Unconventional Monetary Policy: Direct Quantitative Easing (4)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

How are unconventional measures implemented?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

1 Direct Quantitative Easing

When the central bank decides to expand the size of its balance sheet, it has to choose which assets to buy. In theory, it could purchase any asset from anybody. In practice, however, quantitative easing has traditionally focused on buying longer-term government bonds from banks. The idea is twofold: first, sovereign yields serve as a benchmark for pricing riskier privately issued securities. When long-term government bonds are purchased, the yields on privately issued securities are expected to decline in parallel with those on government bonds. Second, if long-term interest rates were to fall, this would stimulate longer-term investments and hence aggregate demand, thereby supporting price stability.

This is where banks play a critical role in the success of any quantitative easing policy. If the aim is to ensure that new loans are provided to the private sector, central banks should mainly purchase bonds from the banks. The additional liquidity would then be used by the banks to extend new credit. However, banks may choose to hold the liquidity received in exchange for the bonds in their reserves at the central bank as a buffer. In this case, the liquidity provided by the central bank remains within the financial sector; it does not flow out of it. This risk can be minimised if the central bank conducts this type of operation only at the lower bound – that is, when it has fully exploited the standard interest rate channel. At the lower bound the remuneration of deposits is null (or almost null) and there is hence little or no incentive for banks to park excess reserves with the central bank. Deploying a policy of quantitative easing at a policy rate different from the lower bound may necessitate a larger expansion of the central bank’s balance sheet and thus increase the risk exposure of the monetary authority.

In light of the above considerations, the soundness of the financial system is critical to the success of quantitative easing. When banks stop intermediating loans, this policy no longer works. Quantitative easing is successful if it narrows the market spreads between the rates paid on selected credit instruments and policy rates, thereby limiting the risks of a liquidity shortfall and encouraging banks to extend credit to higher interest-paying parties.

The Bank of Japan’s policy between 2001 and 2006 provides one example of quantitative easing. It had the following key features: first, it involved a shift in the operational target for money market operations from the uncollateralised overnight call rate to the outstanding balance of current account deposits at the Bank of Japan, or in short the bank reserves; second, it entailed outright purchases of Japanese government bonds to meet the target balance of current account deposits at the Bank; and third, it involved an explicit, public commitment to maintain these open market operations until the CPI did not fall on a sustainable basis.

During that period, the Bank of Japan had discussions with academics about strategies for avoiding prolonged deflation. These talks repeatedly gave rise to one particular question: why didn’t the Bank of Japan simply allow the yen to depreciate in order to stop the fall in consumer prices? This is the essence of Lars Svensson’s prominent suggestion of ‘The Foolproof Way’ out of deflation.  But if it were so simple, why did the Japanese authorities apparently fail to take the necessary measures to prevent deflation? The answer is: it wasn’t that simple. What ‘The Foolproof Way’ underestimates is the enormous difficulty of turning around expectations of prices and economic activity when the functioning of the financial system is seriously impaired. The failures to restructure Japan’s financial and corporate sector and to recapitalise banks have been widely documented as key reasons for the country’s anaemic growth rates and declining prices  – factors over which the Bank of Japan had little control.

Let me just add something on that matter: ‘The Foolproof Way’ wouldn’t work in today’s context either. Given the global dimension of the current financial crisis, it would not be possible for all countries to depreciate their currencies at the same time in order to push inflation up. Such a beggar-thy-neighbour policy would be ineffective in the present circumstances; worse, it would aggravate them by unleashing a protectionist backlash. In fact, the leaders of the G20 recently agreed to refrain from competitive devaluation of their currencies, and it is important to stick to this objective in both words and deeds. Although not all countries belong to the G20, I am confident that all advanced economies will comply with this principle.

There are some important lessons we can learn from the experience of quantitative easing in Japan:

