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How will Yellen get out of Fed chakravyuha?

US monetary policy has left the markets flush with easy money, which big banks are using to become even bigger, writes J Mulraj.

business Updated: Dec 19, 2014 23:13 IST
J Mulraj,US economy,US Federal Reserve

Central bankers steadfastly hold on to the theory that all economic ills can be cured simply by pumping in more money, at least in their own economies (for countries such as Greece, austerity is advocated).

Hence, they resort to successive bouts of quantitative easing, creating new money and pumping it to banks, in the belief (since proved erroneous) that the banks would lend it to consumers, whose consumption would boost the economy, or to companies for investment, which would provide jobs.

The bankers have forgotten the adage that you can take a horse to the water, but can't make it drink. So neither has there been a spurt in consumption, nor in investment. The money has, instead, largely gone into creating asset bubbles. Bubbles, as you know, tend to pop, and when they do, they create havoc.

The banks have used the money to grow bigger, and are considered too big to fail (TBTF). So big, in fact, that they had the clout to steer some of their own clauses into US legislation. The bill that was approved by the US Congress aims to provide $1.1 trillion to the US government to prevent it from going bankrupt! The price, extracted by Wall Street, was to water down the Dodd-Frank provision that sought to prevent TBTF banks from over exposing themselves in the derivatives markets.

Under the newly passed bill, the TBTF banks (JP Morgan, Citi, Goldman Sachs and Bank of America Merill Lynch) can use subsidiaries for derivative transactions, which would be covered by the Federal Deposit Insurance Corporation (FDIC). The current derivative exposure is $303 trillion! In other words, the TBTF banks can get the rewards of successful derivative trades, but penalties for spectacular failures would be the liability of taxpayers!

In effect it means that a 23% loss in the $303 trillion market would wipe out 1 year's global gross domestic product. This is the chakravyuha created by the policy of easy money through quantitative easing.

The US Federal Reserve had a crucial meeting this week. It decided not to raise interest rates. The much watched hike will probably happen in 2015, but the Fed stated that it will be 'patient' with the procedure. The use of the term 'patient' was enough for global stockmarkets to rally sharply, for it gives hope that the monetary party will last.

The Fed has a vexatious problem. It is keeping interest rates low for two reasons. One is to tame inflation, which is happening, though it is because consumers are not consuming and not because money is cheap. The second is to help companies invest and provide jobs.

The November job report appeared to suggest that the economy was recovering fast and throwing up jobs. But the truth is that almost all these jobs are coming from states which have shale gas reserves.

As chair of the Federal Reserve, Janet Yellen knows that job growth, dependent almost entirely on the shale industry, is not a given.

And until a bubble fuelled by this easy money bursts Yellen cannot emerge from the chakryavyuha. Nor will the investors.

So what's happening in India?

Although the long overdue GST (Goods & Services Tax) Bill has been cleared by the Cabinet, however, it has not become a law yet due to the filibustering of the Rajya Sabha by the opposition. In economic news, though wholesale inflation has fell to zero the trade deficit is at an 18-month high thanks to gold imports.

Lower oil prices mean lower customs duty collection for the government. Growth in excise duty collection is also low. This means that the government is expected to cut expenditure by Rs 1 lakh crore in order to meet its fiscal deficit target of 4.1% of GDP. Probably more, because the ONGC stake sale may not fetch as much as expected with the company's market cap dropping some Rs 48,000 crore in the last few months due to drop in crude prices.

What next?

The filibuster is preventing the government from introducing new bills. It has, however, been pussyfooting about existing scams instead of taking the sort of stern action to revive investor confidence. The market may dip to test the bottom it has just reached.

Seeing how Yellen is winking at low interest rates, a dip may be a time to buy selectively. The next dip would be after the Union Budget, when finance minister Arun Jaitley may have to think of new taxes to raise money.

(J Mulraj is a stock market commentator and India head for Euromoney Conferences; views are personal)

First Published: Dec 19, 2014 22:56 IST