Adriano B. Lucatelli: Cheap Money Policy and the Need for a Speedy Change

Adriano Lucatelli finews.first

Adriano B. Lucatelli

It looks increasingly likely that the U.S. central bank will raise interest rates in December – for the first time since 2006 – starting the process of normalization of monetary policy. Such a step is overdue, because asset valuations are distorted by the cheap money policy, leading to misallocations, writes Adriano B. Lucatelli.

This feature by our guest author Adriano B. Lucatelli is the second contribution to our new section finews.first. It is a forum for renowned authors specialized on economic and financial topics. The texts will be published both in German and English. The contributions appear in cooperation with Pictet, the Geneva-based private bank. The publishers of are responsible for the selection of the contributions. Click here for previous contributions  

The signs are on the wall that the Federal Reserve will start tightening monetary policy in December, for the first time since 2006 and thereby initiate the process of normalization in the U.S. Further increases are likely to follow next year. Such a step is overdue, because the low-rate policy tampers with the value of assets, which leads to misallocations of resources.

The policy of cheap money is increasingly criticized in the industrialized world. True, the resolute action by central bankers averted a global recession following the financial crisis of 2008. But a return to normality hasn't been achieved since. The central banks have been shy to finally stop the enormous buildup of debt. The long overdue revision has been delayed for fear of a recession. But the postponement holds big dangers.

«Ben Bernanke urged his colleagues to flood the market with money»

Former Fed boss Ben Bernanke was the father of an extremely loose monetary policy and bond purchases (Quantative Easing, QE). He used to urge his colleagues at the monthly meetings of the central bankers at the Bank for International Settlement (BIS) in Basel to flood the markets with money. He judged the situation to be very serious after the collapse of U.S. investment bank Lehman Brothers and compared it with the crash on New York's stock exchange on October 24, 1929.

According to Bernanke's judgement, there were two factors leading to the Great Depression after the crash in 1929: First, the U.S. central bank reduced its supply of money and second, the collapse of banks sucked further liquidity out of the economy.

For the boss of the U.S. central bank it was clear, that all had to be done to avoid a similar scenario. He advocated a cut in interest rates and hoped that they could be raised again once the economy had recovered thanks to monetary policy measures.

«Central banks to this day are scared of substantial rate increases.»

The expectation was that rising wealth – mainly through stock market valuations – would increase consumer confidence. With cheap loans available companies would also increase their investments and households ask for more mortgages.

This scenario remained wishful thinking. The growth impetus remained meagre and structural improvements, foremost in Europe, were largely elusive. Those had been expected to help the industrialized world to a more rapid expansion and a faster recovery from the crisis.

Central banks to this day are scared of substantial rate increases because they are concerned about a new recession. The experience of Japan illustrates that a swift return to normality from a long-lasting low-rate-policy isn't possible. Japan tried without success to increase interest rates in August 2000 and July 2006 (to 0.25% from zero). But the benchmark never reached a rate above 1% since 1995.

The big danger of cheap money lies in the search of investors for higher returns, shifting cash into equities, real estate, works of art and other valuable goods – prompting an artificial asset boom. With the return to a normal monetary policy the sale of goods leads to a proper crisis.

«For a new global economic equilibrium, China has to make its contribution.»

However, the situation isn't quite as bad. The disappointing economic development at the start of the year has been overcome. There are signs of a revival of U.S. consumption and the world's biggest economy is heading for full employment. Economic data in Europe are also encouraging. Even countries on the periphery, such as Ireland, Spain and Portugal are edging upwards. Italy's economy is recovering. And Japan is finally emerging from its stagnation.

Now, for a new global economic equilibrium, China has to make its contribution. The huge economy in the Far East needs structural reforms because the old growth model has foundered. Instead of relying on (state) investment and exports, China's economy needs to put more weight on (private) consumption and services. If this succeeds an orderly way out of the cheap money policy will be possible. The signs are good that the structural change will be achieved with the help of the state.

Investors seem to have accepted the departure of the U.S. from the zero-rate policy and have already priced it in. A sudden drop of equity markets isn't therefore to be expected. Earlier examples have shown that the initial rate increase doesn't have to prompt big losses.

It is for the Federal Reserve to seize the moment. An increase of the benchmark rate by 25 basis points could be a first, important step towards a normalization of interest rates.

Adriano B. Lucatelli, a 49-year-old Swiss, is a senior lecturer at the University of Zurich, chairman of the readers' commission of Neue Zuercher Zeitung and entrepreneur in the financial services industry.

Lucatelli studied international affairs and economics at the University of Nevada, Reno and at the prestigious London School of Economics. In 1995 he obtained a PhD from the University of Zurich with a dissertation on global financial market regulation.

He is co-founder and managing director of Descartes Finance, chairman of Sagebush Management, co-founder of Yotoco, and a board member of Merlini Finance and Additiv. He started his professional career at Credit Suisse in 1994, where he held various managerial positions in Zurich and London. From 2002 to 2009, Lucatelli was managing director at UBS Switzerland and member of the management committee in Lugano and Zurich.

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