Can the US lift interest rates without causing a recession? – ABC Online

Pyongyang fired off another rocket over Japan on Friday, bringing the region and the globe closer to catastrophic conflict.

Japanese citizens fled to safety as warnings blared and US military chiefs were visibly rattled by the growing possibility North Korea soon may be able to strike American territory.

In response, US President Donald Trump, whose approval ratings have lifted as tensions escalate, tomorrow heads to the United Nations General Assembly — an organisation he’s previously described as an “underperformer” — to implore world leaders, including China, to rally behind the US in its opposition to the hermit kingdom.

But if these are the most dangerous of times, you wouldn’t know it by checking global stock markets, where the euphoria created by a decade of experimental monetary policy continues to trump logic.

Wall Street advanced to new records Friday night, while earlier in the day Japan’s Nikkei index and Seoul’s Kopsi both stacked on healthy gains.

The UK, however, was a different story — the FTSE 100 dived to its lowest level in almost five months on Friday, but not for the reasons you would most suspect.

Barely a thought was given to the latest attack on a London train when trading opened in the city.

Instead, it was a vague hint from the Bank of England that it may consider raising interest rates from current emergency levels of just a quarter of a per cent.

And there’s the key — it is the fear of rates, not rockets, driving global markets.

It’s likely the Donald’s big speech will be given scant regard by investors on Tuesday.

Instead, all eyes will be trained on the woman he despises and would desperately like to replace, Janet Yellen, the head of the US Federal Reserve.

Central bankers in a bind

They successfully dragged the global economy back from the brink of collapse almost a decade ago by flooding the world with cash and slashing interest rates.

But they solved a debt-fuelled crisis by piling on vastly more debt — so much of it in fact, that some fear it is impossible to unwind without causing chaos.

Central Bank Debt Growth

Central bank debt was sitting at around 17 per cent of the size of the global economy when the financial crisis hit. It’s now approaching 40 per cent, worth about $US20 trillion.

It’s pumped up asset prices across the globe, rewarding borrowers and penalising savers.

That’s why real estate from Sydney to Melbourne and London to Beijing has soared.

It’s transformed anyone who bought an ordinary house in the suburbs into multi-millionaires and denied future generations the ability to ever afford a home.

It explains why Wall Street values are now stretched way beyond the dangerous levels of 2007 and are heading towards those that immediately preceded the dotcom collapse.

But how to unwind all this without sparking an even greater recession than perhaps we would have experienced in the aftermath of the financial crisis?

The US central bank has more than $US4 trillion worth of government securities and other debt instruments on its books.

It bought them from financial markets after the US Government issued them, through a mechanism quaintly called quantitative easing.

Essentially, it was a fancy form of money printing, a method to inject cash into the economy.

On Wednesday, after her two-day meeting, expectations are running hot the US central bank chief may explain not just her interest rate intentions but also her plans to begin selling that huge pile of debt.

And that’s where the problems begin. Selling them involves reversing the whole exercise. It will soak up cash, push interest rates even higher and cause panic on financial markets

Who cares about markets?

Economists once believed there were two worlds — financial markets and the real world. Wild swings on stock markets didn’t necessarily result in widespread effects on growth, inflation or employment, they argued.

Hardly anyone thinks that way now. A collapse in the stock market or a massive downturn in the housing market automatically makes large sections of the population immediately poorer.

Anyone with large debts secured by their assets could find themselves in trouble.

That flows through to banks which, having stoked the debt fires on the way up, pull down the shutters during bad times as they overreact to the losses on their bad debts.

Then there’s the psychological impact. Even if you really had no plans to sell your $2 million house, it certainly generated a feeling of wellbeing and wealth and you spent accordingly.

When the values reverse, your spending patterns tend to follow suit — that then hurts businesses, which begin to lay off workers.

Therein lies the great fear among those who really control our world.

For as much as financial markets fret about the prospect of sharp hikes in interest rates, Ms Yellen and her cohorts are frozen stiff at the prospect of a rerun of the 2008 crisis should the markets react badly to their actions.

The tail is now wagging the dog.

What are the chances of another stock market crash?

If history is any guide, imbalances in the financial world tend to sort themselves out, sometimes in violet fashion. The longer the imbalances last, the more unruly the shakeout.

Wall Street Winning Streaks

Wall Street now is enjoying the second-longest winning streak in recent history, pushing towards 1,500 days since a major correction.

On that basis alone, many argue a downturn is overdue. But there are just as many who reckon the bulls have years to run, that the economy is picking up and employment strengthening.

It’s hard to deny that growth is returning, albeit slowly, and that the cosy club of central bankers have managed to chart a course out of the financial crisis.

The problem is that they have nothing left with which to combat another recession. And there is a very real possibility in that by attempting to rearm, they may spark yet another financial meltdown.

Wages growth globally still is weak. Inflation has repeatedly failed to respond to the flood of cash. Productivity growth has been sluggish.

In Japan, the central bank intervention has been so overwhelming that the Bank of Japan owns more than 40 per cent of all Japanese Government Bonds, a level which has threatened to undermine the market’s viability.

It’s since turned to buying stocks on the Tokyo exchange to keep the money printing machines in operation.

Reversing all this will be no simple task. In fact, it may be impossible. Perhaps the only way out is to write off the debts, to simply nuke them and start again.

That will cause mayhem on currency and bond markets. But it may the only way out.

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