InvestMacro

By David Spencer, University of Leeds and Muhammad Ali Nasir, University of Leeds 

The Bank of England (BoE) has raised interest rates once again to 5.25%, mirroring similar moves by the Federal Reserve and the European Central Bank. The fact that the UK is still suffering from high inflation – higher than either the US or eurozone – made another rate rise appear inevitable.

Yet there are reasons to doubt the merits and effectiveness of this approach. The UK’s efforts to bring down inflation quickly could be risking the health of the economy.

It is important to understand how monetary policy “works”. In effect, the BoE is seeking to make households in particular poorer so they spend less. The idea is you dampen down demand to bring it into line with supply, so that upward pressure on prices can be curbed.

The other effect of raising rates is to reduce the wage demands of workers by creating unemployment. This is not the publicly stated goal, but it lies behind the rhetoric of wage restraint that the BoE continually espouses – despite nominal wage growth only recently matching inflation.

The current approach to monetary policy accepts a recession as a price worth paying, while implying a belief that higher unemployment leads to lower inflation. This can be disputed on economic grounds – in the UK in the recent past, low inflation was achieved with low unemployment, so the idea that there is a necessary trade-off between inflation and unemployment can be refuted historically.

There are also moral objections to current monetary policy. It can be argued that the BoE should have a responsibility to protect living standards, not harm them. Its mandate of achieving a 2% inflation target should not be at any cost. Creating unemployment will impose misery on many workers and have scarring effects on the economy, from lost skills to reduced industrial capacity, which may be difficult to heal.

The economic reality

The current inflation is also not a classic case of “too much money chasing too few goods”. There are pressures from higher food and energy prices linked to factors like Brexit and the Ukraine war that cannot be controlled by raising interest rates.

There are also structural problems in the UK, such as labour shortages due to increases in economic inactivity – the result of more over-50s leaving the workforce and rises in ill health. These problems are seen to have put upward pressure on wages, and require responses beyond raising interest rates if they are to be fully addressed.

For example, they require new investment in the health sector to help alleviate hospital waiting lists. A better-funded NHS would create a healthier workforce, overcoming current limits on labour supply due to poor health that are seen to be creating inflationary pressures.

In any case, inflation is set to come down – the BoE’s own forecasts show this. Monetary tightening at this stage is therefore short-sighted and probably counterproductive – especially when the BoE thinks deflation is distinctly possible in the next couple of years. A more cautious approach to monetary policy seems in order.

Other countries have followed different policies with different effects. Spain, for instance, has used mechanisms such as price controls on things like rents and energy to help curb inflation (the UK did also cap energy bills, though not as aggressively). This has helped to reduce inflation while keeping employment high. It shows that crashing the economy is not the only route to low inflation.

In short, the BoE is simply compounding problems rather than solving them through its actions. It is time it learnt the limits of its own policies, while the government needs to play a role too.

In the short term, attention should be given to controlling prices (including energy) and making businesses show restraint in their pricing behaviour. Longer term, greater investment in skills, health and productive capacity is needed to create an economy that allows for rising real living standards with full employment.

About the Author:

David Spencer, Professor of Economics and Political Economy, University of Leeds and Muhammad Ali Nasir, Associate Professor in Economics, University of Leeds

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By George Prior

As China grapples with a serious deflation threat, investors worldwide must prepare for the fallout and adjust their strategies accordingly, warns the CEO of one of the world’s largest independent financial advisory, asset management and fintech organizations.

The warning from deVere Group’s Nigel Green comes as China reports July inflation on Wednesday, with markets looking for further signs of deflation.

The government has been actively playing down fears about deflation, with officials from the People’s Bank of China and National Bureau of Statistics, among other agencies, repeatedly saying there is no basis for long-term price declines.

Talking about the threat publicly is also off the agenda for many China-based analysts and economists, according to media reports.

Nigel Green comments: “China’s economic trajectory has been a focal point of global attention for decades, with its staggering growth and transformation capturing the world’s imagination.

“But the recent emergence of serious deflationary pressures in the world’s second-largest economy is triggering concerns that extend well beyond its borders.

“This economic phenomenon has the potential to set off a chain reaction of global repercussions that could reshape financial markets, trade dynamics and even international relations.”

Deflation – a persistent decline in prices of goods and services – can be as detrimental as rampant inflation, “if not more so”, states the deVere CEO.

In China’s case, the underlying factors driving deflation are complex and interconnected; rooted in weak consumer demand, declining exports and a highly subdued – but critical – property sector.

“China is a critical trade partner for many nations. As its exports become cheaper due to deflation, other economies might face increased competition, forcing them to lower their own prices or risk losing market share,” explains Green.

“Also, reduced demand for raw materials and commodities due to its economic slowdown is likely to lead to a decrease in global commodity prices. Those countries heavily reliant on commodity exports would then experience economic hardships as their revenues decline.

“The deflationary environment can put pressure on central banks to implement aggressive monetary policies, such as lowering interest rates or engaging in quantitative easing. This could distort global financial markets, affecting asset prices and investment strategies.”

