Quantitative easing (the US QE2) and the nature of regulators

I am amazed as to how much the US QE2 (quantitative easing no 2) is pre-occupying the minds of almost all CEOs today. Last week, when I met with Paul Chow, the former CEO of the Hong Kong Exchange, he started talking about QE2 even before we were barely sat down for tea, and this was bigger in his mind than the big announcement by his former employers that same day that they were extending trading hours. It was the same for other conversations I have had in Thailand, Beijing, Singapore. Everyone is worried.

What is really worrying however, is the way in which US Federal Reserve Bank officials keep insisting that QE2 is a matter that is internal to the US, which it patently is not. I would have expected that Janet Yellen, the vice-chairman of the Fed Reserve Bank Board to be the last to try and argue that it was, and exclude the global impact of the US economy, but she did exactly that in an interview with the WSJ after she returned from a BIS meeting in Basel on Nov 16.

She was quoted by the WSJ saying, “I’ve just been in Basel for two days meeting with the heads of the central banks of the 30 or 40 countries most involved in the global economy. I certainly tried to explain the logic of our policy and I think they understand what it is we’re doing.”

I have had the chance to interact with Janet when she was the president of the Federal Reserve Bank of San Francisco, at the first of the annual Asian conference they held at their offices in 2007, and found her to be sensitive in connecting with the Asian and international banking communities.

So, if she was actually listening, the only ones in this time zone who could have given her the impression that they “understand what it is we’re doing,” it would be the Japanese, the Singaporeans and Australians. So, okay, they are very involved in the global economy. If the Koreans, Taiwanese, Hong Kongers, Malaysians, Indonesians, Chinese and Indians were nodding, it was certainly not because they were in agreement, nor could you argue that they are not involved in global trade in any insignificant way.

During Alan Greenspan’s time, the unwillingness to build Fed policy around global issues was reinforced by the insularity of Greenspan himself. The only concession he gave himself to even bother travelling outside of the US was to travel to other OECD countries. Even after he retired, when there was at least $250,000 a-pop on the table for him to be a speaker in an Asian (ex-Japan) conference circuit, including and especially in China, he has consistently done it for a lower fee over video-conferencing instead.

I had a much better experience with Jeffrey Lacker, the Fed president for Richmond, who spoke at the Asian Banker Summit in Beijing in 2009. A very erudite man, he sat through most of the conference on risk and regulation and took copious notes at the sessions. I think he does listen to the rest of the world and like to think that somewhere the ideas get floated in his conversations within the US system.

The quality I liked about Lacker, from my one conversation with him, was his wide range of interests. Some technocrats can be very blinkered and take their profession a bit too seriously. He did not come across as that. Back home in Richmond, he is a active in local issues, and has a broad enough interest in things around him. He also enjoys meeting the business people at the largest US banks and companies incorporated in cities under his jurisdiction, notably Delaware.

But what I also found interesting was that despite his broad working knowledge of the world, Lacker is known to err on the side of greater central bank intervention, and would have been one of the greater minds behind QE2. Essentially, another central banker.

I did wonder if he keeps his life simple by compartmentalising his mind and his diverse roles very well. He is, for example, a very approachable person. He maintains this disposition by limiting any conversation as a Fed official to specific people and shuts everybody else out.

Six to seven journalists have direct access to his office and that’s it. If any of them quote him out of context, he knows who they are. He makes no other other comments as a regulator, not even passing ones, to anyone outside of that circle.

As a member of the local community, he relates to people on that front on different topics and so on. So, despite all that knowledge, as an American central banker, he is, well, a central banker.

The Feds are saying that they have no intention to depress the value of the US dollar, or to force inflation in the domestic economy through their $600 billion treasury bond repurchase programme, but offer no assessment on the evidence that this is exactly what is happening.

Some of us may scratch our heads in bewilderment and cry, “surely they know that this is the impact of their decision on the global economy.” We expect the Feds to have cognizance of the global nature of the US economy, the fact that more than 70% of the dollar circulates outside the country and take into account the headline news screaming from every corner of the world on how it is impacting trade and causing other central banks to put up walls to stem the inflows. Well, even if they did, they don’t.

One American economist, in an op-ed, tried to extrapolate meaning where there was none, by suggesting that the very clever Fed board, in all of its infinite wisdom, is introducing QE2 to actually depress property prices even more in the US, so as to force more bank mergers, and by that process reduce the size of the non-performing assets through the use of market forces instead of warranting a bailout, as a prelude to economic recovery.

The fact is that the continued depressed US economy has indeed resulted in more than 860 banks being closed, nearly 40 since the last quarter alone and more than anything during the 1980s banking crisis. Which made me wonder what Sheila Bair and the people at the Federal Deposit Insurance Corp (FDIC) have to say about the mayhem that QE2 is doing to the banking industry.

The underlining character quirk that I have observed in the personality of people in the “regulation” profession – central banks, bank regulators, risk management people, high court judges – in almost all jurisdictions, but most pronounced in the most developed and most political ones, is that they define their roles very narrowly to the letter of the wordings on their mandate or charter, and no more, no matter what the world says about them or to them (it partially also explains why some people in these professions have this permanent constipated look on their public faces – imagine Greenspan – it becomes them).

