The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Monday, February 27, 2012

Financial markets/economists slow to pick-up on global inflation worries

I've been arguing that inflation is the money printing end-game for years...From David Uren today:

Rising global liquidity
David Uren
The Australian February 27, 2012

THE European Central Bank will open the credit floodgates again on Wednesday, offering banks as much cheap funding as they want.

Over the past two weeks, the Bank of England and Bank of Japan have both increased their programs of expanding the money supply by buying their own governments' bonds.

A provocative report from Morgan Stanley contends there will be further European monetary support and that the US Fed will be printing money again before the year is out...

Analysis of the economic outlook for 2012 has so far mainly focused on whether Europe would implode, and on whether global growth rates would be better or worse than the IMF's slightly below-trend forecast of 3.5 per cent.

However, the expansionary stance of advanced country central banks may turn out to be the most profound influence on Australia's outlook this year.

Morgan Stanley economist Spyros Andreopoulos contends a "great monetary easing is now in full swing", with a run-up in global inflation likely by late this year and becoming more serious in 2013.

He notes that seven of the 10 major central banks in the world have eased monetary policy since the beginning of the last quarter of 2011 (including the Reserve Bank of Australia) and expects this to continue.

"We think the Fed will embark on a further round of asset purchases despite the recent data improvement. The aim is to 'nurture the green shoots' -- support the weak recovery as it unfolds rather than allow it to flag again."

He does not believe Wednesday's ECB refinancing of the banks will be the end of its balance sheet expansion. Although the last E500 billion ($623bn) refinancing, in which banks were offered three-year funds at 1 per cent interest, stopped doubts about the banks' ability to fund themselves, Andreopoulos doesn't expect it will bring the debt crisis to a halt.

JPMorgan forecasts further ECB purchases of government bonds and bank financing operations, with the refinancing rate lowered further to 0.5 per cent.

Not everyone accepts this analysis. Hostility within Europe to the ECB buying government bonds, whether on primary or secondary markets, remains strong. There has been speculation that this week's round of bank funding could rise as high as E1 trillion, but more conservative voices in Germany and Finland are concerned this is setting the scene for future problems.

Bundesbank chief Jens Weidmann warned last week that a "too generous" supply of liquidity could encourage banks to take excessive risks and lead to inflation.

However, the advocates for further expansion can point to the much improved financial conditions in the US and Europe which have followed the latest interventions.

A problem with credit creation is that if it seems to be helping and apparently costs nothing, it can be hard to know when to stop.

Reserve Bank governor Glenn Stevens said on Friday that it would be very tricky for central banks to unwind their balance sheet expansion and raise interest rates from zero at the right time.

"It isn't that surprising that some people worry about the potential for longer-term inflation," he said.

For the moment, output in the advanced countries remains depressed, even in the US, so there is little near-term prospect of the massive credit creation generating inflation locally.

However, further expansion would spill into commodity and securities markets. The effect on commodity markets would not be uniform. Market-traded commodities like copper, oil and sugar will rise as investment funds look for real assets.

The commodities most important to Australia -- iron ore and coal -- provide limited opportunity for global funds and are heavily influenced by what happens to Chinese demand.

That softened late last year. There is no sign yet that Chinese steel production is recovering as it emerges from the New Year holiday.

Morgan Stanley argues that to the extent that emerging countries preserve their tight currency bonds with the US dollar, it will also kick off a new round of emerging-nation inflation.

China tries to sterilise the capital inflow, but this can only ever be partially successful. The emerging countries inevitably wind up importing some of the expansionary monetary policy of the advanced nations.

Inflation in the emerging world then flows back into the advanced countries through rising prices on traded goods and commodities.

If the monetary stimulus does eventually raise global growth, the inflation risks would become more serious. This is particularly so as there are incentives in heavily indebted countries to tolerate higher inflation as a way of reducing their debt burdens.

Globally, the search for yield will gather fresh intensity. This will put new pressure on the Australian dollar as carry trade investors source funds at zero interest rates and buy Australian securities offering the highest-yielding triple-A exposure in the world.

In principle, the expansion in the money supply of the US, Europe and Japan should bring depreciation of all their currencies, although it begs the question of what they can depreciate against. The Australian dollar, as one of the few currencies where the central bank authorities remain opposed to intervention, could rise significantly higher.