Beware the Dog Days of August

Why the Federal Reserve is as much to blame for Turkey’s economic crisis as Donald Trump

By Ann Pettitor and cross-posted from The Independent

Beware the dog days of August, wherein last week, President Trump roiled currency and European equity markets with a shock announcement that the US would double tariffs on Turkish steel and aluminium. It was a move that caused Turkey’s already weakened currency to fall off a cliff on Friday, and threatens wider turmoil.

On one of 2007’s August dog days, the Swiss bank UBS announced that assets on its balance sheet could not be valued fairly, and therefore investors would not be allowed to withdraw funds. This shock caused interbank lending across the world to freeze, and central banks to intervene with massive injections of liquidity.

It began the slow-motion rollout of the global financial crisis of 2007-9, which peaked with the bankruptcy of Lehman’s in September 2008. A crisis that so far, is without end.

While President Trump’s latest foreign policy moves are typically unpredictable and aggressive, they are not alone responsible for global financial turbulence. Blame can also be allocated to the more sedate and discreet, but equally disruptive, policy moves of the US’s Federal Reserve.

For six years after November 2008, the Fed, along with other central banks, took a dominant role in stabilising the global financial crisis. Orthodox economists had advocated a path of “monetary radicalism and fiscal conservatism”. Politicians obliged. And so, central bankers began to purchase and place on their balance sheets treasuries and mortgage backed securities owned by banks teetering on the edge of bankruptcy. Central banks became, in the words of Mark Carney “the only game in town”. The Fed lowered its policy interest rate from 5.25 per cent in September 2007 to 0-0.25 per cent in December 2008, and quadrupled its balance sheet from less than $900bn (£700bn) in 2008 to roughly $4.5 trillion by 2014. At this point, “tapering” of its quantitative easing programme began.

Today’s financial turbulence can be traced back to Fed decisions in June 2017 to begin the “normalisation” of its balance sheet, gradually shedding its bond holdings in monthly stages. This monthly “runoff” of $10bn of maturing assets on to capital markets causes bond prices to fall, and yields to rise. On some estimates the Fed’s bond portfolio is expected to shrink by $315bn in 2018 and $437bn in 2019.

This process of “normalisation” is no simple and stable matter. In the words of market analyst Kristina Hooper, it’s like “defusing a bomb”

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