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“Reverse operation”of US financial policies
Having experienced the impasse of“financial cliff"and“debt ceiling"in the US in 2013,the world reacted strongly to US's withdrawal from the Quantitative Easing(QE).A research institution analyzed that in 2014 the US would finish cutting the QE amount worth US$85 billion.On 17 September 2014,the US Federal Reserve Board announced that they would withdraw from the new principles of the QE policy.This is clearly an indication that the US would raise the interest of the federal fund(the interbank offered rate)as the first step in the normalization of the currency policy.
In October 2014,the US Federal Reserve Board officially announced the termination of the QE3.In the future process of initiating interest rise,the US Federal Reserve Board would mainly adjust the ratio of excess reserve to drive the Federal Fund interest rates into the targeted zone,and at the same time take advantage of the overnight repurchase agreement and other supporting tools to step up control over the Federal Fund interest rates.
As the benchmark interest rate,the Federal Funds Rate would directly affect other short-term interest rates and long-term interest rates,and further affect family spending and enterprise investment.These policies may reduce the market liquidity,resulting in the further increase in long-term interest rates.This will in turn trigger violent volatility in the international financial conditions,resulting in abnormal flow of multinational capital flow,impacting the international debt market and the foreign exchange market.Meanwhile,the US Federal Reserve Board launched the“zero rate prospective guidance"policy to offset global tension.The replacement effect of this policy is still unclear,and there may be drastic changes in the liquid supply-demand pattern in international finance as well as in the commodities and real estate markets.This will bring new uncertainty to the global economy.The withdrawal of the QE currency policy by the Federal Reserve Board was similar to its introduction—while they claim that it was a“domestic"policy,it has important“external"impact.The gradual withdrawal of the QE policy will change the supply-demand pattern of international finance, commodities and real estate market liquidity.This is conducive to maintaining the stability of asset prices and preventing the accumulation of bubbles.But at the same time it may result in developed countries having their long-term interests constantly on the rise,and this will encourage international investors to re-assess their assets and adjust their asset portfolio.
This will also lead to international capital flowing out from developing countries,especially the five fragile countries(Brazil,Indonesia,India,Turkey and South Africa—the so called BIITS).Since May 2013 when the US Federal Reserve Board hinted at reducing the scale of currency stimulation,the market has been expecting chaos and increased sensitivity to the withdrawal of the QE,and there was also an obvious increase in the shock and risks in the market.IMF was of the view that it was difficult for the US to withdraw steadily,and the ability to control the long-term interest rates and market volatility are the key to realize it.If the market volatility is reduced,it may lead to a steep increase in longterm interest rates,creating a spill-out effect in the market.
The withdrawal of the Federal Reserve Board from the QE policy will have an even more obvious influence on the short-term liquidity of these capital assets.The day the Western central banks tighten their currency policies will be the time the emerging markets face real tests on risk management.
It will jack up the interest rates of developed countries in the financial market,and change the investment return contrasts between developed countries and newly emerging economies,so that international capital will flow back from newly emerging economies to the developed countries.This will lead to high volatility in the stock market and foreign exchange markets,and at the same time face the double blow of capital outflow and the drop in the price of export resources.The environment for development will continue to worsen.In fact,since the Federal Reserve Board withdrew from the QE policy,there was intensified volatility in the international financial market.The currencies of some newly emerging economies drastically depreciated.Inflation was serious,the stock market dropped considerably,and economic acceleration dampened.The Institute of International Finance estimated that the private capitals flowing into the newly emerging markets will drop from US$1,200 billion in 2012 to US$1,000 billion in 2014.To prevent capital outflow,newly emerging economies will need to tighten the currency and financial policies,but unfortunately this would further dampen economic growth,which is already slowing down.
