Here is a bet based on the latest episode in a long-running policy dispute.
Last Thursday (October 2), the meeting of the governing council of the European Central Bank (ECB) in the splendors of the Capodimonte ("top of the hill") Palace in Naples, Italy, reaffirmed with overwhelming majority the zero (0.05 percent) interest rate policy and a program of security purchases that could expand the bank's balance sheet by an estimated Euro1 trillion.
Policy deliberations at this regal venue were greeted by some 2,000 protesters clashing with police and braving waves of teargas in a city (Naples) whose unemployment rate of 25 percent is exactly double Italy's average, and whose per capita economic output is more than 30 percent below that of the country as a whole.
True to form, Germany continued to strongly oppose this ECB policy. The German member of the ECB's governing council maintains that the euro area banks don't need virtually free loanable funds and security purchases that will, in his view, again lead to banks' mischief requiring bailouts with taxpayers' money. His position was supported by his Austrian colleague (16:2, in case you want to keep the score).
Who will win? Can Germany again bull its way through this one as it did with the widely condemned austerity policies? (Hint: if you look at the euro's exchange rate, you will see that markets have already voted.)
The ECB will do "whatever it takes"
Staying within the policy mandate, the vast majority of the ECB's governing council is inclined to look for additional measures that would restore the transmission mechanism (i.e., the financial intermediation system) between easy credit conditions and real economy.
The ECB's purchases of asset-backed securities are aiming to achieve that, because they are designed to provide incentives to the banking system to significantly expand lending to euro area businesses and households.
In the three months to August, the euro area loans to the private sector have been falling at an average annual rate of 1.6 percent, with loans to households down 0.5 percent and loans to non-financial corporations falling 2.2 percent.
No improvement is expected in the months ahead. The euro area was on the verge of recession in the second quarter, and the latest survey evidence indicates that the economy continues to stagnate. Last month, for example, indices measuring manufacturing and service activities were at their lowest levels in a year. Labor market conditions are worsening even in Germany, where the number of unemployed in September was the highest since the beginning of this year.
It, therefore, seems a perfectly safe bet that the ECB will not only maintain its 0.05 percent key interest rate, but that it will also augment its credit easing with targeted and sufficiently strong unconventional policy measures.
Easy money in the U.S., China and Japan
The U.S. Federal Reserve (Fed) will also maintain an expansionary policy stance for the foreseeable future.
In spite of some contraction of the Fed's monetary base during the reserve reporting period ending on October 1, the effective federal funds rate was kept in a 0-0.1 percent range, well below the 0.25 percent target.
With an inflation rate likely to remain stable around 2 percent, the Fed has a very long way to go to bring the federal funds in the neighborhood of 4 percent - a position that would signal a roughly neutral monetary policy.
What we are seeing now may be an early sign that the Fed's statement of keeping interest rates low well after the quantitative easing is over is a credible pledge. Still, we have to monitor carefully, as the Fed does, the hourly compensation and productivity gains in the months ahead.
China will continue to use its directed credit flows to keep the economy in the upper range of its 7-8 percent growth target. That policy will aim at supporting domestic demand as the country seeks to rebalance its growth away from a heavy reliance on exports. China's massive monetary stimuli may well be a thing of the past, but appropriately easy credit conditions will be maintained to support structural changes, employment creation and a much needed environmental cleanup.
Most China watchers believe that the government will have to flood the market with liquidity to bail out its banking system allegedly awash in bad loans, and to manage widely commented excess supplies in the real estate sector. Since the actual magnitudes of these problems are not well known to outside observers, I believe that it would be more useful to watch activity indicators as potential triggers of credit policy changes.
Things in Japan are much simpler. An aggressive monetary expansion remains the key policy lever. Large excess supplies of yen liquidity are expected to keep the exchange rate down in order to stimulate exports. That, in turn, should support employment, wages and capital outlays in export-oriented industries, hopefully setting in train Japan's usual pattern of economic recovery.
We have yet to see such a business cycle unfolding, but that is what the government seems to be aiming for. It is also obvious that Japan's extraordinarily easy monetary policy will have to offset the fiscal tightening caused by higher sales taxes.
Investment thoughts
Modest recovery in the United States, stagnation in the euro area -- and restrictive fiscal policies in both economic systems (accounting for 35 percent of world economy) -- leaves expansionary monetary policy as the main instrument of economic stabilization.
China and Japan (another 22 percent of the world economy) also use varying degrees of monetary accommodation. In the case of China, directed credit flows serve to support sectors maintaining a high level of economic activity and facilitating structural changes. In Japan, the role of monetary policy is much more radical; huge liquidity provisions are expected to permanently change the country's growth and inflation dynamics under conditions of a gradual fiscal consolidation.
Those who worry about "overpriced" U.S. equities, with record earnings per share and cyclically adjusted price/earnings ratios (CAPE) 60 percent above their long-term average should remember that these are extraordinary times for monetary policies in nearly two-thirds of the world economy.
The mission of the easy credit stance in the U.S. is not finished; and it still has a long way to go in the euro area, China and Japan. It could also happen that a growing and open U.S. economy will run an increasing trade deficit with the rest of the world. Net exports would then become a serious drag on U.S. growth. And that, of course, would require the Fed to keep the stimulus longer than most of the inflation hawks now expect.
Investors looking at U.S. equity market indicators should not reason in closed economy terms. Liquidity and earning opportunities are also created on a global scale.
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.
