Jake's View

Reluctant borrowers showing interest again

PUBLISHED : Sunday, 23 June, 2013, 12:00am
UPDATED : Sunday, 23 June, 2013, 4:18am

[Asian] central banks are manning their defences as emerging market currency, bond and stock markets have been whipped by fears that trillions of cheap US dollars could leave Asian economies in the face of the biggest inflection point for investors since 2008 - the eventual tightening of US monetary policy.

Reuters, South China Morning Post, June 15

Just look at those helmeted central bankers rushing up to the battlements to man their defences, pikes at the ready, oil boiling in the vats to pour on the heads of the fear-whipped minions who would dare threaten Fortress Asia with their inflection points.

Now let's try another picture of what is really happening here. The problem for central banks everywhere is best expressed by that age old aphorism that you can lead a horse to water but you can't make him drink.

A central bank seeking to boost the economy over which it presides to higher rates of growth may make ample liquidity available to corporate and personal borrowers but cannot make them take advantage of that money if they do not want it.

The central bank can make that liquidity available by the traditional way of simply printing money or, more likely these days, buying government bonds out of the market and lending to commercial banks at very low interest rates.

Enough of this in times of a slow-moving economy and interest rates across the market will fall to low levels, with the money being flooded into the monetary base of the economy. All things being equal, this should produce more borrowing and more economic activity, thus boosting growth.

But these central bank measures are not enough on their own to guarantee this result. They must stimulate borrowers to borrow. This sends the money on a repeated cycle of deposit and loan through the banking system in what is called the multiplier effect. Only then do the monetary aggregates rise and the pace of economic activity quicken.

However, if borrowers do not want to borrow then the whole process stops short and the central bank's purposes are frustrated.

This is what has happened in Europe and America. Corporate and individual borrowers were hit badly in the 2007/08 financial crisis and became reluctant to take on more debt obligations.

They first wish to rebuild their balance sheets by ridding themselves of unproductive assets and by reducing their debt- to-equity ratios. It is entirely reasonable and prudent that they should take this view and the process may still have another year or two to go.

But it just stops the grandiosely named quantitative easing in its tracks. Central banks took their horse to water but the horse wouldn't drink.

The European Central Bank, for instance, has virtually shovelled money at European commercial banks, begging them to make use of it. For the most part they have just put it back on deposit with the ECB. The chart shows the result. Monetary growth on the euro M2 measure collapsed in 2009 and even now is only 4.8 per cent year over year.

It is higher for the US dollar but the story is still much the same. Quantitative easing never really happened. There were no floods of money washing in anywhere. The fact that prices of financial assets rose tells you only that central banks were toying with the pricing mechanism of interest rates.

And if borrowers are now beginning to borrow again and interest rates begin to rise there will be no flood of money washing out of anywhere. Financial asset prices will fall in response to rising interest rates, not because trillions of cheap dollars have fled.

The horse has begun to drink at last, that's all.