#5. National political dysfunction is still a headwind to overcoming economic malaise and restoring genuine and durable financial stability.
We have brief touched on United States government earlier. But all over the world, there is lacking of leadership on the part of government. Needless to say, there are a lot of factors contribute to the issue, but this has increasingly become self-feeding loop of worsening situations.
#6.The “G-0” Slide into the “international Economic Non-System” – As national dysfunction undermines global policy coordination, traditional core/periphery relations fail and geopolitical tensions escalate.
Some economist put it this way: We are now living in G-Zero world, one in which no single country or bloc of countries has the political and economic leverage – or the will – to drive a truly international agenda. Nobody has to follow any rules. Everybody does what they consider is in their own short-term best interest. The real difficulty is: What is in their short-term interest – for example, following ultra-easy monetary policy – could well backfire somewhere, it might be not in their long-term best interest. And as the easy monetary policy influences the exchange rates, it influences other countries. Almost every country in the world is in easing mode, following the Fed, and we have absolutely no idea how it will end up. We are in absolutely unchartered territory here.
The current architecture of the world’s economic and financial system still places the advanced economies at its center. It assumes that these economies will be relatively well and responsibly managed over time. They have lots of influence and retain their historical entitlements. And they have huge influence and veto power over multilateral institutions. In return, they underpin global economic and financial stability. With the advanced economies not able to deliver well on this implicit contract, and increasing number of countries in the periphery of the global system have naturally felt frustration and anxiety.
Unable to improve the design of the global system, and unwilling to stand passively by, a set of countries has been gradually building small pipes that explicitly seek to bypass the core. This is particularly true for the BRICS, a grouping of countries that on paper have very little in common, culturally, politically, geographically, or linguistically. Yet it is a group that has been energized into action by dissatisfaction over the way the advanced countries are managing what is still a Western-dominated international monetary system. This is one of the reasons why the United States and some other countries have opposed the new institutional initiatives pushed by these emerging economies. … Yet United States has suffered the unfortunate experience of seeing one ally after the other ignore its opposition ….The jury is still out on the impact and effectiveness of the young BRICS’s initiatives, including the AIIB and the new development bank. A lot depend on their ability to meet six inherent challenges below:
- Letting meritocracy, rather than politics and national entitlements, determine key appointments and decisions;
- Being able to strike the right balance between developmental and commercial objectives;
- Promoting the replicable use of public-private partnerships;
- Ensuring that projects are environmentally and socially sustainable;
- Comprehensively putting in place supportive institutional, regulatory, and legal structures; and
- Deploying and applying well a more modern set of evidence-based analytical and financial tools.
#7.The Migration and Morphing of Financial Risks – With systemic risks migrating from banks to nonbanks, and morphing in the process, regulators are again challenged to get ahead of future problems.
Undoubtedly, the banking system in advanced economies is now safer – a lot safer. The de-risking has been led by the United states, where in 2009 the government moved forcefully in implementing a rigorous stress testing of banks. The sector as a whole will be made less volatile. Yet this is not to say that systemic risks – that is, the threat of financial accidents contaminating the real economy and thus destroying jobs and likelihoods – will be eliminated or overwhelmingly reduced. After all, the risks are morphing as they migrate out of banks and to other sectors of the financial system. Economist Grep Ip, has a good metaphor to describe what is happening: “squeezing risk out of the economy can be like pressing down on a water bed: the risk often re-emerges elsewhere. So it goes with efforts to make the financial system safer since the financial crisis.”
This development is accentuating a growing imbalance between the shrinking intermediaries in the marketplace (the broker-dealers) and he growing number of end users (asset managers of both the traditional and nontraditional ilk, as well as sovereign wealth funds, pension managers, insurance companies, etc). All these shifts have been turbocharged by the low interest rate environment. Jaime Caruanna of the BIS put it this way: “It is likely, though not undisputed, that the search for yield I a low interest rate environment can contribute to the build-up of financial imbalances. This so called risk-taking channel of monetary policy could be particularly relevant when economic agents anticipate that the low rate environment will persist or that monetary policy will be eased in the case of market turmoil – a kind of central banker’s put, if you will.”