The US's withdrawal from the QE is a large-scale financial reverse operation that is unprecedented in the world economic history.The assets and liabilities table of the US Federal Reserve Board has increased from under US$1,000 billion before the financial crisis to nearly US$4,000 billion in 2013.This is technically very difficult to operate,and will trigger a series of unpredictable risks.2014 is only the first phase.In a prolonged period into the future,the international financial and economic pattern will once again fall into the process of“re-adjustment".
The“Nixon Shock"of the 1970s triggered a competitive depreciation in Western currency,and a climax of debt and financing among the developing countries.In the early 1980s the currency tightening policy of the Federal Reserve Board detonated the debt crisis that swept over Latin America and the former USSR,dragging the Latin American economy into the“lost decade",and exacerbated the economic fiasco of the former USSR.
In the face of the new factors of uncertainty in the world economy,newly emerging markets should be well prepared for the Federal Reserve Board's currency alteration policy,and see how this“domestic policy"will create huge impacts on the external side.
The“after effects”of the European debt crisis
After experiencing the“emergency period"of the European debt crisis,the Eurozone in 2013 was not in good shape.Although the member states reduced the main risks by passing the policy actions and stabilizing the financial situation,they are merely transferred from the intensive care unit to the general ward.They are not yet immune from the recession and are still suffering from a negative growth of 0.4%.The financial system of some member countries was still fragile,and their peripheral economic growth is still constrained by the credit bottleneck,high unemployment,population aging.These issues exert considerable pressure on the financial situation and the task of structural adjustment is still daunting.
The Eurozone economic growth compared with the previous quarter was 0.3%in the second quarter of 2013—the first time after the fourth quarter of 2011.The economic growth compared with the previous quarter was 0.1%in the third quarter,the second consecutive quarter experiencing growth.
With increased confidence in the economic prospect in the market,the Business Climate Index in the Eurozone continued to climb.November 2011 was the 7th month of increase in the index,reaching the highest point since August 2011.In October 2013,the unemployment rate in the Eurozone dropped to 12.1%,the first drop since February 2011.In 2014 the world was worried about deflation in the European Union.Overall speaking,however,business enterprises gradually became optimistic about the prospects of economic development.In January 2014,the Eurozone Purchasing Manager Index(PMI)reached 53.2,higher than the 52.1 at the end of 2013,and reaching the highest point since mid-2011.The subindices in this index,including manufacturing industry and service industry,were clearly higher than the general expectations in society.In the meantime,the urge to invest was also gradually strengthening.Germany,the locomotive in Europe,was enjoying steady economic growth,and France,as the number two economy was making a turn for the better.As for debt-ridden Spain and Italy,their financing cost was at a comfortable level.Meanwhile,the financial and economic situation of Greece also improved.German Chancellor Angela Merkel was re-elected through a convincing win,which was conducive to the sustainability of the European Union and Europe's central bank policies.This is also favorable to the development of the Eurozone towards a“strong Euro".However,consumption spending in the Eurozone was still weak.At the same time,the high unemployment rate and the slow pace of adjustment make it unlikely for the economy of the Eurozone to drastically regain its rising trend.
In 2014,the annual inflation rate in the Eurozone rose by 0.7%,far lower than the 2%target for the central bank of Europe.This shows that there is still considerable threat of deflation in the Eurozone.Moreover,the internal economic revival is still obviously divided,and the rates of economic growth in the core countries and the peripheral member countries are still very different,and the situation is unlikely to be changed.Take the fourth season of 2013 as an example—the GDP increased by 0.3%for France,0.4%for Germany,0.3%for Spain,and 0.1%for Italy.
The resumption of steady growth in the economy of the Eurozone will be a slow process.In the process of addressing the European debt crisis over the past few years,the European Union implemented a range of measures to maintain the revival of the economy.The intervention of the European central bank and the pledges made by government of debt-ridden countries had brought to the Eurozone a degree of stability.