• To begin with, it cannot be taken for granted that an increase in the monetary base results in easier monetary conditions. In fact, the money multiplier has significantly decreased during the last decade. This has, to a certain extent, reduced the effect of injecting money into the economy. 
• Second, as mentioned before, the banking system is crucial for the success of a quantitative easing policy.  However, given the high degree of de-leveraging which the Japanese economy, and the banking sector in particular, was undergoing, banks did not find themselves in a position to pass on the additional liquidity to the non-financial sector.
• Third, one of the expected effects of quantitative easing is a flattening of the yield curve at longer maturity which improves the medium to longer-term financing conditions for the private sector. But what ultimately matters for investment and spending decisions is the real interest rate and hence inflation expectations. Strictly speaking, an increase in the money supply should have implications for the expectations of the future price level. But quantitative easing will only affect expected inflation if the increase in the size of the central bank’s balance sheet is not only sizeable but also perceived as being permanent.  The experience of the Bank of Japan provides a clear-cut example of a temporary expansion of the monetary base that did not affect private sector inflation expectations.
• Fourth, it is not clear how it is possible to increase inflation expectations in a significant way while avoiding a rise in the nominal long-term interest rate after some time. Setting the real long-term interest rate as the operational target for monetary policy seems to be rather challenging in an environment with developed financial markets.
• Fifth, if quantitative easing is perceived as being long-lasting then it could also have an expansionary effect by relaxing fiscal constraints. Expansionary fiscal policies represent a sound instrument to stimulate aggregate demand during a deflationary period. In this respect, outright purchases of government bonds by the monetary authority could further strengthen fiscal effects i) by accommodating the supply of governments bonds, ii) by affecting the long-end of the yield curve - the risk premium - and iii) by re-anchoring inflation expectations to a positive target. In particular, the transition to a positive inflation regime reduces the burden on the future fiscal budget by guaranteeing its financial sustainability.  Of course, the relevance of this effect crucially depends on the duration of the quantitative easing policy and on a credible commitment to a well-defined exit strategy. In this respect, the broad effects stemming from the fiscal and monetary policy mix have been quite muted in stimulating the Japanese economy.
• Finally, it should be recognised that a government bond purchasing programme involves the risk of accumulating significant losses for the central bank. Government bonds would be purchased at rather high prices. If the easing measure turned out to be a success, the ensuing economic recovery would gradually entail an increase in long-term interest rates; this would bring down government bond prices, so that the central bank would eventually face losses. Concerns about central bank’s balance sheet and financial independence can seriously impede monetary policy.  Such constraints may be one reason why the Bank of Japan’s government bond purchasing programme has failed to restore positive inflation rates.

Let me also mention that in the context of the euro area the design of such unconventional policy measures poses some intricate challenges, due to its unique institutional framework. In the first place, we need to be mindful of the Treaty requirements relating to the prohibition of monetary financing and the granting of privileged access, as well as of the consistency with the Treaty principle of open market economy and the preservation of the disciplining function of markets for borrowers and lenders.  Although purchases of government bonds are possible in the secondary market, there is a risk to eventually become a market maker for public debt, which could be construed to be against the Treaty prohibition of monetary financing. Moreover, we have more than just one fiscal authority in the euro area. The Eurosystem would have to decide how to spread purchases of government bonds across euro area countries. If, for example, the Eurosystem only concentrated on public bonds with the best credit rating, it would risk providing privileged access to some countries, contravening Article 102 of the Treaty. If it spread purchases according to a specific key and ended up affecting cross-country differences in yields, it would be seen as granting privileged access, as financing conditions for some governments would be supported to a greater extent than for others. It may also be the case that the risk-free component of corporate bonds would not move exactly in tandem with the risk-free component of government bond yields. This would be tantamount to giving preferential treatment to government debt. These issues would need to be addressed before implementing a government bond purchasing programme in the euro area.

Main characteristics of unconventional measures (3)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

 

Main characteristics of unconventional measures

When conventional tools can no longer achieve the central bank’s objective, policy-makers are confronted with a number of issues.

• First, the unconventional tools include a broad range of measures aimed at easing financing conditions. Having this menu of possible measures at their disposal – which are not mutually exclusive ones – monetary policy-makers have to clearly define the intermediate objectives of their unconventional policies. These may range from providing additional central bank liquidity to banks to directly targeting liquidity shortages and credit spreads in certain market segments. The policy-makers then have to select measures that best suit those objectives.
• Second, they should be wary of the possible side-effects of unconventional measures and, in particular, of any impact on the financial soundness of the central bank’s balance sheet and of preventing a return to a normal market functioning.

In general, unconventional measures can be defined as those policies that directly target the cost and availability of external finance to banks, households and non-financial companies. These sources of finance can be in the form of central bank liquidity, loans, fixed-income securities or equity. Since the cost of external finance is generally at a premium over the short-term interbank rate on which monetary policy normally leverages, unconventional measures may be seen as an attempt to reduce the spreads between various forms of external finance, thereby affecting asset prices and the flow of funds in the economy. Moreover, since these measures aim to affect financing conditions, their design has to take into account the financial structure of the economy, in particular the structure of the flow of funds. Let me elaborate on the possible measures.

One way to affect the cost of credit would be to influence real long-term interest rates by impacting on market expectations. Expectations may work through several channels. For instance, the central bank can lower the real interest rate if it can induce the public to expect a higher price level in the future.  If expected inflation increases, the real interest rate falls, even if the nominal interest rate remains unchanged at the lower bound. Alternatively, policy-makers can directly influence expectations about future interest rates by resorting to a conditional commitment to maintain policy rates at the lower bound for a significant period of time.  Since long-term rates are prima facie averages of expected short-term rates, the expectation channel would tend to flatten the entire yield curve when policy-makers commit to stay at the lower bound. Moreover, a conditional commitment to keep the very short-term rate at the lower bound for long enough should also prevent inflation expectations from falling, which would otherwise raise real interest rates and curtail spending. In either case, if the management of expectations is successful, it would – ceteris paribus – reduce the real long term rate and hence foster borrowing and aggregate demand.