This scenario is “worsened by the lack of transparency” as some leading academics, analysts and economists are reportedly being censored by Beijing, which is fearful of creating a doom cycle with negative news.

The interconnected nature of the global economy means that China’s deflation doesn’t remain confined within its borders.

As such, investors around the world should adopt strategies that “promote diversification, consider more defensive investments, and remain adaptable to changing economic conditions,” suggest the deVere boss.

“By staying informed and understanding the nuances of China’s deflation, investors can better position themselves to mitigate risks to their long-term wealth and capitalise on the significant opportunities that we expect to emerge amid the turmoil.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of offices across the world, over 80,000 clients and $12bn under advisement.

By Martijn Jeroen van der Linden, Hague University of Applied Sciences 

Over the past decade, the super-rich and large corporations have been able to borrow at record low interest rates. This influx of easy money has shored up markets for yacht-backed-loans and securities, dividends, share buy-backs, and merger and acquisition deals.

Meanwhile, those not deemed “creditworthy” find themselves barred from credit, the powerless witnesses of ever surging rents and living costs. Time and again, the financial sector has flooded certain parts of the economy while other parts remained parched. The question is: Why is it so hard to fix the money system?

Two parts of financial literacy

Lack of financial literacy among most citizens is at least one of the causes – though there are competing definitions of the latter. On 7 June, the European Commission (EC) lamented that “levels of financial literacy in the EU are too low”, posing a threat to “personal and financial well-being, households and society more broadly.”

However, here the institution takes a rather narrow view of financial education, limited to personal finance – i.e., teaching people how to manage budgets, achieve saving goals, and understand different financial products. Earlier in March, Sigrid Kaag, the Dutch Minister of Finance, echoed a similarly minimalist view of financial literacy: “By practising how to save, plan and make choices from a young age onwards, children learn how to make sound financial decisions.”

The other view of financial literacy, which we support, entails a far more ambitious understanding of the money system. We call it systemic financial literacy. “In the age of the CDS and CDO, most of us are financial illiterates”, wrote US financial journalist Matt Taibbi in 2009, referring to the complex financial products that triggered the Great Recession. Fast forward fourteen years later, and most of us remain unfamiliar with the jargon of economists, bankers and tax experts. As in 2009, today’s democracies continue to be divided into what Taibbi describes as a “two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below.”

With this in mind, we believe any project seeking to boost financial literacy ought to educate us on the roles of a central bank, but also payment infrastructure, the tax regime, and the investment of our pension savings. A number of questions ought to be raised, too, to this end: What do we consider public utilities? Which financial services can better be assigned to private companies? Who gets the power to create and allocate new money – and for what purposes? To answer these big questions requires not only a deeper understanding of the structures of finance, but continuous political engagement.

The waterworks

Together with cartographer Carlijn Kingma and investigative financial journalist Thomas Bollen, we sought to create a project that would inspire such questions and demystify the world of finance. For two and half years, we developed the “waterworks of money”, an architectural visualisation of our money system that bypasses the economic jargon.

Kingma spent 2,300 hours drawing this map by hand, based on in-depth research and interviews with more than 100 experts – from central bank governors and board members of pension funds and banks to politicians and monetary activists. In an animated video, we walk you through a metaphorical representation of our money system, its hidden power made manifest.

What do we water?

The metaphor of water was critical to the design of our map. Indeed, the financial sector is to the economy what an irrigation system is for farming lands. Just as irrigation helps crops grow, money allows the economy to flourish.

The architecture of our financial irrigation system and the way the sluices and floodgates are operated impacts us all. “What do we water, and what goes dry?” Kaag asked economists, bankers and reporters in June 2022. “Choices made by the financial sector determine what grows and what dies off. That’s where banks, pension funds, asset managers, and insurance firms can make a difference,” she said.

In our map, the long and complex process of financial irrigation starts at the top of the so-called tower of society, where big money keeps their reservoirs. The world’s largest companies, including big oil, big pharma and big retail, are lodged there. Open the floodgates and money flows downstream, setting the wheels of industry in motion. Salaries make their way through the waterworks, and trickle down into employee piggy banks. In return, everyone goes to work.

Money eventually seeps down into the lowest ranks of society, where the conveyor belt is always running, products are assembled and raw materials, mined. People then spend the wages they’ve earned, often in shops and businesses. Sale revenues get pumped up to the reservoir at the top, and the cycle starts all over again. Or at least, that is the idea.

In reality, trickle-down economics popularised by US president Ronald Reagan and UK prime minister Margaret Thatcher, does not take place. Money circulates mainly between the top of the tower and the financial sector. Moreover, the huge growth of the financial sector over the last decades has dug the gap between the haves and have-nots deeper. The growing quantity of money is driving up share prices, house prices and management fees, but most of the money does not reach the everyday economy in the tower of society – where it can be used for productive investments, generates income and add social value.

The structure of our money system is not a natural phenomenon. The way the waterworks are put together is a political choice. In democracies, higher levels of systemic financial literacy are a prerequisite to change this architecture and make the financial sector serve society better.