The financial markets in the Eurozone is becoming more and more stable,and are working towards setting up a stronger currency alliance,and consolidating the financial system.However,there exist a lot of weak spots,including the deteriorating public debts,high-cost lending,and fragile banks.Through policy actions,the Eurozone has reduced the main risks,but the Eurozone financing departments are still working hard.Some of the countries still hold on to their very week financial situations,but the financial departments in the Eurozone are still very fragile.The prepheries'economic growth is still constrained by the credit bottleneck.The structural reform and financial reorganization carried out by the European Union will certainly constrain investment and consumption demands,and this suggests that the speed of economic growth will slow down.The high unemployment rate and population aging will exert considerable pressure on the public financial situation,and private debt,which remains high,will still be a long way on the path of structural adjustment.Hence the European Union still needs to use relevant policies to improve the prospects of economic growth,and enable the European Union economy to gather more vitality,in order to withstand the shock from inside and outside.
Moreover,although the deficits and debts in the Eurozone are being adjusted in a controlled manner,and the financial markets(such as sovereignty debts and stock market)are regaining the approval of the investors,there are still two stubborn challenges that cannot be taken lightly:the currency supply cannot be easily transformed into credit expansion,and the contraction of the total credit has yet to be improved.Indeed,deflation is continuing to deepen in multiple dimensions.
In terms of government fiscal deficits,after laborious adjustments,the total deficits of Eurozone governments are gradually approaching a reasonable level.Since 2010,the deficits are 6.2%,4.2%,3.7%and 3.1%,and in 2014,the figure further dropped to 2.5%.
If we look at the several countries with relatively high risk,we will find that Greece's deficit was adjusted from 15.6%to 4.1%,Ireland from 30.5%to 7.6%,Portugal from 10.2%to 5.5%,and Spain from 11.2%to 6.7%.We can say therefore that the reduction in deficits was remarkable.From the perspective of the proportion of government debt in the GDP,we see that in 2013,the Eurozone showed a moderate increase to 95.7%,and we expect 2014 to reach 96.1%,before starting to drop.At this stage the debt levels of the relatively risky countries are:Greece 176%,Ireland 123%,Italy 132%,Portugal 124%,and Spain 94%.In 2013,there are eye-catching positive changes in the financial markets in the Eurozone,especially in the sovereignty debt market,where the investors have regained confidence,and the rate of return from debt has drastically lowered to the original level.In Greece,the rate of return on its 10-year national debt was over 30%at its highest,and in 2013 it returned to 8.5%.Correspondingly,Portugal dropped from 14%to 6%,Spain from 7.5%to 4.1%,Italy from 7.6%to 4.2%,and Ireland from 12%to 3.5%.
In the Eurozone,the stock market maintained its pattern of rise,and the German stock market and the US stock market were in synchronization when they set a historical high.Although the rates of other countries were less spectacular,the trend was also on the rise.However,it is difficult to transform the currency expansion in the Eurozone to credit expansion,and the issue of total credit contraction has not yet improved.From the perspective of currency and credit,the Eurozone has fallen into the“liquidity trap".This is not just a problem in currency policy,but also a theoretical problem in the realm of currency finance.
M3,which is closely monitored by the central bank of the Euro,increased by 1.4%in 2013,and before the crisis the increase rate was about 8%,with the highest value at 12%.The de-leveraging process of enterprises is continuing.In 2013,corporate credit lending registered a negative growth of 3.5%,and the corporate leveraging,measured by the asset-liability ratio,dropped from the height of 77%to 69%.The de-leveraging process of family departments was more moderate,and family loans registered zero growth over the year.The family leveraging,measured by the debt-disposable income ratio,slowly dropped from 101%in 2010 to 99%in 2013.Although the family financing rate had been lowered to the low level of about 3%,the ratio of interest liability in the income was drastically reduced by over 50%when compared with the pre-crisis level,yet the family sector is still unable to enter the leveraged period.Without corresponding credit expansion,it is difficult for the consumption and production of the European Union to fundamentally recover.At the same time,the threat of deflation in the Eurozone continued to deepen in multiple dimensions.As the Eurozone is still in the periodic cycle of credit contraction,the pressure of deflation is inevitable.Inflation rate dropped from 3%in 2011 to 2%in 2012,and further dropped to 0.9%in 2013.
