• DECEMBER 17, 2009

When bankers become speculators...

There are few more things that could be in inertia in the US.

The labour market is yet to show any sign of recovery. The income growth remains in low single digits. House buyers still seem wary of further correction. Banks are unwilling to lend. Now you could also add interest rates to this list. Yesterday the US Fed confirmed its resolve to keep interest rates near zero for an 'extended period'. The same backed by hopes of recovery. Ignoring the fact that trillions of dollars of stimuli have had little impact so far.

But that has not stopped the Fed from speculating and fuelling speculation. Probably it has few options. The US Fed certainly has a tough job at hand. Comforting investors, taxpayers, unemployed citizens, other regulators and global financial community is not easy at one go.

In the Fed chief's own words, the US economy faces formidable headwinds including a weak labour market and tight credit. It thus cannot help but speculate about more jobs being created and exit from the loose policy stance. Besides supporting economic growth, it needs to show that it is concerned about potential inflation as well. But the least it can afford is to send out signals that monetary tightening will occur sooner or later. For this could complicate efforts by policy makers to reduce the 10% unemployment rate.

Meanwhile Treasury Secretary Timothy Geithner sees plenty of reason for US taxpayers to cheer. First the US banks that have started repaying TARP funds will be in a better position to resume lending. Second, banks are repaying taxpayers with interest. As per his calculations, TARP has earned more than US$ 15 bn in income from the sector. Thus he believes that the rising asset values have a strong fundamental backing.

For the rest of the world, the inertia in US interest rates puts a lot at stake. The strength of the dollar, the reserve currency, being the most important amongst them. Whether central banks would continue to purchase gold? Whether exports to the US would remain profitable? Whether foreign inflows would be speculative rather than strategic? The answers to these questions determine the future of world economic order.

Meanwhile global asset prices, be it gold, stocks or real estate may continue to be backed by US speculation. A weak dollar may continue to push gold prices upwards. Hot FII money may find solace in expensive emerging market stocks. In some markets like China, most of it may end up funding more buildings and factories than the citizens need.

We believe that speculation is best left to those who wish to make a quick buck from every sound byte or every character of a news item. Few can do so profitably for long. Having said that, bankers and more specifically central bankers have their roles as long term watch dogs clearly cut out. A basis point of change in interest rate may not hazard their jobs. But they certainly cannot risk the future of the economy by tweaking interest rates to suit their speculative interests. We hope the Fed will also realise this soon.

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