Central Bankers See New Economic Risks

Central bankers around the world have finally reached the point, after many years, when a period of strong economic growth allows them to unwind their post-crisis easy money policies.

But at the US Federal Reserve’s annual retreat in Wyoming over the weekend, they found themselves eyeing new risks, including widening trade disputes and political challenges to their independence, news outlets reported.

Traditionally, a healthy expansion can lift the economy’s long-run growth rate if tighter labor markets lead to higher wages or productivity-boosting investments.

“Unfortunately, disruption of the global trading system has come at just the point where that was about to occur,” said Bank of Canada Gov. Stephen Poloz during a concluding panel Saturday.

Smaller nations with open economies could be most exposed to any fallout from slower global growth. “There are some measures now which make even me worried, and which I don’t applaud,” said Oystein Olsen, Norway’s central bank governor. He said he was confident “strong institutions and also the general common sense in the American people over time will not lead to a major setback.”

Central bankers never mentioned President Donald Trump by name but made clear they were concerned about his trade policy. Since the beginning of this year, the Trump administration has imposed tariffs on tens of billions of dollars’ worth of imports from a host of countries, including close allies.

“It’s paradoxical that the United States is starting to put obstacles in the road at a time when its economy is firing on all cylinders,” said Agustin Carstens, general manager of the Bank for International Settlements, which serves as a central bank for the world’s central banks.

The problem with the current US policy of using tariffs to pursue trade and economic strategies is that they are such a crude tool to use within such a complex, sophisticated and global ecosystem.

Speaking at the Jackson Hole meeting of central bankers in Wyoming at the weekend, Carstens provided a detailed road map of how protectionism could set of a "succession of negative consequences" that endangered decades of global economic gains.

A Perfect Storm

His starting point was that low barriers to trade and investment and international competition steered resources towards more productive industries and firms, disciplined prices and acted as a countervailing influence to oligopolies and the margins of dominant firms.

Reversing globalization, he said, could lead to higher prices, increased unemployment and lower growth while risking unraveling the financial inter-dependencies that enabled and encouraged trade and investment links, AP reported.

In turn that could unsettle financial markets and decrease capital spending and the interaction between the real and financial risks could amplify each other, creating that "perfect storm".

He linked the low inflation of recent years to the globalization of firms and markets, with competition from low-cost countries and advances in technology driving down production costs and prices in advanced economies.

Trump administration officials, who didn’t attend the conference, have said they see tariffs as a way to boost US industries by forcing other economies to lower their own trade barriers, buy more American exports or reduce foreign competition.

Global Value Chains

Global trade in intermediate goods and services is now almost twice as large as the trade in final goods and services. Global value chains, Carstens said, were particularly important in advanced manufacturing, like cars.

A retreat to a world of local production could undermine the market discipline that helped curb inflation and inflate prices but industries built around global value chains couldn’t switch from imported to local inputs overnight. US production costs would, for instance, rise with tariffs on imported inputs, WSJ said.

If prices rise so does the pressure on central bankers. The US is already in the process of slowly raising its rates, a policy reaffirmed by the US Federal Reserve Board chair, Jerome Powell, at the same conference. Higher US inflation could increase the pace and trajectory of US rate increases.

That in turn could lead to a further strengthening of a US dollar that has already appreciated nearly 7.5% in the past six months, hitting US exporters with a "double whammy" while tightening financial conditions for emerging markets, particularly those that borrowed heavily and cheaply in US dollars in the post-crisis period.

"We’ve already seen a raft of developing economies—Argentina, Indonesia, Turkey, Philippines, Brazil, India and Pakistan forced to raise their rates to defend their currencies and attempt to deter capital outflows," Carstens said.

It isn’t just trade that has been globalized but its financing, with Carstens saying that complex trading relationships like global value chains need complex financial services, with lots of working capital, lots of exposures to foreign currency risk and lots of complex derivatives and hedging strategies to offset the risks.

Other policy makers at the conference expressed worry about the future of central banking generally at a time when structural changes in the economy have left some workers less satisfied with the quality of jobs.