There was an even greater drop in the inflationary price level of manufactured products,from 5.7%in 2011 to 2.8%in 2012.Starting from June 2013,the figure dropped to the area of negative growth,with 1.4%deflation at the end of the year.Based on the mutual relationship between inflation and salary,the inability of salary to grow is an important factor for consumption to rise significantly,and for the suppression of inflation.This is testified by real data.Before the crisis,the salary cost increase in the Eurozone was at the 2.5%level,and it fell to 0.9%in 2013.The excessive gap in employment has created an obvious constraint on salaries and inflation.
The Eurozone continued to strengthen its QE effort in currency policy.The central bank of Europe made twice interest rate reductions in 2013.The first time was the decision in May to lower the Prime Interest Rate from 0.75%to 0.5%.The second time,in November,further lowered the benchmark rate to 0.25%.The lowering of the interest rate by the European central bank had an immediate and positive result.On the one hand,it suppressed the excessively fast value appreciation of the Euro,and on the other hand,it suppressed the rise of the longterm interest rate in Europe.
Before the interest rate reduction,the rates of return of US and European long-term bond were generally at a reasonable level,but after the interest rate reduction,the US long-term bond rate of return rose from 1.6%to about 3%,with the anticipation that the QE would be withdrawn.Meanwhile,the rate of return from long-term bond in the Eurozone is maintained at within 2%.
In contrast,the policy theme of the US Federal Reserve Board was reducing QE,while that of the Japanese central bank was expanding QE.Meanwhile,the situation of the European central bank was in between the two—and the theme was how to stabilize the easing projection.The following factors impose constraints on the currency policy stand in the Eurozone.First in the aspect of public financial reorganization,the active coordination of currency policies is essential,because it creates a longer and more stable transition period for the process of public financial contraction.Second,the inflation level is still too low,and the output gap is still too wide,and the risk of deflation must not be neglected. Third,the credit market in the Eurozone is still gloomy,and both the credit supply and credit demand are shrinking,and the process of adding leverage is still non-existent.
Hence in the short term the Euro should not maintain a strong stance.In 2013,the surplus in the current accounts in the Eurozone reached 3%of the GDP,the highest in history(-2%in 2008).This is an essential factor in driving the economic recovery,and the Eurozone is carefully maintaining this status.In February 2013,the Euro appreciated so drastically that the governor of the European central bank,Mario Draghi,twice expressed his views to intervene.Deflationary risk is currently the main threat facing the Eurozone economy.
In the process where private enterprises and the government are de-leveraging,there appeared in the Eurozone a large amount of idle capacity,resulting in the inflation rate remaining lower than the potential level.In August 2014,the Eurozone inflation index HICP rose by 0.3%compared with the same period in the previous year,and dropped to the lowest point since the end of 2011.In the past several months,Spain,Portugal and Greece fell into deflation.At the same time,the inflation rates in Germany and France were lower than 1.0%.In September 2014,the European central bank officially announced that it would start to implement the QE currency policy,putting the ABS purchasing plan on the agenda.To address the deflationary risk faced,Mario Draghi disclosed that the balance sheet of the European central bank would increase by 700 billion Euros to 2,700 billion Euros,suggesting that this time the European central bank would inject 700 billion Euros.
Deceleration of Abe's Arrow
The Abe Economics launched by the Japanese Government managed to increase the acceleration of its economy to 2%in 2013,to grow its exports,and to end the negative growth of the prices.However,the short-term effects have started to shrink.If Japan fails to amply implement its public financial and structural reforms,the result might be the recurrence of deflation,with the banks holding more debt,the public financial stability being challenged with risk,and the super expansionary policy faced with uncertainty.
