What is the subsequent trend of the US monetary policy?

June is approaching, the time when the Federal Reserve completes the $600 billion US Treasury bonds purchase programme. Thus, how will the Board of Governors of the Federal Reserve System and the Federal Open Market Committee evaluate the efficiency of this programme and its contribution to the main monetary policy goals to promote the maximum employment, stable prices and moderate long term interest rates? Similarly, what are their insights regarding the subsequent monetary trends?

Financial stability decision to increase money supply and keep low interest rates should have supported the global trading in the world dominating currency - dollar; however, excessive growth of the money supply creates hyperinflation and this is even harder task to manage on the global level.

So, let’s consider whether the inverted Federal Reserve’s decisions to increase interest rates and to convince international financial institutions to buy the US treasuries bonds are favorable scenario to mitigate inflation. Moreover, what should be the cost of such policy? The US long-term credit rating AAA may be downgraded as S&P lowered its outlook from stable to negative according to the estimated US ability to reduce government spending and manage limits - $14 trillion ceiling on borrowing. Additionally, the policies of emerging markets may also be disadvantageous as emerging countries most likely will keep high interest rates to avoid the domestic economy overheating. So, how much and quickly the US interest rates should be increased to make the US Treasury bonds attractive investment. Incidentally, how will the described price stability policy affect the economy growth?

By the way, could it be that international financial institutions will buy the US treasuries bonds regardless of their credibility and profitability in order to sustain financial stability. Is this scenario reliable? Maybe, but if it is not – what is the next?

Current state - the macroeconomic crisis

During the plenary session of International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund in Washington in April 16, 20011 the enhanced role of the IMFC as a key forum for global economic and financial cooperation was welcomed. Also, the members committed to continue working together and intensify efforts to balance global economy growth, strengthen global financial sector’s stability and its ability to support economic recovery.

The policy makers agreed that the U.S., Japan, Germany, France, U.K., India and China will be examined by the IMF and the survey will include the monitoring and comparison of budget deficits, private debt and external trade balances for signs of excess. However, the future surveys will only supplement to the macroeconomic outlook that is already evident from the publicly analysed events: the US’s aggressiveness to boost the recovery and demand of their production by implementing QE2 programme, depreciating the dollar, keeping low interest rates and stimulating economy through measures that steadily increase sovereign debt, China’s intentions to keep export leaders positions and support domestic development simultaneously by their plans to increase M2 and hold down the renminbi as long as China is in the strong economic leadership stance and Europe’s considerations regarding slow recovery, raising inflation and sovereign debts issues.

In addition, the Financial Sector Assessment Handbook prepared by the IMF in 2005 includes the macroeconomic approach which is based on the Demirgüē-Kunt and Detragiache (1998) study and is used to predict financial crises. The study showed that the macroeconomic policies cause crisis when economy growth is low and inflation is high. The practical evidences of the current macroeconomic crisis may be the following: high bond yields of the eurozone "peripheral" countries, concerns regarding the restructuring of Greece debt and uncertainties about the financing of Portuguese debt while the Europe’s economy growth is low and its recovery suffer from the pressure of high inflation as well as the US enlarged burden to repay its debt because of its excessive liquidity policy that created high inflation in its own low growth economy.

Thus, I believe that current data and macroeconomic events are enough to acknowledge that we already suffer a macroeconomic crisis and immediate solutions are required now but not then the IMF survey of the 7 most influential countries is accomplished.

Moreover, in order the cooperation goals were achieved and significant macro policies’ cross-border effects were minimized the statement from the Integrating Stability Assessments Under the Financial Sector Assessment Program into Article IV Surveillance (August 27, 2010) that determines systematic stability as the following:

“...systemic stability is most effectively achieved by each member adopting policies that promote its own “external stability” – that is, a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements. In the conduct of their domestic economic and financial policies, members are considered to be promoting external stability when they are promoting their own domestic stability – that is, when they comply with the obligations of Article IV, Sections 1 (i) and (ii) of the Fund’s Articles.”

should be revised and acknowledged by the IMFC that countries those are promoting only macroeconomic policies of their own domestic stability most often cause economy recessions in other regions.

The leaders' focus on prevention rather than escape of the systematic risks

Deep anxiety over the hardly observable systematic risks that cause financial crises and therefore the fragility of the global financial systems brought me to the Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments: Initial Considerations—Background Paper. The report to the G-20 Finance Ministers and Central Bank Governors was prepared by the staff of the International Monetary Fund and the Bank for International Settlements, and the Secretariat of the Financial Stability Board in October 2009. The questionnaire of the survey was sent to 27 central banks, the central banks of G-20 and central banks of other countries which are treated as host countries of important international banks. The purpose of the study was to find out how countries identify and assess systematic relevance and whether the countries consider any particular sector and individual institution within that sector systematic.

According to the survey respondents identified the banks as the most systematically important institutions. It was also revealed that the stock market, interbank money market, foreign exchange market and government debt market have the greatest systemic impact among markets. Moreover, many countries acknowledged that their payment and settlement systems are critically important infrastructure which is required for smooth functioning of the financial systems and, in addition to that, the respondents specified that the size, interconnectedness, leverage, maturity mismatches and concentration risk were the most important factors contributing to the systematic importance of the financial crises.

The survey accomplished more than a year ago shows clearly views and perceptions of the 27 most influential central banks regarding the systematic risks and is a keystone for G-20 leaders, the Central Bank Governors and the financial stability preserving international bodies to pursue financial system’s improvements, id est. enhance international cooperation, improve access to timely data on inter-institutional exposures and solve existing information gaps in markets and infrastructure.

