The Continental Economics
Institute’s Financial Market Snapshot
September 3, 2013
by Antony Mueller
Economic growth and monetary
conditions
The period of relative tranquility
on the international financial markets over the past couple of months is
ending. Major changes have already taken
place, many more are about to happen. In the United States, the American
central bank is about to end its monetary policy of quantitative easing. The
effects of this change have already led to a shift in international capital
flows. Money moves out of the emerging markets. This way not only the Brazilian
real has weakened, but devaluation also hit hard the Indian rupee. In Europe,
the announcement of its “Outright Monetary Transactions” program by the European
Central Bank (ECB) last year has tranquilized financial markets and lowered the
risk perception of international investors of the creditworthiness of the
European crisis countries. Growth is picking up in the United States and in
Japan. Over the past couple of years, the major central banks have swamped the
globe with liquidity. If economic recovery should continue, a new tough job already
awaits central bankers: how to avoid worldwide inflation.
Commodities
There are signs that the super cycle
in commodities is not yet over. There is little reason to expect the oil price
to fall. On the contrary, the tensions in the Middle East are rising. Conflicts
that are even more violent seem inevitable. This way oil and gold are set for
rebound. Other commodities will benefit when global economic recovery will
continue. There are signs that Europe is moving out of its slump and that the
United States and Japan are back on their growth paths. Latest figures of the
Brazilian gross domestic product indicate the end of the economic downturn of
this country. The Chinese hunger for natural resources is still unbroken. With these
demand factors well in place and given the immense liquidity overhang in the
financial markets, the failure by central banks to curb excessive monetary
growth can rapidly transform into a wave of price inflation.
International trade
One of the good signs over the past
couple of years has been the fact that the international economic and financial
crisis has not provoked protectionist measures. Except by some leaders of
emerging economies, there has been no threat of protectionism among the major
industrialized countries. Even in the face of persistently high trade deficits,
the United States did not bring up protectionism. Nevertheless, the global
macroeconomic constellation has remained unsustainable. It cannot go on forever
that China and other Asian emerging economies as well as countries like Brazil
and other emerging economies will continue to finance the American trade
deficit in its present dimensions. The problem with postponed necessary
adaptations is that these eventually tend to take place in vehement and
uncontrolled manner.
Outlook
The monetary policy of the past
couple of years with its extreme expansion of the monetary base comes back now
to haunt central bankers for years to come. Solid economic recovery is under
threat because the gigantic liquidity overhang threatens price stability. Much
earlier and stronger than otherwise - if there had not been a monetary expansion - central bankers
will now have to raise interest rates in order to avoid price
inflation. Soon we may hear from the policy makers that it was due to their
action that the recovery finally has come. They will assert that the threat of
price inflation is a completely different matter with no link to earlier
monetary policy. In reality, however, things are quite the opposite of what
these statements will say. Not only would economic recovery have come much earlier without central bank intervention, the return to economic growth would also not have to face the risk of price
inflation as it does now because of the excessive creation of central bank
liquidity over the past couple of years.
