• Central bankers have taken their eye off the ball
  • Profligacy and overregulation are curbing economic progress
  • Leaders need to refocus on reining in cheap money and promoting free trade

In a question-and-answer session at the British Academy in London on June 27, 2017, United States Federal Reserve Chair Janet Yellen declared that she thought a financial crisis on the scale of the one that occurred between 2007 and 2009 would not repeat – at least not in her lifetime. This is due, she said, to new, robust regulations and supervision.

It is certainly true that the U.S. banking system is more robust than Europe’s. After the crisis, U.S. regulators insisted on reestablishing strong capital requirements for banks, so that they would again be able to extend loans to businesses.

In Europe, stress tests were introduced, and some banks tried to reduce their loan portfolio instead of increasing their capital. Still, we can only hope that Ms. Yellen’s assurance relates to the strength of the global financial system and not to the robustness of her own health.

We know that especially due to big public deficits and excessive debt worldwide, financial systems across the globe (including in the U.S.) are quite fragile. Though Europe is frequently mentioned as having such problems, we should not ignore that Japan and China are also dealing with these challenges. Now is not the time to stop worrying.

Blame game

President of the European Central Bank Mario Draghi has also changed his focus. Instead of seeing the lack of inflation as the main cause of insufficient growth, he has begun blaming inequality as the root of the problem.

This is very confusing. First, the flood of cheap money due to quantitative easing promoted “inequality” by hugely inflating asset prices. The influx of cheap money was used to buy shares, companies and real estate. This demand caused increased prices and valuations.

The buzzword “inequality” has become an excuse for the bad shape of financial systems and economies

Nevertheless, the ECB continued to lament the lack of inflation. Prices of company shares and real estate skyrocketed, artificially and on paper, causing a larger concentration of wealth with fewer people. The low (and in some cases negative) interest rates also hit people with savings in banks. This inequality was widely caused by central banks’ policies. As this bubble is bound to burst eventually, a leveling off will take place – but at a very high cost.

A second cause for inequality was innovation. It made some people very rich, but also created jobs, income and rising living standards for millions of other people. It meant a great majority of people could afford more.

In the past, Mr. Draghi was right in blaming governments that they did not use the opportunities cheap money gave them to carry out reforms and reduce deficits. It seems that this battle is lost, and governments are happy to continue spending and to refrain from implementing reforms. The buzzword “inequality” has become an excuse for the bad shape of financial systems and economies.

It also seems that nobody knows how to get out of the cheap-money trap. Mr. Draghi recently mentioned very shyly that the economy is in good shape – maybe this means he will tighten monetary policy. But doing so would lead to huge problems in most of the countries that received a bailout guarantee from the European Central Bank and Mr. Draghi.

Warren Buffet
Investor Warren Buffet said that people like him should not have been able to accrue so much wealth – but it was mostly central bank policies that allowed that to happen (source: dpa)

On top of all that, the “Oracle of Omaha,” Warren Buffet, said that it is a problem that people like him have been able to amass such huge wealth. While it is true that cheap money helped drive that phenomenon, the message from Mr. Buffet sounded less like a criticism of cheap money and more like a call for a redistribution system – which again ties in with Mr. Draghi’s statements on inequality.

What is unsettling in all this news is that the two most important central bankers in the world, as well as one of the world’s biggest investors, are making statements which appear to be intended to create a certain perception of injustice, but without offering any substance to their argument. The statements do not quite mesh, and they end up sounding more like despair than policy. This is a very troubling symptom for the health of the world economy and for serious investors.

These are the concerns on the monetary side, but there are also worries on the trade side.

Trade troubles

The rise of protectionism did not begin when Donald Trump became president of the U.S. During the administration of Barack Obama, many discriminatory measures were implemented. Overregulation – which is not only a problem in the European Union – is also a form of protectionism. At G7 and G20 meetings, there are always proclamations that countries will work toward freer trade. But looking at the progress made so far in the negotiations at the level of the World Trade Organization, these statements seem like mere lip service. As the Trump administration is considered protectionist, President Xi Jinping of China and new President Emmanuel Macron of France have rolled out the flag of free trade. However, both countries have a protectionist history and are unlikely to change soon.

With the world in a fragile financial situation, healthy trade is the only remedy for the crisis

With the world in a fragile financial situation, healthy trade is the only remedy for the crisis. All these confusing statements, the lack of courageous policy and the constant, poisonous “cure” of additional regulations is a toxic mix. Innovation and productivity are being curbed, and trust is disappearing. There is much talk now that the world is undergoing an economic recovery, but without a robust monetary policy and free trade, any recovery will be short-term.

Let’s hope that the G20 summit in Hamburg on July 7-8 will be the first such meeting with meaningful results. It is possible, simply because the new U.S. administration is challenging the system, regardless of whether its policy is the right one.

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