Another way in which the central bank can influence the cost of credit is by affecting market conditions of assets at various maturities – for instance, government bonds, corporate debt, commercial paper or foreign assets. Two different types of policies can be considered. The first aims at affecting the level of the longer term interest rate of financial assets across the board, independently of their risk. Such type of policy would operate mainly by affecting the market for risk free assets, typically government bonds. This policy is typically known as ‘quantitative easing’. The second policy is to affect the risk spread across assets, between those whose markets are particularly impaired and those that are more functioning. Such a policy would be usually referred as ‘credit easing’. The two types of policies affect differently the composition of the central bank’s balance sheet.  Another difference is that ‘credit easing’ can generally be conducted also at above-zero levels of the short-term nominal interest rate, while quantitative easing should make sense only when the interest rate is at zero or very close to zero. However, both operations aim at increasing the size of the central bank balance sheet and therefore expanding its monetary liabilities.

Let me now consider quantitative easing and credit easing in turn.

Why implement unconventional policy measures? (2)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

Why implement unconventional policy measures?

Let me start with the first question: why and when do central banks need to resort to unconventional policy measures?

Let me first clarify what we mean by ‘conventional’ measures. Nowadays, monetary policy mainly acts by setting a target for the overnight interest rate in the interbank money market and adjusting the supply of central bank money to that target through open market operations. To minimise the risk exposure of the central bank’s balance sheet, all liquidity-providing operations normally take place in the form of reverse transactions against a menu of eligible collateral. In other words, in normal times the central bank is neither involved in direct lending to the private sector or the government, nor in outright purchases of government bonds, corporate debt or other types of debt instrument. By steering the level of the key interest rates, the central bank effectively manages the liquidity conditions in money markets and pursues its primary objective of maintaining price stability over the medium term. This has proved to be a reliable way of providing sufficient monetary stimulus to the economy during downturns, of containing inflationary pressures during upturns and of ensuring the sound functioning of money markets.

But in, so to speak, abnormal times conventional monetary policy tools may prove insufficient to achieve the central bank’s objective. Generally, there may be two reasons for this.

• First, the economic shock is so powerful that the nominal interest rate needs to be brought down to zero. At that level, cutting policy rates further is not possible, so any additional monetary stimulus can be undertaken only by resorting to unconventional monetary policy tools. Broadly speaking, the additional monetary stimulus when the policy interest rate is at zero can be achieved in three complementary ways: (i) by guiding medium to long-term interest rate expectations, (ii) by changing the composition of the central bank’s balance sheet, and (iii) by expanding the size of the central bank’s balance sheet.   All of these measures have one element in common: they are designed to improve financing conditions beyond the very short-term interbank interest rates.
• Second, non-conventional measures may be warranted even when the policy interest rate is above zero if the monetary policy transmission process is significantly impaired. Under these circumstances, central banks have two (not necessarily mutually exclusive) alternatives, namely (i) to reduce the short term nominal interest rate even further than in normal conditions, and (ii) to act directly on the transmission process by using non-conventional measures.

The experience of the past year and a half – a very stressful time for the global financial system – have shown that non-standard tools might be needed even before policy rates have been cut to their lower bound. When the turmoil started in summer 2007 and central banks worldwide stepped in to provide additional liquidity to financial markets, it appeared that conventional measures could still do the job. Although markets were not operating normally, far from it, tensions in the euro area interbank market were considerably eased by supplementary longer-term refinancing operations. But things changed as the crisis intensified in September and October last year. Shortly after the collapse of Lehman Brothers, the spread between the three-month Euribor and the overnight interest rate EONIA – which in normal times would on average be around 10 basis points – rose to an all-time high of 156 basis points on 13 October. Market liquidity virtually dried up, and the sudden loss of confidence among market participants threatened to have a lasting effect on the orderly functioning of the euro area money market.

Under these circumstances, easing monetary policy by simply lowering official interest rates would not have been enough. Whenever the transmission channel of monetary policy is severely impaired conventional monetary policy actions are largely ineffective. Any policy decision therefore needed to take account of the extraordinary situation in money markets. Central banks have different tools to cope with the extraordinary situation in interbank markets, and their choice largely depends on institutional characteristics, but not only. The situation of the banking sector and the types of shock hitting it are also important. So while it is tempting to draw cross-country comparisons among such non-conventional measures, it is also rather misleading.

An issue to consider when implementing non conventional policies is the risk of hindering the functioning of markets by substituting or interfering with them. Agents’ refinancing needs may become excessively dependent on operations settled with the central bank. In other words, financing conditions may become overly attractive as a result of central bank operations and may crowd out other channels, reducing the incentives for restarting normal market conditions.

Conventional and Unconventional Monetary Policy (1)

Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

The escalating financial crisis since last autumn of 2008 has pushed the theme of conventional and unconventional monetary policy to centre stage. 

Central banks throughout the world have been responding to the crisis by taking both 

• conventional and 
• unconventional policy measures. 

It is important to have a 

• good understanding of the unconventional policies and 
• how they differ from the conventional ones.

To understand, focus on four groups of questions:

1.  First, why and when should central banks resort to such measures? 

There is no tried-and-tested timetable or sign-posted pathway for moving from conventional to unconventional measures. For instance, an issue to consider is whether unconventional measures should or can be implemented 

• only after the nominal short-term interest rate has reached its lower bound and while downside risks to price stability prevail, or 
• be adopted while interest rates are still positive.

