Feature Stories | Oct 16 2019
Saxo bank suggests the failure of a decade of monetary policy experimentation will lead the world into recession despite the lowest rates in history. It will begin with US dollar intervention.
-Despite historically low rates, the global slowdown continues
-Demand for US dollars unabated, as liquidity runs dry
-A slow-moving Fed may be usurped by an angry Administration
By Greg Peel
"When history is written, suggests Saxo Bank in its December quarter global outlook, "2019 will most likely be remembered as the beginning of the end of the biggest monetary policy experiment ever – the year that kicked off a global recession despite the lowest ever nominal and real interest rates in history".
The GFC forced global central banks into the "experiments" of quantitative easing and negative cash rates. Ten years later, the US Federal Reserve is reintroducing QE and central banks elsewhere are lowering cash rates further into the negative in order to avoid another global recession. The Fed is arguing the billions it has pledged to buy short-term Treasury bills through to at least January is not QE – QE is the purchase of longer term Treasury bonds – but critics consider the argument semantical.
The major reason monetary policy does not work over a full economic cycle is that classic easy money policy works only in "normal times," Saxo suggests. When rates become too high or too low the model breaks down.
For example, Argentina's cash rate is 80%, which should result in massive capital inflows into the country. Germany's cash rate is now deeply negative, so money should thus be fleeing the country. But rather, capital is fleeing Argentina and being hoarded in Germany.
If monetary policy is failing then fiscal policy needs to step up to save the day. And at historically low interest rates, the opportunity for cheap government funding has never been greater. But the problem is, everyone is already up to the eyeballs in debt.
With monetary policy failing, and fiscal policy response following a long and difficult path, there is only one other tool left in the box for the global economy, suggest Saxo. And that is to lower the price of global money itself.
The Reserve Currency
There is an estimated US$240trn of debt in the world, or 240% of global GDP. Far too much of this debt is denominated in US dollars, says Saxo, due to the dollar's role as reserve currency and the deep liquidity of US capital markets.
Hence, movement in the value of all asset classes become a function of US dollar liquidity and direction. Too high a dollar not only impacts on US export competitiveness but on emerging markets with a high dependency on US dollar funding. A stronger greenback will thus weigh on global growth and create de facto disinflation, Saxo warns, despite central bank efforts to lower policy rates.
Financial markets value the US dollar against a weighted basket of the currencies of America's major trading partners, known as the US dollar index or DXY. The Fed has a broader version on the same trade-weighted basis that it uses as its own US dollar valuation. That is currently above 130, its highest ever level, and some 30% above the prior peak as recently as 2013.