This article was co-written with investigative financial journalist Thomas Bollen and cartographer Carlijn Kingma.

Martijn Jeroen van der Linden, Professor of Practice in New Finance, Hague University of Applied Sciences

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Cristina Bodea, Michigan State University 

The campaign to fight U.S. inflation by upping interest rates has been going on for a year and a half – and its impacts are being felt around the world.

On July 26, 2023, the Federal Reserve announced another quarter-point hike. That means U.S. rates have now gone up 5.25 percentage points over the past 18 months. While inflation is now coming down in the U.S., the aggressive monetary policy may also be having significant longer-term impact on countries across the world, especially in developing countries. And that isn’t good.

I study how economic phenomena such as banking crises, periods of high inflation and soaring rates affect countries around the world and believe this prolonged period of higher U.S. interest rates has increased the risk of economic and social instability, especially in lower-income nations.

Ripples around the world

Monetary policy decisions in the U.S., such as raising interest rates, have a ripple effect in low-income countries – not least because of the central role of the dollar in the global economy. Many emerging economies rely on the dollar for trade, and most borrow in the U.S. dollar – all at rates influenced by the Federal Reserve. And when U.S. interest rates go up, many countries – and especially developing ones – tend to follow suit.

This is largely out of concern for currency depreciation. Raising U.S. interest rates has the effect of making American government and corporate bonds look more attractive to investors. The result is footloose foreign capital flows out of emerging markets that are deemed riskier. This pushes down the currencies of those nations and prompts governments in lower-income nations to scramble to mirror U.S. Federal Reserve policy. The problem is, many of these countries already have high interest rates, and further hikes limit how much governments can lend to expand their own economies – heightening the risk of recession.

Then there is the impact that raising rates in the U.S. has had on countries with large debts. When rates were lower, a lot of lower-income nations took on high levels of international debt to offset the financial impact of the COVID-19 pandemic and then later the effect of higher prices caused by war in Ukraine. But the rising cost of borrowing makes it more difficult for governments to cover repayments that are coming due now. This condition, called “debt distress,” is affecting an increasing number of countries. Writing in May 2023, when he was still president of the World Bank, David Malpass estimated that some 60% of lower-income countries are in or high risk of entering debt distress.

More broadly, any attempt to slow down growth to lower inflation in the U.S. – which is the intended aim of raising interest rates – will have a knock-on effect on the economies of smaller nations. As borrowing costs in the U.S. increase, businesses and consumers will find themselves with less cheap money for all goods – domestic or international. Meanwhile, any fears that the Fed has pulled on the brakes too quickly and is risking recession will suppress consumer spending further.

The risk of spillover

This isn’t just theory – history has shown that in practice it is true.

When then-Fed Chair Paul Volcker fought domestic inflation in the late 1970s and early 1980s, he did so with aggressive interest rate hikes that pushed up the cost of borrowing around the world. It contributed to debt crises for 16 Latin American countries and led to what became known in the region as the “lost decade” – a period of economic stagnation and soaring poverty.

The current rate increases are not of the same order as those of the early 1980s, when rates rose to nearly 20%. But rates are high enough to prompt fears among economists. The World Bank’s most recent Global Economic Prospects report included a whole section on the spillover from U.S. interest rates to developing nations. It noted: “The rapid rise in interest rates in the United States poses a significant challenge to [emerging markets and developing economies],” adding that the result was “higher likelihood” of financial crises among vulnerable economies.

Widening the wealth gap

Research I conducted with others suggests that the kind of financial crises hinted at by the World Bank – currency depreciation and debt distress – can rip the social fabric of developing countries by increasing poverty and income inequality.

Income inequality is at an all-time high – both within individual countries and between the richer and developing countries. The 2022 World Inequality Report notes that, currently, the richest 10% of individuals globally take home 52% of all global income, while the poorest half of the global population receives a mere 8.5%. And such a wealth gap is deeply corrosive for societies: Inequality of income and wealth has been shown to both harm democracy and reduce popular support for democratic institutions. It has also been linked to political violence and corruption.

Financial crises – such as the kind that higher interest rates in the U.S. may spark – increase the chance of economic slowdowns or even recessions. Worryingly, the World Bank has warned that developing nations face a “multi-year period of slow growth” that will only increase rates of poverty. And history has shown that the impact of such economic conditions fall hardest on lower-skilled low-income people.

These effects are compounded by government policies, such as cuts in spending and government services, which, again, disproportionately hit the less well-off. And if a country is struggling to pay back sovereign debt as a result of higher global interest rates, then it also has less cash to help its poorest citizens.

So in a very real sense, a period of higher interest rates in the U.S. can have a detrimental effect on the economic, political and social well-being of developing nations.

There is a caveat, however. With inflation in the U.S. slowing, further interest rate increases may be limited. It could be the case that regardless of whether Fed policy has threaded the needle of slowing the U.S. economy but not by too much, it has nonetheless sown the seeds of more potentially severe economic – and social – woes in poorer nations.

About the Author:

Cristina Bodea, Professor of Political Science, Michigan State University

This article is republished from The Conversation under a Creative Commons license. Read the original article.