Bubble Bobble – blowing and bursting bubbles
Those of you that grew up in the mid 80’s might remember the pre-internet/smartphone era when playing electronic games involved leaving your home and physically going to an amusement park or arcade.
This usually meant having to put metal coins into big clunky machines to get the benefit of playing the video game of your choice, usually starting off with three lives and either earning more as you went along or having to feed the machine with money again to get another chance at playing after getting wiped of your lives.
One of my favourite games at the time was Bubble Bobble which involved the twin Dragons “Bub” and “Bob” travelling through different levels, blowing and bursting bubbles all while having to dodge different enemies and picking up a variety of items which usually increased Bub and Bob’s powers. Complexity in the meanwhile increasing as you cleared it stage.
The game is somewhat analogous to what we are experiencing in the global economy at the moment. Since the financial crisis and deep recession most of the developed economy has faced since 2008, Central Bankers have reduced interest rates close to zero while blowing bubbles in their balance sheets and certain asset classes in a dire attempt to avoid deflation and jump start their economies.
Their argument is that that this type response is necessary in the aftermath of such extreme economic dislocations. History teaches us that this type of response certainly comes with an inevitable cost. Low interest rates and quantitative easing encourages investors, savers and cash rich enterprises to spend and invest money in order to increase returns and avoid capital erosion. This in turn inevitably increases risky behaviour which can potentially lead to more bubbles. The jury is currently out as to whether this is the case Central Bankers are dealing with at the moment.
Traders, investors and large corporations pay attention to every word of the ever increasing influential Central Bankers as they try to decipher what they will do next. This sensitivity and attachment to their words was very well demonstrated last year when the Federal Reserve suggested a reduction in the level of bond purchases. The so called “taper tantrum” was a rude awakening for investors and Central Bankers alike who found out that withdrawing stimulus of such epic proportions might not be as straight forward as once thought and even hints of such action cause market shudders.
It appears that we are now at a turning point and excessive debt levels racked up by most of the developed world’s important economies; interest rate levels have been kept artificially low for an extended period of time and offshoots of economic recovery is in question. All signs indicate to the existence of bubbles throughout. Much like the work you might expect from my childhood friends, Bub and Bob.
The main question at the moment is how do Central Banks navigate through these bubbles and steer the global economy out of this precarious situation. Technocrats seem to believe that the macro-prudential or anti-bubble policies which aim to limit systemic risk and financial distress at the macro level have the power to pop these bubbles gently, offset the effects of low interest rates and contain the possibility of future financial crises of grand scale.
Some of the policies and recommended tools such as countercyclical capital adequacy, liquidity and reserve requirements as also suggested by Basel III while laudable might not be as effective as regulators would have us believe. Additional regulation and controls are not always the answer and usually carry unintended consequences and might be limited in their effectiveness.
Research suggests that tools such as higher reserve requirements reduce the growth of bank credit which in turn extends recession and the case of some enterprises forces them to borrow outside the banking system at higher interest rates again creating other risks to the financial system.
To be effective such policies require regulatory authorities that have the expertise and clout to supervise and enforce such policies which ultimately need to be accompanied by appropriate monetary and fiscal policies. The question being how much more can government deficits increase in the case of fiscal policy and how do you handle interest rates that are constrained to zero.
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