“The reluctance of policymakers to take the politically difficult steps of bringing revenues into alignment with spending via tax hikes at lower income thresholds, which would have yielded far larger revenues, or through an aggressive reduction in entitlement spending, especially medical costs through the Medicare programme, will over time probably result in an unfortunate economic choice: currency debasement and inflation as substitutes for hard choices about taxes and spending. Due to the postponement of the automatic sequestration and the quickly approaching debt ceiling in mid-February, the potential release by firms of pent-up capital expenditures that would be beneficial to both growth and employment might be put off until later in the year.”
Thus wrote Joseph Brusuelas, economist for Bloomberg. In other words, the deal struck between the US Congress and the President of the US to avoid the US falling over a fiscal cliff (automatic spending cuts and tax increases kicking in from the New Year) ducks core issues and does not eliminate economic uncertainty. In fact, it is rather funny that the phrase ‘fiscal cliff’ was deployed to refer to spending cuts and tax increases that would restrain a country with a general government gross debt ratio of over 100% and a budget deficit ratio of more than 10% as of 2011, according to IMF (International Monetary Fund) estimates. The UPA (United Progressive Alliance) in India should be miffed that another government could be more profligate than it is and yet be cheered for remaining that way.
Instead of welcoming the fiscal restraint that would be applied, commentators engaged in an orchestrated and coordinated breast-beating exercise and called it a cliff to evoke visual images of someone plunging into an abyss. It had the desired effect. The result was a deal that postpones all tough decisions. America retains its triple-A credit rating. Stock markets around the world cheered and the world’s prime barometer of unhealthy risk appetite, the Australian dollar, rose strongly against the US dollar in the face of data reporting sustained contraction in the manufacturing and services sectors of the economy.
Dissatisfied with this demonstration of far-sightedness that they are capable of, long-duration equity investors wasted no time in reinforcing their image, lest someone did not get the message. The American Federal Reserve Board released the minutes of its policy meeting held on 11-12 December. In the meeting, members of the policy committee discussed the potential side effects and consequences of their asset purchase measures. They did so without explicit recognition of the consequences that were already evident.
Sample this gem: “In monitoring for possible adverse effects of the current environment of low interest rates, the staff surveyed a wide range of asset markets and financial institutions for signs of excessive valuations, leverage, or risk-taking that could pose systemic risks. Valuations for broad asset classes did not appear stretched, or supported by excessive leverage. Indicators of risk-taking and leverage had moderately increased, on balance, over the past couple of years but remained notably below their levels before the financial crisis.”
Both the staff and the FOMC (Federal Open Market Committee) members have been well trained in the attitude of ‘see no evil, hear no evil’ in the monetary policy of the Federal Reserve. They did not bother to recognize the inconsistency of the farcical conclusions that they had reached about the absence of ‘adverse effects’ of the current environment with the situation in the commercial real estate (CRE) market: “Financial conditions in the commercial real estate sector were still generally strained amid elevated vacancy and delinquency rates. However, prices for CRE properties continued to increase in the third quarter, and issuance of commercial mortgage-backed securities remained at a solid pace in the current quarter.”
There you have it. Fundamentals stink but hey, who cares. CRE property prices continue to climb and the securitization rope-trick is back. That is what matters to the Bernanke doctrine of asset prices triggering and fuelling an economic revival. This is the doctrine that investors have got used to since the dawn of the new millennium and hence any discussion of the side effects of this doctrine was lead in their ears. They chose to send a warning to the Federal Reserve. Stock prices dropped on the day the minutes were released.
The reaction of stock markets and currency markets to the postponement of fiscal restraint and the minutes of the Federal Reserve policy meeting sends a clear message to policymakers. Policymakers should postpone tough decisions that would bolster long-run economic fundamentals at the cost of depressing asset prices in the short-run. Investors would have none of it. They have been fed instant gratification and they want more of it. In other words, the new normal is that economic policy should support the chimera of economic growth and asset prices at all times and by all means and to hell with the consequences.
This is the trap that financial markets and policymakers in capitalist democracies have laid for each other. Long live capitalism and democracy.
V. Anantha Nageswaran is the cofounder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at firstname.lastname@example.org.
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk