In search of a positive ‘policy shock’

David Riley, head of Credit Strategy at BlueBay Asset Management, discusses the timely location of the G20 Finance Ministers meeting in Shanghai this weekend and argues the case for global policy coordination and less reliance on unconventional monetary policies to sustain global growth and restore investor confidence

The location of the next meeting of G20 Finance Ministers and central bankers in Shanghai (February 26-27) has rarely been more opportune. Without coordination, extraordinary monetary policies that helped prevent a global depression in the aftermath of the 2008 financial crisis threaten to descend into a race to the bottom with China as the principal causality.

An orderly deleveraging of China’s excessively indebted corporate sector requires Beijing to adopt more fiscal and monetary stimulus and further depreciation of the Chinese renminbi. Competitive monetary easing by the ECB and Bank of Japan is in danger of placing an unsustainable share of the burden of adjustment onto the US and Chinese economies.

Fed quantitative easing and zero interest rates facilitated household deleveraging after the ‘sub-prime’ credit binge with the US consequently spared the prolonged asset price deflation and stagnation experienced by Japan in the aftermath of the bursting of its ‘bubble’ economy in the 1990s.

China in particular supported the global economy as part of a coordinated policy easing formulated at the G20 Summit in London in April 2009 that also boosted business and investor confidence and helped dispel fears of another Great Depression.

The US current account deficit subsequently halved and China’s current account surplus fell from 10% of GDP in 2009 to less than 3%. The Chinese renminbi appreciated by 20% and other emerging market currencies rose as capital flowed out of the US.

Seven years on and after US$7tn of asset purchases and liquidity injections by the world’s major central banks, the global economy is once again facing a crisis of confidence. Investors are losing faith in the efficacy of unconventional monetary policies to sustain global growth and increasingly fearful of the distortionary effects of QE and negative interest rates.

Highly accommodative monetary policy has created space for governments to pursue growth-friendly fiscal policies as well as productivity-enhancing structural reforms.

Greatly diminished market liquidity is exaggerating the severity of the re-rating of QE-inflated asset prices to lower growth and profit expectations. Asset prices risk over-shooting, excessively constraining the supply and raising the cost of capital with adverse consequences for corporate default rates and private investment.

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