Jaime continue to say, that “There is relatively little knowledge as to what policy measures could be taken to address the build-up of financial excesses that originate from outside the banking system. A relevant consideration here is the way in which credit intermediation is moving away from the banking sector to the debt securities market.” Mohamed El-Erian said he would add that it is moving well beyond even that.
#8.The Liquidity Delusion – When the market paradigm changes, as it inevitably will, the desire to reposition portfolios will far exceed what the system can accommodate in an orderly fashion.
Unlike other bond markets, US Treasuries are viewed as being open for business for the entire global trading day … Any indications that the market can suddenly shut down with little warning raises troubling questions about how the nature of trading has changed in recent years.
The impact on liquidity of ETFs, liquid alternatives and the Volcker Rule are yet to be tested in tough times. We’ll see what happens in the next serious downturn. Investors appear to strongly believe that the markets would provide ample liquidity for them to reposition their portfolios should they ever need to, yet there are many reasons why this is unlikely to be the case, setting up the markets as w whole for some harrowing roller coaster journeys.
Mohamed believe there is a potentially dangerous of systemic underestimation of the liquidity risk facing the global financial system, one that is hard to deal with easily, given its structural underpinnings.
#9. Bridging the Gap Between Market and Fundamentals – Yet none of these uncertainties and fluidities seemed to disturb financial markets that, operating with unusually low volatility, went from one record to another. As such, the contrasting gap between financial risk taking (high) and economic risk taking (low) has never been so wide.
Logically you would expect higher financial market volatility in the face of the long list of economic, financial, institutional, geopolitical, political and social uncertainties we’ve covered thus far. Yet this hasn’t happened much from 2011 to present. The explanation for this unusual “vol” behavior lies in a combination of facts – from growth having been stuck in a low-level equilibrium to investors seeking “carry” income and other investment gains as a means of meeting ambitious return targets that are resistant to any meaningful downward revisions regardless of how much asset prices have already risen. The result is to live in the moment, downplaying its artificial nature and the subsequent risk of major dislocations. This special moment has been underpinned by two huge injectors of cash into the marketplace: central banks and the deployment of unusually large cash balances held by large companies.
The determined efforts of central banks and their unquestionable influence on financial assets have translated to markets operating under the mantra that “bad economic news is good for markets.” Needless to say, the reactions of the markets – seeing central bankers again confirm that, whenever there is some doubt, they will opt for being more dovish –during both episodes were similar: they took off in a big way.
#10. It is Hard to Be a Good House in a Challenge Neighborhood – All of this adds up to considerable headwinds for the better-managed part of national, regional, and global systems.
Coming out of the financial crisis, companies opted to retain earnings and build up a cash cushion, minimizing the chance of being traumatized again by the market grinding to a halt. But with the growing reality of activist investors – that is, financial investors that use various instruments to place considerable pressure on managements and boards to change – it became only a matter of time until money started flowing back to shareholders through share buybacks and higher dividend payments. Business ecosystem has evolved significantly and presents a daunting challenge for companies working to resist short-term market pressures.
Jaime Caruana observed: “while we now have a sense that all the policies involved need to pull their weight, the truth is that our understanding of how they might interact is still limited. In summary, the enormous scale and scope of the potential gains for society as a whole is held up by a system that hold back long-term economic risk taking and limits the upside of individual empowerment.
The frustrating (and avoidable) headwinds to new-growth divers add to the factors discussed earlier that undermine the effectiveness and credibility of central banks. Remember, the policy bet is underpinned by the expectation (hope) that growth will come roaring back despite the repeated failure of governments to promote a more conductive productive environment, and that this will also help contain and manage the risk of future financial instability, reduce inequality, restore institutional credibility, relieve political dysfunction, and alleviate social tensions.