China's conundrum: Selling FX reserves to support the yuan threatens deflation. But falling yuan fuels capital flight http://t.co/XGz6S4HPz6
— Colin Twiggs (@Colin_Twiggs) August 29, 2015
AND capital flight causes collapsing stock and real estate prices, which could lead to…… deflation.
Steven Russolillo at WSJ reports:
Actions by central bankers across the globe are propping up asset prices to artificial levels that are potentially putting investors at risk, Pimco CEO Mohamed El-Erian said in an interview with the Wall Street Journal.
“Investors should recognize that in virtually every single market segment, we are trading at very artificial levels,” El-Erian told WSJ’s Francesco Guerrera. “It’s true for bonds, it’s true for equities. It’s true across the board.”
This reinforces my long-term bullish outlook for gold. Central banks are unlikely to cease their easy money policies any time soon. What we are currently witnessing is the opposite, with the Bank of Japan going ‘nuclear’ in an attempt to kill persistent deflation that has dogged them for over two decades.
I strongly recommend that you watch the video interview at Pimco’s El-Erian: Markets Trading at ‘Very Artificial Levels’ – MoneyBeat – WSJ.
If financial imbalances can build up in an environment of low inflation it stands to reason that a monetary policy reaction function that does not respond to these imbalances when they occur can unwittingly accommodate an unsustainable and disruptive boom in the real economy. The result need not take the form of inflation, although latent inflationary pressures would normally exist. Rather, it would be a contraction in economic activity, possibly accompanied by outright deflation, amplified by widespread financial strains. Accordingly, one could argue that the more serious “bubble” was in the real economy itself.
In this scenario, the consequences of failing to act early enough can be serious. If the contraction in economic activity is deep enough and prices actually decline, they can cripple the effectiveness of monetary policy tools and undermine the credibility of institutions. The Japanese experience is very instructive here. Moreover, reaction functions that are seen to imply asymmetric responses, lowering rates or providing ample liquidity when problems materialise but not raising rates as imbalances build up, can be rather insidious in the longer run. They promote a form of moral hazard that can sow the seeds of instability and of costly fluctuations in the real economy.
This paradigm sees the financial imbalances as contributing to, but, more importantly, as signaling distortions in the real economy that will at some point have to be unwound. In other words, the behaviour of prices of goods and services is not a sufficient statistic for those distortions. This runs contrary to the standard macroeconomic models used nowadays.
Asset prices, financial and monetary stability: exploring the nexus
by Claudio Borio and Philip Lowe
July 2002
Colin Twiggs: ~ Extract from BIS Working Paper No.114, co-authored in 2002 by Dr Philip Lowe, who has been appointed as the new RBA deputy governor. Looks like a good choice.
I believe that the RBA is determined to prevent any reinvigoration of the Australian housing bubble……. yesterday we had [] confirmation that the bank is structurally remodelling itself as an asset price hawk, with the appointment of Phil Lowe to the deputy governorship. In 2002, whilst working at the BIS [he] wrote a defining paper on the identification and targeting of asset prices….his history shows both the intelligence and fearlessness needed to be an effective senior governor. Bravo.
via The RBA gets hawkish on asset prices – macrobusiness.com.au | macrobusiness.com.au.