When the US was preparing to withdraw from the QE policy,Japan,under the guidance of the Abe Economics,stepped up its effort to implement the QE policy in order to pull its economy out of deflation.The three arrows in Abe Economics are:first,expansionary monetary policy;second,public financial stimulation on a large scale;and third,a basket of growth strategies,including relaxing control and facilitating innovation,with an aim to stimulating the Japanese economy and escaping completely from deflationary recession.
Under the strong effect of monetary policy and fiscal policy,Abe Economics raised the confidence of the Japanese in their domestic economy.In the short run,the Japanese people will be stimulated.The Japanese economy will maintain its revived growth,and the policy will progressively demonstrate its effects.After experiencing two“lost decades"during which the people suffered from deflation,Japan's consumer prices are on the rise.Supported by very expansionary monetary policies and stimulating fiscal policies,coupled with a drastic depreciation of the Japanese yen,the Japanese economy in 2013 saw moderate revival.The unemployment rate dropped,private consumption rose,industry production grew moderately,and export rose again.In September 2014,Japan's core Consumer Price Index(CPI)rose by 2.6%over the same period in the previous year.The prices expectation showed a rising trend,as expected,which is conducive to helping Japan walk out of its shadow of deflation.With the implementation of the QE policy on a large scale,the Japanese central bank drastically suppressed the exchange rate of the Japanese yen.This was favorable to the Japanese exports,with increased overseas income for Japanese enterprises settling in Japanese yen.While enterprise profits grew,this also jacked up the prices of imports,increasing the costs of energy and resource imports.
However,the Japanese economy is facing an increasing number of uncertain factors.The short-term effects of the Abe Economics are shrinking,and the deceleration of economic growth is becoming more and more obvious.Although in the first quarter of 2014 Japan's GDP increase was 1.5%compared with the previous quarter,registering six consecutive quarters of positive growth and reducing the signs of deflationary risks,yet the main reason for the soaring of the Japanese economy was that the increased consumer tax(from 5%to 8%)implemented on 1 April 2014 resulted in the phenomenon of premature spending in the first quarter.Meanwhile,the implementation of the consumer tax exerted downward pressure on the economic growth in the second quarter,and the sub-50 PMI is an indication that there is relatively great pressure for the economy to slow down.
After April 2014,the negative effects of tax adjustments started to surface,creating a constraining effect on growth in consumption.Personal spending was clearly shrinking,with the sales turnover of domestic electrical appliances such as TV sets and air conditioners dropping by about 20%compared with the same period in the previous year.Car sales were also affected,and mining productions declined by 0.6%compared with the previous month,creating a constraining effect on the economy.The motive power for the revival of the Japanese economy has weakened.To escape from deflation and to facilitate economic revival,Japan's central bank announced that the country would maintain its super expansionary currency policy.The country also decided to extend the so-called financial supporting fund system,which was due to mature at the end of March 2014,for one year,to encourage banks to continue to offer loans to enterprises.To address the downside risk of the economy,brought by financial constraints,the Japanese central bank may continue to implement its super expantionary currency policy,but the effects of this policy are uncertain.
If Japan cannot fully implement the financial and structural reforms,the country may experience deflation once again,leading to banks holding more debts,and intensifying the link between sovereignty debts and banks,and putting financial stability at greater risk.Japan is facing the deep-level issues of aging population,and inadequate internally-generated motivation in the economy.As the“third arrow"of Abe Economics—structural reform—is unlikely to produce results,there is considerable risk in maintaining economic growth in the future.Even if Japan is adopting relevant fiscal stimulations,there are negative factors such as rising costs of energy and resource imports,prolonged increase in interest rates,and pressure from financial debts.Hence Japan's economic growth in 2014 may be lower than in 2013.For example,in July 2014 the Japanese central bank adjusted the country's 2014 fiscal year's GDP increase projection from 1.1%(as forecast in April 2014)to 1.0%,and at the same time maintained the 2015 and 2016 GDP forecasts unchanged at 1.3%and 1.5%respectively.