Cutting Rates is Counterproductive When Avoiding Bubbles

by on November 10, 2013 5:37 am BST

When growth is controlled by central banks, it is inevitable for rate cutes to happen in order to create growth in slowdown. The aim is not to create asset bubbles, but the reduction of benchmark rates tend to have a counterproductive result while being the catalyst that pops the bubble.

The European Central Bank is unique, rather good or bad, in the sense that its mandate does not allow them to purchase massive amounts of debt over the open market, it could spur legality issues. And the ECB was running out of tools as the euro quickly advanced against the dollar when the Federal Reserve put off tapering their own quantitative easing program. This intensified the risks of deflation in the eurozone. The euro declined with the rate cut rumor during the previous week when inflation in the euro-bloc declined to .7 percent, and the eurodollar declined dramatically since the ECB’s decision last thursday. Although, some see this rate decision as a mere reactionary decision.

Banking giant JP Morgan released a report surviving as a warning that the current excess of global liquidity is the most extreme ever. The report indicated that these levels were last seen in 1993 to 1995, 2001-2006, and in response to the Lehman collapse. Unfortunately, the first two periods led to a massive destruction of wealth. The reported noted “the current episode of excess liquidity, which began in May 2012, appears to have been the most extreme ever in terms of its magnitude.”

Real Money Supply v. Demand, provided by JP Morgan

Real Money Supply v. Demand, provided by JP Morgan

Signs of potential bubbles are evident. The US reported solid GDP and unemployment data, and the market sold off fearing a potential taper from the Federal Reserve. The US 10Y treasury note is on the rise, and rise in housing prices in the United States and aboard are causing concern.

Everyday, some analyst on television vicariously explains that equities are the only place to earn returns across markets given the dramatically low rate environment. They seem to acknowledge the fact bubbles are forming but offer a ho-hum excuse on why gluttonous and greedy actions are due to central banks. Markets do not seemed worried, but perhaps that is the calm before the storm.

“It could be a warning if fundamentals are out of whack. Markets could be vulnerable next year if that liquidity starts to disappear,” said Nikolaos Panigirtzoglu, one of the JP Morgan economists that dove into the liquidity concerns.

Can we blame the central banks for market collapses by creating the environments they need to grow, like bacteria in a petri dish? Perhaps, central banks are the scapegoats for the inaction of politicians and officials. Numerous documents, including the JP Morgan report, suggested that if more easing was necessary that it should be done through fiscal policy. Fed chairman Ben Bernanke even said, while in front of Congress, that the levels of quantitative easing currently being implemented would not be needed if fiscal policy was there to take its place. With bubbles abound, there is enough blame to pass around.