So it is, that the New Zealand central bank concerns itself with its self-defined concept of inflation-targeting, regardless if private sector debt in the country has gone through the roof, and woe be anybody who even tries to point out that the country is in trouble. The textbook lessons against a narrow view of regulation has already been written for us. The story of how Iceland’s commercial over-extended themselves in foreign currency outside of the country, while the central bank persuaded itself that the domestic economy was sustainable. (I heartily recommend this book “Why Iceland? By Ásgeir Jónsson” to anyone who is interested.

The more integrated regulators around the world – the UK today and some Asian countries – generally have that broader view of issues institutionally, even if specific personalities within their system may be blinkered, because their institutional mandates are broader, there is sufficient cross-skill conversations and perhaps most importantly, they are mandated to do something with that. But that is another discussion.

So the reasons for this narrow definition of the scope of central bankers is not necessarily due to the personalities involved. While there are some, like Greenspan, who reinforce their narrow world view with their personal biases, there are others, like Lacker and Yellen, who take note of the world, and then still deliver to the strict mandate of their office.

Something not clearly understood by many commentators is that the Fed has just two charters, given to it by the US Congress – one to manage inflation, and the second to create employment. There is no charter for the Feds to ensure the systemic stability of the US financial system, surprising as we may think it is. So the impact of QEII on the US banking industry is not within its ambit and that is why I am so interested to know of any altercations between the Fed and the FDIC – they will be worth following.

Monetary policy, as a tool of pursuing the Fed’s main policies, including the actual purchase of the treasury bonds, is under the ambit of the FOMC (Federal Open Market Committee). The FOMC is a strange creature. Neither the Fed, nor its subsidiary FOMC have any jurisdiction over exchange rates, which is under the ambit of the US Treasury. The FOMC is mandated to work with the Treasury to ensure they are coordinated.

So it is that even if we like to think that there is some secret tryst between the Treasury department, which is the public face on US reactions to the Chinese reminbi and the falling US dollar, and the Feds FOMC, we should not be disappointed when there is actually none.

In any other country, using monetary policy to deal with external currency threats, is normal. In the US, the treasury and the Feds probably talk about it all the time, but the Feds would still do nothing because it is not in their mandate to use that weapon in their hand. Which in turn leaves the Treasury department officials appear forlorn during their conversations with Chinese officials because the weapon is not in their hands to use.

To be fair to treasury secretary Timothy Geithner, his comments to Congress on China have always been measured and thoughtful. He has had enough international experience to put himself in the other person’s shoes, and has pointed out in his Congress testimonies the difficulties China would have in revaluing its currency without the supporting pillar of a domestic economy in place. Much of the screaming headlines we read come from the other members of the executive arm and the local politicians playing to the domestic galleries.

Follow closely the quarterly reports by the fed chairman, and his testimonies to the congress. Look for comments connecting a broad view of internatinal issues or the global economy as the basis of his public policy decisions. There is none. References to the global economy are made only as passing obervations. Frightening but true.

On the other hand, we do need to sympathize with central bankers. If they defined their role any more broadly than provided by their charter, they risk being criticised by everybody else in the political system and taking on roles that nobody intended them to. In its extreme, I think that the New Zealand model of “inflation targeting” is extremely dangerous, because it is possible to get the numbers right and the story wrong. Someone over and above the regulators themselves should have a more composite view of the economy and double check the regulators self-defined targets with what is actually happening in all aspects of the economy, especially the parts that the central banker does not take into account.

The US problem is that the cross-purposes of a central bank releasing liquidity into a marketplace where even the government of the day cannot meet its own financial obligations is unsustainable. What is true about Greece and Ireland is true for the US.

Secondly, assuming money is created into circulation, it does not necessarily go to where you want it to go. It flows to the places wth the most return. So, whenyou have an open economy, all the money created is not going to stay within the US, but flow out to where the return is highest in the most stable of Western and emerging economies.

All things said, the most worrisome indicator I obtained recently of what is to come, was revealed in a passing chat I had with Richard Chng, the general manager of a commodities trading house, whose office is on the same floor and along the same corridor from mine in downtown Singapore. Richard said that his October and November sales of hard commodities – iron, aluminium, copper – has already slumped.

Althought you may think that such information is apocryphal, the supply and demand of commodities is the forerunner of subsequent data that the market uses to judge the future, such as manufacturing output and consumer sales. In the absence of a futures market, the performance of these traders business lead the rest of the demand data by about three months. If we extrapolate this ingredient, then we can know for sure that manufacturing output will be recording a dip by January.

Whether it is an anticipatory dip created by the manufacturers themselves, given the uncertainties in the marketplace, or a real slump in demand, is not clear just now. How the market itself will react to the formal data to come, is also not clear yet.

The impact of QE2 is just one factor influencing supply and demand global economy. The unwillingness in the market to take long positions on reminbi or Chinese trade, given the strength of the reminbi and rising prices are just two non-US related factors. There are others.

I do think we have reasons to be really worried about the next 3-6 months.

The irony is that if the US Fed then pulls back on its QE2, the asset inflation that is already being created by QE2 around the developed world will collapse, and central banks around the world will be scrambling to readjust prices and rescue their banking system from having been over-extended.

Strangely enough, the reaction of the US Feds will then be, just as they said when the European economy tanked after the US banking crisis in 2008, “oh, you have a crisis too.”


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