2.  Second, what are the main characteristics of unconventional measures?

3.  Third, how are unconventional measures implemented if and when they are needed? 

To answer this question, we have to distinguish between different types of unconventional measures, 

• from quantitative easing 
• to credit easing. 

Each measure has different effects and counter-effects, depending on the structure of the financial system or other factors.

3.  Fourth, how and when do central banks need to unwind the extra monetary stimulus? 

By definition, unconventional measures are not what is generally done, so they are not supposed to become the standard mode of monetary policy. When deciding on them, monetary policy-makers have to think ahead and ask themselves: 

• “We can get in, but how do we get out?” 
• They need to consider carefully the timing of their withdrawal of such monetary measures – for there are risks in doing it too early, and there are risks in leaving too late.

"The time to sell a stock is - almost never." The four rules of selling.

Philip Fisher, in his book Common Stocks and Uncommon Profits wrote, “If the job has been correctly done when a common stock is purchased, the time to sell it is—almost never.”

I sincerely believe in this idea of never selling my stocks, IF I did the job of picking them well. But then, there are times when you must sell your stocks, and one of the keys to investment nirvana is the ability to know when to do that. 

Four rules of Selling

A value investors in India, Sanjoy Bhattacharyya, wrote on the art of selling stocks some years back, wherein he shared the four rules of selling –

While remaining disciplined in terms of the process of stock-picking, the seasoned value investor waits patiently for Mr. Market to provide opportunity.

          
     Typically, there are just four reasons to sell:

1. A clear deterioration in either earning power or ‘asset’ value.
2. Market price exceeds ‘fair’ value by a meaningful margin.
3. The primary assumptions, or expected catalysts, identified prior to making the investment are unlikely to materialise or are proven to be flawed.
4. An opportunity likely to yield superior returns (with a high degree of certainty) as compared to the least attractive current holdings is on offer.

 https://www.safalniveshak.com/riskiest-moment-in-investing/

The Riskiest Moment in Investing

Peter Bernstein said that “the riskiest moment in investing is when you’re right.”

On being asked how investors can avoid being shocked, or at least reduce the risk of overreacting to a surprise, Bernstein replied –

Understanding that we do not know the future is such a simple statement, but it’s so important. Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. So, in many ways, it’s better not to be so right. That’s what diversification is for. It’s an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place. I want to make sure I’m exposed to it. Somebody once said that if you’re comfortable with everything you own, you’re not diversified.

Here is another article Peter Bernstein wrote for Bloomberg many years back, titled The 60/40 Solution, wherein he talked about the lessons from history –

The constant lesson of history is the dominant role played by surprise. Just when we are most comfortable with an environment and come to believe we finally understand it, the ground shifts under our feet. Surprise is the rule, not the exception. That’s a fancy way of saying we don’t know what the future holds. Even the most serious efforts to make predictions can end up so far from the mark as to be more dangerous than useless. 

All of history and all of life is stuffed full of the unexpected and the unthinkable. Survival as an investor over that famous long course depends from the very first on recognition that we do not know what is going to happen. We can speculate or calculate or estimate, but we can never be certain. Something very simple but very penetrating stems from this observation. If we never know what the future holds, we can never be right all the time. Being wrong on occasion is inescapable. As the great English economist John Maynard Keynes expressed it some 80 years ago, “A proposition is not probable because we think it so.” The most important lesson an investor can learn is to be dispassionate when confronted by unexpected and unfavorable outcomes.

 https://www.safalniveshak.com/riskiest-moment-in-investing/

Tug of war between Deflation and Inflation: the most Challenging Investment Climate today

A Central Banker’s Worst Nightmare


#Inflation and Deflation

From a mathematical perspective, inflation and deflation are two sides of the same coin.

• Inflation is a period of generally rising prices. 
• Deflation is a period of generally falling prices.

Both are deviations from true price stability, and both distort the decisions of consumers and investors.

• In inflation, consumers may accelerate purchases before the price goes up. 
• In deflation, consumers may delay purchases in the expectation that prices are going down and things will be cheaper if they wait.

To investors, inflation and deflation are bad in equal, if opposite, measure.

But, from a central banker’s perspective, inflation and deflation are not equally bad. 

• Inflation is something that central bankers consider to be a manageable problem and something that is occasionally desirable. 
• Deflation is something central bankers consider unmanageable and potentially devastating. 

#Central banks fear deflation more than inflation

Understanding why central banks fear deflation more than inflation is the key to understanding central bank monetary policy today.

1.  Central bankers believe they can control inflation by tightening monetary policy. 

• Generally, monetary policy is tightened by raising interest rates. 
• Since rates can be raised to infinity, there is not limit on this tool. 
• Therefore, no matter how strong inflation is, central banks can always tame it with more rate increases.
• The classic case is Paul Volcker in 1980 who raised interest rates to twenty percent in order to crush inflation that had reached thirteen percent.  
• Central bankers feel that if the inflation genie escapes from the bottle, they can always coax it back in. 

