Failure Of Central Bankers


Source of graph: Reuters


By John Richardson

THE Federal Reserve has got it badly wrong, and could compound its mistake by launching a third round of quantitative easing (QE3), warns Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley.

“The first two rounds of quantitative easing fuelled a commodity bubble, increased income inequality and set a bad example for the rest of the world,” wrote Sharma, in this article in the Financial Times.

“During the 16 months of round one, up to March 2010, the CRB (Commodity Research Bureau) commodity price index rose 36 percent, while food prices rose 20 percent and oil prices surged 59 percent.

“During round two, in the eight months up to June last year, the CRB rose 10 percent, the CRB rose 10 percent, with food up 15 percent, while oil prices rose 30 percent.”

And now stock and commodity markets have responded in anticipation of QE3. They have also reacted positively to the European Central Bank bond-buying decision, which, in effect, amounts to quantitative easing.

For example, as crude went higher, by last Friday the September ICIS Petrochemical Index (IPEX) had rebounded 2.6% from the year-low in August to 307.77, driven mainly by an almost 10% gain in Europe. The US component edged up by 1.6%, while Asia experienced stagnant growth.

Out of the sub-indices, olefins gained the most by 5.7%, followed by aromatics at 5.2% and then polymers at 3.9%.

Sharma identifies exchange traded funds, and other financial products, as being at the core of the problem. Commodity prices tend to now move in lock-step with equities. This is the point we made in chapter 3 of our e-book, Boom, Gloom & The New Normal, when we explained the dysfunctional nature of oil markets.

For most people, especially those in emerging markets who are very poor by Western standards, higher oil and food prices act as an effective extra tax on their spending.

As Sharma points out:

*When the price of oil hits $120 a barrel, consumer spending on oil reaches 6 percent of total worldwide income and starts to cut into spending on other goods.

*Estimates suggest that in the US, every $10 a barrel increase in the price of oil shaves 0.3 percent from GDP, and adds 0.3 percent to inflation.

*Illustrating the point about the poor getting poorer, in the US again he adds that families in the bottom 20 percent of income earners spend 8 percent of incomes on petrol and 30 percent on food, while the top 20 percent spend just 2 percent on petrol and 5 percent on food.

Fellow blogger Paul Hodges, and co-author of our e-book, also argues in this post that quantitative easing has failed.

He makes the point that in China, a very poor country by Western standards, oil prices are close to record-high levels.

Inflation in China rebounded in August as a result of more expensive food and fuel. This is limiting economic stimulus options.

And because demand is so weak in China, the polyethylene (PE) industry is struggling to fully pass-on higher raw-material costs to the converters and fabricators. Northeast Asian integrated PE margins are in deep negative territory.

One group of people that have benefited from quantitative easing are those who are lucky enough to own equities (Sharma adds that 75 percent of all stocks in the US are owned by the top 10 percent of income earners).

And the other beneficiaries are the bankers who got us into this mess in the first place.

The ability of these few people to buy extra yachts, Gucci handbags and luxury Manhattan apartments, isn’t going to get the world economy going again.

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