However, improved quantitative and qualitative indicators, stress tests, scenario analysis and assessments of market developments are just techniques to identify systematic risk and ongoing legal, operational, regulatory and supervisory improvements are just the emergency guidance in the event of financial crises.

Thus, I wonder more about the G-20 leaders, the Central Bank Governors and the financial stability preserving international institutions’ extreme focus and concentration on the improvements of the current financial systems rather than stepping back and analysing broader the potential impact of proposed political leaders’ decisions on the attractiveness of business environment and global economy state. From my point of view, some systematic risks may not be caused by financial institutions and the reasons of them may not be identified on the balance sheets. So, while leaders try to find solutions how to prevent but not how to avoid systematic risks, the possibilities of the recurrent financial crises are highly reliable.

Is it a financial crisis? Maybe not, it is rather a crisis of sound leadership

The budget preparation and submission for the parliament approval is a test on the political influence. George Osborne, the Chancellor of the Exchequer of the UK passed the challenge on Wednesday, however, José Sócrates the Prime Minister of Portugal resigned after the parliament’s rejection of the austerity plan.

A burden of rising debts and a threat of insolvency force Europe to undertake budget deficit reduction measures and perhaps most importantly, to seek for the effective means to stimulate the recovery of the economy. As practice shows the political intentions to achieve the financial balance by increasing tax burden for corporations and individuals as well as the political commitments to protect and satisfy the essential needs of the increased socially vulnerable community, weaken states incomes and financial reserves. Consequently, that kind of policy deepens recession. In fact, political concentration on the solutions to ease the barriers of trade and production, to support business competitiveness and even small changes in tax reduction are welcomed by entrepreneurs and investors.

According to Osborne’s unveiled budget, politicians committed to reduce the costs of public sector and social support. Instead, they obliged themselves to create 21 new enterprise zones and apply specific measures to support businesses and high value manufacturing within those zones. At the same time presented similar public cost-cutting measures by Sócrates were opposed. Thus, political uncertainty, high yields on Portuguese bonds and a threat of insolvency, will foster Portugal to seek a bail out from EU and the IMF.

So, is it a financial crisis Portugal has to tackle? I do not think so. It is rather a crisis of leadership. If the budget was presented not as a plan of changed taxes and budget allocation in percentage terms but as an action plan of the development strategy it would be easier to gain political credibility and achieve support by the majority.

The outcomes of G-7’s intervention to support Japan’s recovery

G-7 agreed on selling the yen on Thursday night to prevent the Japanese currency from appreciation and help its domestic economy to recover after the natural disaster. The solidarity of the U.S., Japan, U.K., Canada, France, Germany and Italy and the nation’s prompt response to the critical situation is respectful, however let’s view the scenarios and outcomes of such intervention.


After the sharp decline of Japanese stock markets Japan threw trillions of yen into the markets to keep financial markets functioning. These monetary actions treated as financial stability measures are based on businesses self-support expectations. While Japan’s production is competitive and exchange rate is favorable to sell produced goods in foreign markets, it is likely that export industries will keep operating and even increase their production. Those desirable outcomes are well understood as one of the most important things for Japan is to master the rise of unemployment and place people those lost their jobs during the disaster.

On the other hand, additional sales of yen by G-7 central banks should support the devaluation of yen. However, what are the long term implications of this policy?

During a couple of years we saw the financial crises in US, Europe and now in Japan. The reasons of financial instability are different but one thing is common to all crisis management - monetary policy actions are just a short term relief. The increase of money supply which is used to keep financial stability and boost recovery most likely will have negative implications in the future. Uncontrollable money spread in to the markets may not reach those who really need financial support and directly contribute to the recovery. Moreover, excessive money amount in the markets boost inflation.

Thus, from my point of view, the G-7’s purchase of Japan’s government bonds and Japanese targeted subsidies to restore the outcomes of disasters would be a better decision.

Could the eternal engines be created?

Uncontrollable disasters sweep created wealth momentary and remind about the humans’ vulnerability against the nature powers. Destructive earthquake, tsunami and the explosion of nuclear power reactors in Japan weakened Japanese stock markets and coursed self-acting decline in global markets.

According to the direct damages, the companies those infrastructure were destroyed and production suspended as well as insurance companies may have a long lasting exposure to Japan. However, shares of rebuilding companies and producers of alternative energy resources may keep accelerating.

Beside the material losses in Japan, the explosion of the nuclear power reactors rise global concerns regarding the benefits of their efficiency versus risks due to radiation. Thus, after the Japan’s disaster the most attention may be shifted to better utilization of the nature powers such as wind, solar, water and thermal heat for generating practically eternal engines.

The rationality of current financial systems

Money is equivalent of value and its main purpose is facilitating swaps of products or services. Thus, does it mean that the value of produced goods or provided services fluctuates by itself according to the volatility in the foreign exchange markets? From my point of view, intrinsic value does not change however, the demand may be affected substantially. In short term, there are measures to hedge market risks but do we have foundations to keep stability of currency?

Today’s financial systems are more sophisticated and money possesses more functions. The one is very important – it is used as a device for future value creation. So, could the interest of producers to growth their businesses as well as sustain price stability and financial intermediates goals to multiply existing capital be harmonized?

Moreover, how much the same amount of money could be multiplied? Theoretically, as much as it is not restricted, in reality the amount of money is as much as it was issued. Thus, is an uninterrupted growth of financial wealth available and isn't sustainable growth losing its meaning in the current financial systems?

The same misunderstanding may be applied to the financial decisions that are made according to the market expectations. What is a rationality of managing market expectations rather than cash flows?

I think that markets fail to reflect real value and money is losing its main purpose - being an equivalent measure of worth.