2.  Central bankers also believe that inflation can be good for an economy.  

This is because of something called the Marginal Propensity to Consume or MPC.   The MPC is a measure of how much an individual will spend out of an added dollar of income.

• The idea is that if you give a poor person a dollar they will spend all of it because they struggle to pay for food, housing and heath care. 
• If you give a rich person a dollar, they will spend very little of it because their needs are already taken care of, so they are more likely to save or invest that dollar.  
• Based on this, poorer people have a higher MPC. 

3.  Inflation can be understood as a wealth transfer from the rich to the poor. 

• For the rich person, his savings are worth less, and his spending is about the same because he has a low MPC. 
• By contrast, the poor person has no savings and may have debts that are reduced in real value during inflation. Poor people may also get wage increases in inflation, which they spend because of their higher MPC.

4.   Therefore, inflation tends to increase total consumption because

• the wealth transfer from rich to poor increases the spending of the poor, 
• but does not decrease spending by the rich who still buy whatever they want. 

The result is higher total spending or “aggregate demand” which helps the economy grow.




#Deflation hurts the government in many ways

Deflation is not so benign and hurts the government in many ways.


1.  It increases the real value of the national debt making it harder to finance.

• Deficits continue to pile up even in deflation, but GDP growth may slow down when measured in nominal dollars. 
• The result is that the debt-to-GDP ratio can skyrocket in periods of deflation. 
• Something like this has been happening in Japan for decades. 
• When the debt-to-GDP ratio gets too high, a sovereign debt crisis and collapse of confidence in the currency can result.

2.  Deflation also destroys government tax collections. 

• If a worker makes $100,000 per year and gets a $10,000 raise when prices are constant, that worker has a 10% increase in her standard of living. 
• The problem is that the government takes $3,000 of the increase in taxes, so the worker only gets $7,000 of the raise after taxes.
• But if the worker gets no raise, and prices drop ten percent, she still has a ten percent increase in her standard of living because everything she buys costs less. 
• But now she keeps the entire gain because the government has no way to tax the benefits of deflation. 
• In both cases, the worker has a $10,000 increase in her standard of living, but in inflation the government takes $3,000, while in deflation the government gets none of the gain.

#What is good for government is often bad for INVESTORS.

For all of these reasons, governments favor inflation.   It can

• increase consumption, 
• decrease the value of government debt, and 
• increase tax collections. 

Governments fear deflation because

• it causes people to save, not spend; 
• it increases the burden of government debt, and 
• it hurts tax collections.

But, what is good for government is often bad for investors. 

In deflation, investors can actually benefit from

• lower costs, 
• lower taxes and 
• an increase in the real value of savings. 

As a rule, inflation is good for government and bad for savers; while deflation is bad for government and good for savers.

#Flaws in the thinking about inflation and deflation by the government and economists

There are many flaws in the way the government and economists think about inflation and deflation.

The idea of MPC as a guide to economic growth is badly flawed.

Even if poor people have a higher propensity to consume than rich people, there is more to economic growth than consumption. 


1.  The real driver of long-term growth is not consumption, but investment. 

• While inflation may help drive consumption, it destroys capital formation and hurts investment. 
• A policy of favoring inflation over deflation may prompt consumption growth in the short run, but it retards investment led growth in the long run. 
• Inflation is a case of a farmer eating his own seed-corn in the winter and having nothing left to plant in the spring. Later he will starve.

2.  It is also not true that inflation is easy to control. 

• Up to a certain point, inflation can be contained by interest rate increases, but the costs may be high, and the damage may already be done. 
• Beyond that threshold, inflation can turn into hyperinflation.  

3.  Hyperinflation

At that point, no amount of interest rate increases can stop the headlong dash to dump money and acquire hard assets such as gold, land, and natural resources. 

• Hyperinflation is almost never brought under control. 
• The typical outcome is to wipe out the existing currency system and start over after savings and retirement promises have been destroyed.

#Central banks favour inflation over deflation:  Its Implications

In a better world, central bankers would aim for true price stability that does not involve inflation or deflation.

But given the flawed economic beliefs and government priorities described above, that is not the case.

1.  Central banks favor inflation over deflation because it

• increases tax collections, 
• reduces the burden of government debt and 
• gooses consumption. 

If savers and investors are the losers, that’s just too bad.


2.  The implications of this asymmetry are profound.

• In a period where deflationary forces are strong, such as the one we are now experiencing, central banks have to use every trick at their disposal to stop deflation and cause inflation. 
• If one trick does not work, they must try another.

Since 2008 central banks have used

• interest rate cuts, 
• quantitative easing, 
• forward guidance, 
• currency wars, 
• nominal GDP targets, and 
• operation twist to cause inflation. 

3.  None of it has worked; deflation is still a strong tendency in the global economy. This is unlikely to change.  The deflationary forces are not going away soon.

• Investors should expect more monetary experiments in the years ahead. 
• If deflation is strong enough, central banks may even encourage an increase in the price of gold  in order to raise inflationary expectations.

4.  Eventually the central banks will win and they will get the inflation they want.

• But it may take time and the inflation may turn into hyperinflation in ways the central banks do not expect or understand. 
• This “tug-of-war” between inflation and deflation creates the most challenging investment climate in 80 years.

