Gradual Revival

Gradual Revival

 The US Federal Reserve has ended its stimulus programme, with a mind and eye to sustain it. For the moment, the economies of the world are holding up quite well. But what will be the gradual effect of this contraction in global liquidity? Will there be massive volatility as the risk-averse money starts returning from across the globe to the purported safe-haven of the US? Will the Emerging Markets including India, despite its reviving economy and reform initiatives, take a massive hit on its stock markets and its FDI expectations?

Will the US bourses, also pumped up on the near-free money, not necessarily in relation to prudent valuations, head sharply downwards? Will the returning money go back mostly into US Government Bonds?

This indeed is the  majority, if status-quoist view. But, is The US the only safe-haven  for the global trillions of investible funds anymore? Some analysts say that that it is time to simultaneously re-rate global risk and reward perceptions across all the options.

To these eyes, the US Bonds may be thought safe,  but the American Government is in trillions of dollars of debt, much of it being financed by other countries. The Government bonds cannot, in any case, give the kind of returns that global equity and commodity markets can deliver. So is the safe- haven argument all that it seems to be, given that the US Government is struggling to finance even its current account needs with ever higher borrowing limits?

The US stimulus was practically interest free money, $85 billion worth per month, being pumped into the global economy. On its ending, Japan has started a massive stimulus programme of its own, promising to buy 33% more in assets, involving trillions of dollars. This has cushioned the blow for the time being as well.

But the US stimulus money did set off a commodity markets boom, including in the prices of petroleum and gold. Both have reduced sharply of late, partly because the demand -supply dynamics have changed, and because the stimulus money was being tapered before being stopped altogether now.

Today, the biggest single global source of optimism is the price of oil, reduced by over 20% from its peaks and heading lower. The US has, over the last decade, rendered itself self-sufficient and even exports a surplus. This is a big change in the calculus because it once consumed 50% of the global output. This fact is bound to change the face of the petroleum sector permanently and profoundly affect the geopolitics of oil.

Yet, the massive indebtedness of the US and most of the interconnected developed world remains, even after six years of ‘Quantitative Easing’ (QE). Unemployment in the US is still near double-digits, the US economy is growing quarter on quarter, but the situation is still fragile, and the EU is not looking good with France and Germany also limping. Poor demand, stagflation, cries for write-offs of huge debt, persist.   

But now, with a mild attempt to balance the books in the works, it is widely expected that the  US Federal Reserve will start raising interest rates in the middle of 2015. Will this unleash a second stage of insecurity in the global economy?

It is hard to predict the amount of reaction and pessimism about the future that could result, but again, kicking the can endlessly down the road is not prudent. Some analysts even talk of an impending crash that will dwarf 2008 because of the artificiality of long-term stimulus.

But even then, will the Obama Administration, tasked with setting the stage for a Democratic Party re-election in 2016, want to chance leaving a volatile, turbulent economy to its successors?

What could save both sides of the argument and provide clarity, is  Janet Yellen, Chairperson at the Fed’s stance. Yellen maintains that there could arise a case for additional stimulus if things look bad, or interest rate tightening if all parameters look like they are on the mend. The Federal Reserve intends being both cautious and responsive to the realities rather than ideologically doctrinaire. There is no Hawk or Dove ruling the roost. It is going to be a pragmatic response, based on economic ground realities.

But the US knows it cannot decide in isolation. If its own recovery sustains over the next few months, it  will still be buffeted by global problems. There is a slow-down in the EU. And another in China, with Japan struggling to reverse its deflationary trends, and so on.

Yet, on balance, the policy of massive stimulus has worked, staving off a global economic melt-down. And so, in future, even as the direction has been enunciated, the policy action will be tempered by ground realities. The US is going to take the lead, as it must, and do nothing to plunge the economies of the world into an avoidable crisis.

 (807 words)

November 5^th, 2014
Gautam Mukherjee