When easy money stops
Normalising credit policies will strain system
by Desmond Lachman in Washington
Wed 23 Aug 2017
Ultra-easy monetary policies allow even borrowers with the poorest of credit records to raise money on relatively favourable terms. But, as the late Hyman Minsky never tired of reminding us, the lending practices that easy liquidity encourages all too often contribute to the next global financial crisis.
This month, war-torn Iraq successfully placed a six-year government bond independently without any US guarantee. Indeed, its $1bn offering was more than six times oversubscribed, and it priced at a relatively low yield of around 6.75%.
Iraq’s bond placement is hardly an isolated case of a borrower of dubious creditworthiness being able to tap into the global market on favourable terms. A few weeks ago, Argentina, a country that has defaulted five times over the past 100 years, was able to place a $2.75bn 100-year bond at a relatively low yield. Then Greece, which defaulted on €206bn in government debt in 2012, raised more than €3bn with a five-year bond placement at 4.5%.
In addition, over the past few years highly leveraged emerging market corporate borrowers have been able to tap the global bond market on favourable terms for very large sums of money.
All this activity is fine as long as the global credit market remains strong. However, experience tells us that at some point it will slow down. The turning point may well come next year when the world’s major central banks are expected to start normalising their monetary policies. When that happens, risky creditors will be vulnerable, as they have been all too often in the past.
We should be watching particularly carefully what happens in Europe. The European Central Bank’s €60bn a month bond purchase programme runs until the end of the year. A decision on whether and how to extend it will be even more controversial and difficult in the light of the German constitutional court’s stronger than expected statement last week drawing attention to possible legal problems with the continuation of the programme. The court spoke of ‘weighty reasons’ why the implementation of the programme may violate the European treaty prohibition of monetary financing of government budgets. In addition, in deciding the programme, the ECB may be exceeding its mandate by extending its powers into areas that are the responsibility of the member states.
The constitutional court has not yet delivered a final judgement pending a request for European Court of Justice to answer key questions. This action perpetuates legal ambiguity over the ECB’s actions, and could contribute to the ECB winding down QE more quickly than expected.
When global liquidity tightens we are likely to find that many financial institutions have made risky loans at interest rates that do not nearly compensate for the inherent uncertainty.
We must hope that global policy-makers do not seriously believe Fed Chair Janet Yellen’s recent statement that ‘we will not see another global economic and financial crisis in our lifetime’. Policy-makers should surely be starting to think seriously about how to respond to the severe strains the world’s financial system is likely to face when easy money stops.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.
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