The best investment strategies involve a balanced portfolio of hard assets and cash so investors can be ready for both. 

Lessons from the Great Depression

#Depression, Recession and Expansion

The term “depression” is not well understood and is not in wide use today.

Economists prefer terms like

• “recession,” which means two or more consecutive quarters of declining GDP with rising unemployment, and
• “expansion” which covers periods of rising GDP between recessions. 

Economists like the fact that recession is mathematically defined and measurable, whereas depression is subjectively defined and somewhat in the eye of the beholder.

Policymakers avoid using words like depression for fear that the public may become depressed and stop spending — the opposite of what is desired.


#Characteristics of Depression

Depression does not imply long periods of declining GDP. 

It is possible to have rising GDP, falling unemployment and rising stock prices in a depression.  Indeed, this is exactly what happened from 1933 to 1936 in the middle of the Great Depression.

What characterizes a depression is that

• growth does not return to long-term potential, and 
• total output, labor force participation and asset prices languish below prior peaks in some combination. 

This definition was first laid out by John Maynard Keynes in 1936 in his magnum opus, The General Theory of Employment, Interest and Money. It is not mathematically precise, but it is highly serviceable.

The importance of Keynes’s definition is that depressions are not merely longer or more persistent versions of a recession.  They are qualitatively different. 

# Tackling recession and depression

A recession is a cyclical phenomena amenable to liquidity and interest rate solutions applied by central banks.

Depressions are structural and do not respond to central bank remedies.

Depressions are only cured by structural changes in areas such as fiscal policy, regulation, and labor markets that are not controlled by central banks, but rather by legislatures and the executive.

#Lessons from the Great Depression of 1929 to 1940

The mystery of the Great Depression is not why it began but why it lasted so long.

The answer appears to be something economists call regime uncertainty.

• The Hoover-Roosevelt programs seemed to come out of nowhere and disappear just as quickly confusing business leaders. 
• Programs were launched with great fanfare then abandoned based either on Supreme Court decisions declaring  them unconstitutional or because of their failure to produce results.
• In response, private capital went to the sidelines and refused to invest. Instead of a labor strike, there was a capital strike. 
• No amount of government intervention could make up for the lack of private capital investment caused by the policy uncertainty of those years.

The Great Depression in the United States is conventionally dated from 1929 to 1940. These dates are somewhat arbitrary.

• It began with the stock market crash in October 1929, and only ended when the U.S. massively restructured its economy to produce war material, first for our allies, particularly the U.K., in 1940, and later for our own forces after the U.S. entered the Second World War in December 1941.
• The U.S. depression was part of a larger global depression that was visible in the U.K. in 1926, and in Germany in 1927, and that was not fully resolved until the new international monetary arrangements agreed at Bretton Woods in 1944 and implemented in the post-war years. 
• But the core period, 1929–1940, covering President Hoover’s single term, and the first two terms of President Franklin Roosevelt, are the object of intensive interest by historians and scholars to this day.

The conventional narrative of the Great Depression is known by rote.

• Herbert Hoover and the Federal Reserve are the typical villains who committed a series of policy blunders that first caused the depression, and then failed to alleviate it.  
• Franklin Roosevelt is portrayed as the hero who saved the day and led the country back to growth through activism, government programs and massive spending. 
• This narrative has been the blueprint and justification for liberal government intervention and spending programs ever since.

This narrative is almost completely wrong.

• One much closer to the truth of what happened in the 1930s shows that there was a great deal of continuity between the Hoover and Roosevelt administrations. 
• Both were activists and interventionists.
• Both believed in public works and government spending.  
• Major depression-era projects such as the Hoover Dam were begun in the Hoover administration; Roosevelt merely continued such hydroelectric and flood control projects on a larger scale with his Tennessee Valley Authority and other projects.
• Importantly, Roosevelt did not end the depression in the 1930s; he merely managed it with mixed results until the exigencies of war production finally helped the U.S. escape it. 
• Indeed, the U.S. had a severe relapse in 1937–38, the famous “recession within a depression,” that reversed some of the gains from the period of Roosevelt’s first term.

#Implication for the U.S. today

Indeed, the U.S. is in a depression today, and its persistence is due to the fact that positive structural changes have not been implemented. 

Federal Reserve policy is futile in a depression.

The implication is that the current period of low growth in the U.S. will continue indefinitely until positive structural changes and greater clarity in public policy are achieved. 

This new depression may be a long one.  

Malaysia is not heading for deflation: Economists

Publish date: Mon, 25 May 2020 



KUALA LUMPUR: Malaysia is not heading for deflation despite Consumer Price Index (CPI) having deflated further 2.9 per cent to 117.6 points in April from 121.1 in the same month in 2019, the lowest level since 2010, economists said.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said the core CPI, which removes the volatile items such as fresh food and administered prices, had been recording positive growth of 1.3 per cent for the past three months now.

"Therefore, it is not deflation since the primary driver for the decline in headline CPI was due to fuel prices and electricity charges whereby both sub indices have declined by 38.2 per cent and 33.3 per cent respectively during April.

"I do not think deflation is going to happen in a truer sense. We can see food prices are still at elevated levels. Some items have been reporting quite substantial increment," he told the New Straits Times.

Afzanizam said besides that, the country had been recording trade deficits in food items.

He expects food prices to stay high with the ringgit continuing to be weak.

He said in 2019, Malaysia had recorded a trade deficit in food items of RM17.4 billion. The deficit has remained since 1990.

He noted that the country's Self Sufficiency Ratio (SSR) for rice, beef and chilli had stood at 70 per cent, 25.5 per cent and 38.8 per cent respectively in 2017.

"This would mean Malaysia has been relying from import source in order to satisfy its local demand," he said.

Putra Business School associate professor Dr Ahmed Razman Abdul Latif said he did not foresee the country heading towards deflation as the lower CPI was caused mainly by the decrease of global crude oil price for the past few months.

He said this had in effect reduced the costs of transportation and fuels.

He said, however, prices of global crude benchmarks such as Brent had steadily increased for the past few weeks towards US$35 per barrel which will stabilise the CPI movement.

"In addition, the price of food and beverages has increased steadily and this will also ensure that the CPI will not go towards negative number," he said.

RAM Ratings expects a deflationary trend in the second and third quarters of this year.

The firm revised its headline inflation projection for 2020, from 0.7 per cent to 0.0 per cent.

This is mainly due to weak global oil prices, generous discounts for household electricity bills, and subdued demand.

"While inflation remained stable at 1.5 per cent in January-February, it is expected to ease to -0.2 per cent in March," it added.



https://www.nst.com.my/business/2020/05/595198/malaysia-not-heading-deflation-economists



Comments:

What makes deflation such a dreaded condition is that, once it takes hold, it motivates consumers to hold back on spending in the expectation that they will be able to buy things at a cheaper price later. This causes further drop in demand today, leading to more cutbacks in production and even slower economic activity, which feeds into more price declines -- a highly destabilizing dynamic.

The Downfall of Money. Risks of Hyperinflation.

#The risks of hyperinflation in the U.S. today.

Today’s problems in the U.S. economy, too much debt and too little growth, are identical to the problems confronting Germany in 1921. 

• Then, as now, the solutions were mainly structural. 
• Then, as now, the politicians refused to compromise on solutions and looked to the central bank to paper over the problems. 
• Then, as now, the central bank accommodated the politicians.

Central bank independence is largely a myth and only appears to be a reality during stable economic times.

• But when the legislative and executive branches become dysfunctional, as they are today, and when debts and deficits spin out of control, as they appear to be, then central banks must bow to the politicians and monetize the debt by money printing. 
• This is what happened in Germany in 1921–23.

Something similar may be starting to happen in the U.S. today.

• The U.S. is not yet at the point of no return that Germany reached in 1921. But it is moving in the same direction. 
• It has a dysfunctional political class and accommodating central bankers. 

You want to know about the warning signs of hyperinflation before its most virulent stage wipes out your savings and pensions.

Mark Twain once wrote, 
“No occurrence is sole and solitary, but is merely a repetition of a thing which has happened before.” 






#Weimar hyperinflation

Weimar hyperinflation offers a historic guide to something that has happened before and that may repeat in the U.S. under remarkably similar conditions.

Despite the widespread identification of “Weimar” with hyperinflation, few investors know the detailed history and political dynamics that led to Germany’s catastrophic outcome.

• The facts that Germany had recently been defeated in the first World War and bore a heavy debt burden in the form of reparations to France, the U.K. and other victorious powers are necessary background.
• You may also know that communists and proto-Nazis fought street battles, led regional rebellions and engaged in assassinations of high-profile political figures.

 But even this backdrop does not tell the whole story.


#Rudolf Havenstein, the director of the Reichsbank, the central bank of Germany. 

Most accounts of the Weimar hyperinflation focus on Rudolf Havenstein, the director of the Reichsbank, the central bank of Germany.

• Havenstein had control of the printing presses and was directly responsible for the physical production of the banknotes, eventually denominated in the trillions of marks.
• At one point, the Reichsbank printed such huge volumes of currency that they were physically constrained by paper shortages. 
• They even resorted to printing on one side of the banknote in order to save ink, which was also in short supply. 
• Havenstein is routinely portrayed as the villain in the story the man whose money printing ruined the German currency and its economy.

#The culprit was the political leadership

• Yet the culprit was the political leadership that refused to compromise on the structural reforms needed to restore growth to the German economy so it could begin to deal with its debt burden.
• Politicians looked to the central bank to paper over their problems rather than fix the problem themselves.  
• Havenstein is not an autonomous actor out to destroy the currency. 
• He is simply the handmaiden of a weak, dysfunctional political class who refuse to make hard choices themselves.

This insight, is of the utmost importance as you try to assess the risks of hyperinflation in the U.S. today. Investors like to point fingers at the Fed for “printing” (actually digitally creating) trillions of U.S. dollars out of thin air; they maybe not totally correct.







