, with the availability of investment finance for long-term productive assets – essential to sustainable growth – severely limited.” I only see such experiment on buffer is similar to fly a balloon to the moon; but, I am just remind Mr. Otaviano Canuto that Black Friday will come in the October after the clearing off the third quarter and finalizing the year end summary would tell the truth. It has reached its diminishing returns since the buffer may not reach deep in every livelihood of those supporting their currencies. Stimulation to growth would turn into a nightmare of stagflation’s return that recession may not stop till depression comes.
    There is no remedy to what we call the imbalance of the classes or sovereignties which are harmed by the liquidity from the Central banks. Currently, the Central Banks is determined to change the law of physics in patching the fallen banks that carried with the toxic capitals assets. We saw the collapse of the financial system in the past that many recommendations are made to secure the capital assets to thwart off the imbalance of the trade, and they demanded growth to sublimate deflation and make profits through their macro economics; but, it created another problem for those live under the myopic budgetary constraint that debts became negativity in the sense of growth especially those live under the pension and youth in the course of education leaving the burden on the middle class, and austerity would stun growth even for research and development. Besides, liquidity creates bubbles in the margin of affordability, and it polarizes the rich and poor. It is a call on the coming disaster, an inevitable recession through the mines in its due courses of micro economics. It is why I often said on Zones is more appropriate than G20; and corrections are applicable to its classes and sovereignties.
    After all, the prices on commodity goods is rising, profit margin is narrowing,and labor cost is going up; that many sovereignties is short on social programs to relieve the pressures that make the marginal affordability sustainable. More uprisings in regions will revolt against its governments who failed to give a sustainable living, even in US and China. It is not a game on numbers like per capita, it seems plausible in turning $49000 to $46000 in America, or a cost of a hundred years of labor on a dwelling home for Chinese; this is the questionable subsidies or restructuring its infrastructures can afford to swing in order to calm its citizens from turning against its governments.
    However, If we are focus on the balance of the basis of micro economics which we reason on the productivity and consumption that we designated to trade or interact through the entities or sovereignties; we will recognize the gravity of the issues is how the currencies that given us the fundamentals and valuation on the sovereignties and their citizens are using such currency to calculate what to produce and consume. So, it is not a long term investment or profitability on the margin that would made the balance on the global economy. In conclusion, G20 may emphasized on how the Emerging market nations can save the developed nations by marching at the same pace; but reality so it differently; and its policy is being choked off by its margin of affordability that liquidity in crediting the developed nations would have a diminishing return, just like US. After 700 Billions liquidity flashed into our economy and Mr. Obama inherited $1.7 billion to our nation debts, we still doubt on the sustainable 2% growth.
    Another example, Apple is the best production we can depend on. Does Iphone 5s make its mark to grow and bring Apple back to 1000?or would you ignore Samsung by piling your long term investment in Apple if some say Apple will grow and its stock will come to a thousand dollar a share? Well, I am just a impartial observer during the past twenty years of G20 in actions; so far so good. October will come. I just hope the World Bank would make its decision on being the central bank of currencies other than G20.
    May the Buddha bless you?

  3. CommentedRitesh Kumar Singh

    In my opinion, the major cause of slowdown in Euroze or US is growing pessimism among the minds of people...so consumer don't want to spend, businesses thus don't want to invest....so employment doesn't improve...

    The way to deal with is revive international trade by all G-20 countries simultanesously through faster conclusion of Doha Round since there's not much scope for improving household consumption demand in a bleaker environment ...if exports increases AD increases...investment growth will happen...so does employment generation....US and EU instead of giving cheap money to banks...invest directly in infrastructure creation to bring employment back.

  4. CommentedRitesh Kumar Singh

    In my opinion, the major cause of slowdown in Euroze or US is growing pessimism among the minds of people...so consumer don't want to spend, businesses thus don't want to invest....so employment doesn't improve...

    The way to deal with is revive international trade by all G-20 countries simultanesously through faster conclusion of Doha Round since there's not much scope for improving household consumption demand in a bleaker environment ...if exports increases AD increases...investment growth will happen...so does employment....US and EU instead of giving cheap money to banks...investment directly to bring employment back..

  5. CommentedKen Presting

    It struck me as odd, to explain the lack of new infrastructure projects in terms of banks being unwilling to lend. Isn't it the public sector which decides when to build a new road or bridge?

    What the EU needs is a repeat of Germany's effort after reunification, or the USA's Marshall Plan. Instead of creating liquidity and giving it to the banks, those Euros should be paid to Greeks and Italians who are willing to work. Then when they deposit their paychecks, the banks' balance sheets will improve just the same.

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