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Finance

Macroscope | Trump-Takaichi meddling in finance spells more turbulence ahead

This post was originally published on this site.

When the world’s leading central banks rode to the rescue during the global financial crisis in 2008, they were hailed as knights in shining armour intent upon slaying the twin dragons of economic recession and deflation. Now it seems the knights are no more, to quote an old English hymn, and yet the dragons are not dead.

US President Donald Trump’s nominee to head the Federal Reserve, Kevin Warsh, has expressed doubts over whether the Fed acted wisely when it became the biggest buyer of US government debt in the wake of the 2008 crisis, greatly enlarging the central bank’s balance sheet. More recently, the Fed has been set on contracting the size of that balance sheet.
Now the Bank of Japan (BOJ) – the biggest foreign holder of US Treasury securities – is questioning the wisdom of its own quantitative easing policies. These have involved massive purchases of Japanese government bonds and likewise have left the BOJ as the biggest single holder of Japanese debt.

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Both central banks are intent on reducing the size of their balance sheets by selling part of their vast bond holdings in the market. Such a move will drain at least some of the sea of liquidity which has helped push stocks and other financial assets to record highs and fuelled a borrowing boom internationally.

These moves raise questions that, so far at least, appear to have attracted relatively little attention. For example, what will be the impact of this balance sheet adjustment upon the financial system as a whole and upon the global economy? Who will ride to the rescue in the event of another crisis, fiscal or financial?

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What will be the impact going forward on interest rates? The specific intent of quantitative easing policies and balance sheet expansion by both the Fed and the BOJ was to lower interest rates so that distressed financial institutions and the global economy could survive. Will this not result simply in more financial distress?