Read:

The Downfall of Money: Germany’s Hyperinflation and the Destruction of the Middle Class, by Frederick Taylor. This is the best and most thorough account of the Weimar hyperinflation yet and is likely to remain the definitive history.  Read this to understand exactly what happened, and why a repetition in the U.S. is a real possibility today..

Be a Leader: How to Change People Without Giving Offense or Arousing Resentment

If You Must Find Fault, This is the Way to Begin

It is always easier to listen to unpleasant things after we have heard some praise of our good points.

Begin with praise and honest appreciation.

How to Criticize - and Not Be Hated for It

Calling attention to one's mistakes indirectly works wonders with sensitive people who may resent bitterly any direct criticism.

Talk About Your Own Mistakes First

It isn't nearly so difficult to listen to a recital of your faults if the person criticizing begins by humbly admitting that he, too, is far from impeccable.

Admitting one's own mistakes – even when one hasn't corrected them – can help convince somebody to change his behavior.

Talk about your own mistakes before criticizing the other person.

No One Likes to Take Orders

Asking questions not only makes an order more palatable; it often stimulates the creativity of the persons whom you ask. People are more likely to accept an order if they have had a part in the decision that caused the order to be issued.

Ask questions instead of giving direct orders.

Let the Other Person Save Face

Letting one save face! How important, how vitally important that is! And how few of us ever stop to think of it! We ride roughshod over the feelings of others, getting our own way, finding fault, issuing threats, criticizing a child or an employee in front of others, without even considering the hurt to the other person's pride. Whereas a few minutes' thought, a considerate word or two, a genuine understanding of the other person's attitude, would go so far toward alleviating the sting!

Even if we are right and the other person is definitely wrong, we only destroy ego by causing someone to lose face.

How to Spur People on to Success

Let us praise even the slightest improvement. That inspires the other person to keep on improving.

Praise is like sunlight to the warm human spirit; we cannot flower and grow without it. And yet, while most of us are only too ready to apply to others the cold wind of criticism, we are somehow reluctant to give our fellow the warm sunshine of praise.

Jess Lair

Everybody likes to be praised, but when praise is specific, it comes across as sincere – not something the other person may be saying just to make one feel good.

Abilities wither under criticism; they blossom under encouragement.

Give a Dog a Good Name

[...] if you want to improve a person in a certain aspect, act as though that particular trait were already one of his or her outstanding characteristics.

Give the other person a fine reputation to live up to.

Make the Fault Seem Easy to Correct

Tell your child, your spouse, or your employee that he or she is stupid or dumb at a certain thing, has no gift for it, and is doing it all wrong, and you have destroyed almost every incentive to try to improve. But use the opposite technique – be liberal with your encouragement, make the thing seem easy to do, let the other person know that you have faith in his ability to do it, that he has an undeveloped flair for it – and he will practice until the dawn comes in the window in order to excel.

Making People Glad to Do What You Want

Always make the other person happy about doing the thing you suggest.

The effective leader should keep the following guidelines in mind when it is necessary to change attitudes or behavior:

1. Be sincere. Do not promise anything that you cannot deliver. Forget about the benefits to yourself and concentrate on the benefits to the other person.
2. Know exactly what it is you want the other person to do.
3. Be empathetic. Ask yourself what is it the other person really wants.
4. Consider the benefits that person will receive from doing what you suggest.
5. Match those benefits to the other person's wants.
6. When you make your request, put it in a form that will convey to the other person the idea that he personally will benefit.

Reference:  How to Win Friends and Influence People by Dale Carnegie

When Nothing Else Works, Try This

How to Win People to Your Way of Thinking

That is what every successful person loves: the game. The chance for self-expression. The chance to prove his or her worth, to excel, to win.

Reference:  How to Win Friends and Influence People by Dale Carnegie

The Movies Do It. TV Does It. Why Don't You Do It?

How to Win People to Your Way of Thinking

Merely stating a truth isn't enough. The truth has to be made vivid, interesting, dramatic. You have to use showmanship. The movies do it. Television does it. And you will have to do it if you want attention.

Dramatize your ideas.

Reference:  How to Win Friends and Influence People by Dale Carnegie

An Appeal That Everybody Likes

How to Win People to Your Way of Thinking

[...] all people you meet have a high regard for themselves and like to be fine and unselfish in their own estimation.

[...] a person usually has two reasons for doing a thing: one that sounds good and a real one. The person himself will think of the real reason. You don't need to emphasize that. But all of us, being idealists at heart, like to think of motives that sound good. So, in order to change people, appeal to the nobler motives.

Reference:  How to Win Friends and Influence People by Dale Carnegie

What Everybody Wants

How to Win People to Your Way of Thinking

Wouldn't you like to have a magic phrase that would stop arguments, eliminate ill feeling, create good will, and make the other person listen attentively? Yes? All right. Here it is: "I don't blame you one iota for feeling as you do. If I were you I would undoubtedly feel just as you do." An answer like that will soften the most cantankerous old cuss alive. And you can say that and be 100 percent sincere, because if you were the other person you, of course, would feel just as he does.

Be sympathetic with the other person's ideas and desires.

Reference:  How to Win Friends and Influence People by Dale Carnegie