Global Economy: Chilling ways the global economy echoes 1930s Great Depression era - by John Coumarianos

One view of what caused the Great Depression in the 1930s is that the Federal Reserve failed to prevent a collapse in the money supply.

This is the famous thesis of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, 1867-1960, and it was, more or less, the view of Ben Bernanke when he was chairman of the Federal Reserve.

The global economy today resembles that of the 1930s in several ominous ways.

Financial author Edward Chancellor recently called attention to a paper written by Claudio Borio, head economist at the Bank of International Settlements, that provides a fuller picture of the causes of the Great Depression. The paper also draws parallels between global economic conditions that led to the rise of protectionism in the 1930s and our situation now.

Now, as in the 1930s, the global economy is stretched. A low interest-rate regime in the developed world has encouraged lending to emerging markets. Additionally, China’s and Europe’s banking systems are burdened with bad debts.

Moreover, last year, as Chancellor reports, emerging markets experienced their first capital outflows in nearly three decades, and that movement of capital appears to be continuing in 2016. Ratings agencies have downgraded South Africa and Brazil sovereign debt, while commodity prices continue to plunge.
Protectionism is in the air with the European Union and the U.S. imposing tariffs on Chinese steel. Also, anti-immigration sentiment is rising.

Although the additional restrictions imposed by a gold standard don’t exist today, the peg of Chinese yuan to the U.S. dollar DXY, +0.05%  is unsustainable in Chancellor’s opinion, as may be the euro EURUSD, -0.1617%

So much elasticity or the buildup of imbalances can be painful during the process of restoring balance. Therefore, regarding monetary policy, it’s important, according to Borio, to lean “against the build-up of financial imbalances even if near-term inflation remains low and stable.”

Borio’s paper was written in August 2014, so it’s difficult to know what advice he’d have for the Federal Reserve today. But in his paper, he notes that the imbalances that low rates and elasticity produce may “return us to the modern-day equivalent of the divisive competitive devaluations of the interwar years; and, ultimately, [trigger] an epoch-defining seismic rupture in policy regimes, back to an era of trade and financial protectionism and, possibly, stagnation combined with inflation.”

Read more: Chilling ways the global economy echoes 1930s Great Depression era - MarketWatch

Central Banks: Timid central bankers have failed to convince sceptical audience

The job of central bankers more like that of technicians, carefully turning knobs as they fine-tune the economy, or magicians, manipulating the audience into the suspension of disbelief? Most of the time it is the former. Monetary maestros nudge interest rates up and down with meticulous precision.

Yet in extreme cases—such as when economies become trapped in a low-growth rut—central bankers must try to conjure up a change in the public’s economic outlook. Just as uncertain magicians often fail to pull off their tricks, so central banks are finding their audiences in an ever-more sceptical mood.

Economists have long acknowledged the role of mass psychology in business cycles. In 1936 John Maynard Keynes described the “animal spirits” that could drive swings in spending or investment.

The power of an abrupt change in market beliefs came sharply into focus in the early 1980s, when many economies were struggling to clamp down on stubbornly high inflation. Economists at the time worried that using interest rates to rein in inflation would be enormously costly.

Because the public had come to expect high inflation, they reckoned, growth-crushing rate rises would be needed to force down prices and create new consumer expectations. A common estimate at the time had it that reducing America’s inflation rate by just one percentage point would cause economic damage of nearly 10% of GDP.

In this fraught world, central bankers risk falling into what Mr Krugman has called a timidity trap. The longer that knob-turning fails to get an economy out of the zero-rate rut, the less credible markets are likely to find subsequent attempts at regime change. Recent efforts to push interest rates into negative territory seem to have unnerved markets rather than sparked confidence.

Perhaps more importantly, central bankers tend not to adopt major shifts in mandates and targets unless urged to do so by popularly elected governments. It is difficult to muster Rooseveltian resolve without a Roosevelt. Expect growing scepticism about the power of knob-turning until voters choose politicians confident enough to wave a magic wand.
Read more: Slight of hand | The Economist

US economy : S&P will plunge 75% on China deflation: SocGen bear - by Matt Clinch

A falling Chinese yuan will unleash a wave of global deflation that will send the U.S. into its next recession and pull the S&P 500 back down to 550 points, according to a strategist at Societe Generale.

Albert Edwards, the notoriously bearish analyst at the French bank, released a note on Wednesday in response to the recent currency devaluations by the People's Bank of China (PBoC).

This depreciation - with reports last week that it's far from over - is a result of an asset price bubble that the U.S. central backed helped to create, according to Edwards.

"(Quantitative easing in the U.S.) may not have done much to boost U.S. growth, but it certainly inflated global asset prices into the stratosphere," he said in the note thisWednesday January, 13, 2016.

"If I am right, the S&P would fall to 550 (points), a 75 percent decline from the recent 2,100 peak. That obviously will be a catastrophe for the economy via the wealth effect and all the Fed's QE hard work will turn (to) dust."
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Read more: S&P will plunge 75% on China deflation: SocGen bear

Euro Deflation And How To Interpret It

If you read Larry Summers in the Financial Times, you know that recent data confirm falling prices in the euro zone.  Summers argues that the deflation indicates global stagnation, though we find disagreement on the appropriate interpretation. For some it is no more than the transitory effect of falling petroleum prices.

The focus on petroleum prices indicates the analytical limitations of,composite price indices for understanding what is unfolding in the euro zone. A professed function of these indices is to serve as an indicator for central bank inflation targeting. The relationship is well-known.

Central banks take a rise in the composite price index above some arbitrary guideline to indicate the need to increase interest rates. The increase in the central bank rate allegedly curtails credit growth and dampens inflationary pressures.

Even should one believe the interest rate to inflation causality, a composite price index is not the appropriate indicator for central bank action be it measured for consumers, producers or GDP as a whole.

Composite indices all mislead more than they inform.

The misleading effect of composite prince indices is especially serious for the euro zone. First and most obviously, euro zone price  indices conceal variations in inflationary pressures across member countries.

Read more: Euro Deflation And How To Interpret It