Friday, 28 August 2015

Financial markets are not free – they're one of the last bastions of socialism

Larry Elliot in The Guardian

You can’t buck the market, Margaret Thatcher once said, but the world’s policymakers have been giving it their best shot. Photograph: PA/PA

You can’t buck the market, so said Margaret Thatcher back in the late 1980s. Maybe you can’t, but the world’s policymakers are giving it their best shot.

Let’s just consider the context. During August there was a big sell-off in shares amid concerns that the Chinese economy was in trouble. The declines, however, followed a long bull market in which prices were supported by the quantitative easing programmes pursued by central banks rather than by underlying economic strength. A true believer in free markets would have seen the recent sell-off as both inevitable and healthy.

But financial markets are by no means free. They are, on the contrary, one of the last bastions of socialism left on earth. Everything possible is done to boost asset prices and when overstimulation leads to bubbles bursting it is all hands to the pump to prevent them from falling too far.

So, in the last couple of days we have seen the chief economist of the European Central Bank musing openly about the possibility of additional QE. We have had the president of the New York Federal Reserve dropping the biggest possible hint that an interest rate rise will be delayed. And we have had the authorities in Beijing buying up shares on the Shanghai stock market.

And guess what? It has worked. Shares have been going up around the world because investors have been given guarantees that they will be protected from the consequences of their own folly. Despite the upward revision to US growth figures, all that Wall Street needs to do to prevent a Fed rate rise is to have another flash crash between now and mid-September. The Fed will then back off. If things get really bad, it will need to consider a fourth dose of QE. Yes, really.

George Saravelos, of Deutsche Bank, says there is a reason western central banks, starting with the ECB and the Bank of Japan, might need to again resort to the electronic printing presses: China’s use of its foreign exchange reserves to defend the external value of the yuan.

Effectively, China has been selling a chunk of its holdings of foreign bonds, such as US Treasuries. QE involves buying bonds, so what the People’s Bank of China has been doing is QE in reverse or, as Saravelos puts it, quantitative tightening or QT.

Ostensibly, QT has always been part of the plan. When central banks embarked on their asset-buying programmes, the intention was that they would be sold back to the markets when things had returned to normal. The problem is that things have never returned to normal and, judging by recent events, never will.

Zero interest rates were supposed to be temporary. They are now the norm. QE was an unconventional measure for use in an emergency only. It is here to stay, albeit subject to the law of diminishing returns.

Clearly then, you can buck the market. Corrections can be delayed and halted, even reversed, by determined policy action. But, as the history of bubbles from Dutch tulips to subprime mortgages has shown, only for a while. In the long run, Mrs T was right.

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