Easing policy could become a common response to crises

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The world is entering into a new easing cycle. Nearly two-thirds of analysts expect trade tensions between the United States and its trading partners to intensify within this year, with more than 80% calling it the start of a global easing cycle, according to a Reuters poll.

That expectation is borne out by the fact that central banks in most major emerging economies are moving to the dovish side, with a growing number of countries joining the interest rate cuts.

For example, countries such as India, South Korea, Indonesia, South Africa, Turkey, Russia, Malaysia, and the Philippines have announced interest rate cuts. Among them, India’s central bank has cut its interest rates three times this year and it may do so again next month. In addition, central banks in Egypt, Kyrgyzstan, Georgia, Jamaica, Azerbaijan, Nigeria, Ukraine, Paraguay and other emerging markets have also cut their interest rates within this year. Central banks in developed countries such as Australia, New Zealand and Switzerland have also cut interest rates.

Despite central banks in U.S., Europe and Japan having yet to announce rate cuts, it is expected they will cut their interest rates soon. Expectations are that the Fed is expected to cut rates by 25 basis points at its July meeting.

On the other end, the European Central Bank may ease their policy at any time, though it has not announced a rate cut and the likelihood that the Bank of Japan will implement a loosening of its policy has also risen.

It should be pointed out that the current easing policies of central banks around the world are different from that of 2008, when the U.S. economic crisis led to other economies around the world to different degrees of crises.

At that time, central banks collectively adopted consistent easing policies to get rid of the crisis. However, the coming easing cycle has not been marked by an economic or financial crisis, or even a recession. At most, there has just been a slowdown in economic growth. In this case, the central banks are rushing back to the easing operations.

On one hand, it is possible that the central banks have been forced by political pressure to implement a loose policy. On the other hand, it shows that these countries still cannot come up with better policies to cope with the economic slowdown, which can only be solved by expansionary monetary policy.

In addition, the current central banks’ loose policies have certain competitive characteristics. Central banks want to maintain the stability and prosperity of their capital market through easing policy, and as such they do not want to lag behind in the decision to loosen monetary policy.

As a result, whenever there is volatility in the economy or financial markets, central banks will choose to respond with easing policy, thereafter making this operation a common practice. Despite this however, the stimulus effect of easing policy on the real economy has been weakening.

A Reuters poll of more than 500 analysts showed that despite expectations of further interest rate cuts or policy easing by major central banks, the risk remains that global economic stagnation could intensify.

Analysts that were polled remain concerned about the trade war between China and the United States. Sovereign bond yields on major countries have fallen as most recent economic data have heightened such growth concerns. Growth appears to be slowing in most industrialized and major developing economies.

Despite clear signs that trade conflicts and geopolitical uncertainty have dented investment and economic activity, the loosening of monetary policy has pushed the stock market up. Chetan Ahya, global head of economics at Morgan Stanley, pointed out that, “as uncertainty around trade policy is unresolved, the impact on the growth outlook is becoming more pronounced.

We project global growth to slow even further, and any sustained escalation from here raises recession risks”, and added that “while we believe that the easing cycle will be back in full swing, the drag from elevated uncertainty should still weigh on the macro outlook”.

As more and more central banks around the world begin to implement easing policy, the side-effects are likely to intensify. Institutions such as the Institute of International Finance (IIF) and Bank for International Settlements (BIS) have begun to warn the world of the risks of returning to an easing cycle.

A recent IIF report noted that falling global interest rates fuelled a new lending boom in the first quarter of 2019, with emerging market debt soaring to a record high of US$ 69.1 trillion from US$ 68.9 trillion a year earlier, and the overall global debt stock jump by $3 trillion to $246.5 trillion, just US$ 2 trillion shy of the all-time high reached in the first quarter of last year. Emre Tiftik, deputy director of global capital markets at the IIF, warned that the growing reliance on short-term debt may leave many emerging markets exposed to sudden shifts in global risk appetite.

“The 2018 slowdown in debt accumulation is looking more blip than trend: helped by the substantial easing in financial conditions, borrowers took on debt in Q1 2019 at the fastest pace in over a year.” He also stated that, “looking ahead, broad-based central bank easing could very well prompt more debt build-up across the board, undermining deleveraging efforts and reigniting concerns about long-term head-winds to global growth”.

Coincidentally, BIS recently has also warned that there is almost no economic value towards further interest rate cuts, and that short-term stimulus may cause more harm than do any good.

According to BIS, real growth cannot be achieved by zero interest rates and quantitative easing alone. Similarly, the trade-offs brought about by asset booms are increasingly difficult to justify.

Similar to the leverage in 2008’s bubble, it is likely that a large-scale sell-off will be triggered in the next round of economic downturn.

BIS General Manager Agustín Carstens pointed out that central banks also need to be cautious about any easing policies. According to Carstens, it is important to reserve some room for manoeuvres that tackle a more serious recession.

BIS also believes that emerging markets are often affected by foreign capital, which may have an impact on exports and asset prices and trigger inflation. If these factors suddenly change, the market would become vulnerable.

In these situations, foreign exchange intervention and macro-prudential policies are more effective tools for central banks of emerging markets to cope with hot money flowing into their economies.

Anbound’s researchers believe that from the current situation, the easing policies of central banks around the world are becoming the norm. Using such measures to deal with the economic slowdown may bring out short-term stimulus results.

In the long run, however, the risks will be constantly accumulated.

As Anbound’s Chief Researcher Chen Gong mentioned in his book Crisis Triangle, the “crisis triangle” in the long run is the triad of “urbanization – capital surplus – economic and financial crisis”, and the current “central banks’ easing policies – capital surplus – economic and financial crisis” also constitute a type of “crisis triangle”. Specifically, the easing policies of central banks around the world can only temporarily mask economic risks.

In fact, this will directly lead to a global capital surplus, which in turn will lead to bubbles in various assets.

Once the bubbles burst, it will aggravate the fluctuation of the world economy. Such fluctuations can lead to a real economic crisis, especially for developing countries.

Final analysis conclusion:

Central banks around the world have commenced with a new round of easing cycles. Unlike in 2008, the current easing measures are preventive operations, and it shows a competitive feature between the countries, making measures a new kind of normal. Although the easing policy can stimulate economic growth in the short term, it will accumulate more risks in the long run. When this risk becomes too huge, the easing policies will become ineffective, and then the world will usher in real crisis as a result.

Anbound Malaysia

Anbound Consulting (Anbound) is an independent Think Tank with the headquarter based in Beijing. Established in 1993, Anbound specializes in public policy research, and enjoys a professional reputation in the areas of strategic forecasting, policy solutions and risk analysis. Anbound Research Center (Malaysia) is located in Kuala Lumpur. The Center is mainly engaged in ASEAN regional economy and policy research. It also advises Malaysian government agencies, Chinese companies in Malaysia and Malaysian companies in China. Anbound has established close research partnerships with Malaysian top think tanks and research institutions.

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