Stephen Ganden writes: The Federal Reserve decided to keep rates where they were for another month, and indicated that it was only likely to raise rates twice in the next year and four times in 2017.

The Fed has a history of tricking it self into believing the economy is stronger than it really is.

The problem is it’s hard to see why the Fed is so confident, not only that the economy will continue to improve, and to do so enough to whether more rate increases, especially when the first rate increase went pretty terribly.

Despite the falling unemployment rate, there has been little sign of wage increases. Although she said anecdotally there seems to be signs of a pick up in wages. Yellen also sidestepped a question about why consumers haven’t increased spending more given the steep drop in gas prices.

Does this signal that consumers are still worried about the economy? Yellen said it was really hard to say why consumers were doing what they were doing.

Also, it’s been 81 months since the end of the last recession, meaning the current economic expansion is due for a downturn. Perhaps, that’s why default rates on a wide rate of debt from auto loans to high-yield corporate debt is rising faster than it has in years.

Add the risks ahead, which are sure to raise volatility in the market and the economy, including the possibility of England’s “Brexit” from the euro, as well as a contentious election here and it’s hard to see how the Fed will be able to meet its interest rate goals.

The biggest problem though is overseas.  Sales of big international companies. will decease because the dollar is likely to strengthen, causing sales of U.S. multinationals to fall further.

Fed and interest rate hawks will counter that exports only make up a small portion of the overall economy, which is generally still driven by U.S. consumers — and that the Fed would be better off raising rates now so it has room to lower rates later.

The international economy means a lot to the largest stocks in the country, and the stocks that make up the S&P 500; more than it used to.

That’s key because even more than jobs or wages or inflation, perception has the power to drive the economy. As the economy continues to improve, exit polls from the primaries say that the economy remains most voters’ top concern. As long as that remains the case, the Fed’s determination to raise rates is going to remain out of whack with reality.

After all the shouting, are we any closer to knowing whether free trade agreements are good or bad for the country – and for your wallet?

The attempts to provide answers to those questions have been thrust into the spotlight by President Barack Obama’s futile last-minute efforts to salvage his power to freely negotiate what would be the world’s largest free trade pact, the Trans-Pacific Partnership.

In the eyes of those within his own party, including the House minority leader, Nancy Pelosi, free trade agreements have been disastrous for ordinary Americans, hurting their wages, eroding the health of entire manufacturing sectors and putting the United States at a disadvantage against countries that engage in underhand trade practices. Their success last week managed to strip Obama of fast-track negotiating authority, pushing him into an unusual partnership with congressional Republicans in an effort to find a way to rescue the package of legislation by restructuring it. If you thought the political battle over Obamacare was high drama, just wait until Obamatrade really gets going.

Negotiating a free trade agreement is always going to involve a leap of faith – a leap of faith in the future. There are simply far too many variables involved, and too many “unknown unknowns”.

Consider the US-South Korea free trade agreement, completed in 2010 and in effect from 2012. Far from helping US exports to South Korea to climb, they have fallen as imports from South Korea have risen, causing the trade deficit to widen.

The problem with those who try to draw conclusions about free trade agreements in general from this example, however, is twofold. Firstly, it covers the experience of only about two years: an absurdly short time frame. Secondly, economic growth rates in South Korea peaked in 2010, the year the free trade pact was negotiated and all those rosy forecasts about US exports were drawn up. Right now, however, the economic picture looks bleak, and it’s probably fair to say that few expected that would happen.

The picture gets even more muddled if you try to look at the grandaddy of all free trade agreements, the North American Free Trade Agreement, or Nafta. Signed by Canada, the US and Mexico in 1992, Nafta was a model for many of the large trade agreements that followed, including TPP; it also was one of the first free trade pacts between economies with varying standards of living, labor standards and other business and environmental rules.

Critics argue that by 2010, a total of 682,900 jobs had been lost to Mexico, on a net basis. Of these, 415,000 were manufacturing jobs, many of which paid healthy living wages. Meanwhile, a small trade surplus with Mexico had become a deficit by 2000.

Had those jobs not gone to Mexico, would they have stayed in the United States? Not necessarily, suggested Mauro Guillén, a management professor at the Wharton School of Business; they might well have ended up in China. Meanwhile, some of the products made in Mexico are still being designed in the United States, he has noted.

In 1995, the year after Nafta took effect, Mexico had its own financial crisis, causing the value of the peso to nosedive and triggering a recession. As is the case with South Korea today, events that had nothing to do with the free trade agreement itself ended up causing a big drop in Mexican imports from the United States. The timing, however, made it appear as if the trade deficit was tied to free trade – but correlation isn’t causation. More recently, US demand for crude oil produced by Mexico, and the high prices for crude, sent that trade deficit higher again. Once again, that imbalance had nothing to do with free trade and everything to do with a supply/demand imbalance for crude oil within the United States.

American incomes have continued to stagnate in the period since Nafta kicked off the negotiation of free trade agreements. Again, however, correlation isn’t causation. The biggest culprits may include technology that has made it easier for workers in low-wage countries like China to do jobs that were once done here in the United States – or the policies of companies with respect to how they treat their work force. Apple already can choose to make its products in China, Vietnam or the United States. Their choice is clear. David Autor, an economist at MIT, argues that it is the spike in global trade, not free trade agreements, that has led to this result; he calculates that imports from China (not party to any free trade agreement with the United States) are responsible for 21% of the plunge in American manufacturing.

None of this means that the TPP is certain to be a great idea – or a bad one. Folks like the president and David Autor may argue all they like in favor of the pact, suggesting that it will give us an edge against China and, by protecting our intellectual property, help us expand our exports of computer services. Critics can charge that it will be a disaster, costing millions of jobs, accelerating climate change and doing untold damage to everything from our access to healthcare to worker’s rights.

It’s a roll of the dice.

Challenges of security in financial instituions

Bangladesh’s central bank governor resigned over the theft of $81 million from the bank’s U.S. account, as details emerged in the Philippines that $30 million of the money was delivered in cash to a casino junket operator in Manila.

The rest of the money hackers stole from the Bangladesh Bank’s account at the New York Federal Reserve, one of the largest cyber heists in history, went to two casinos.

They said a mix of dollars and Philippine pesos was sent by a foreign exchange broker to the ethnic Chinese junket operator over several days, a haul that would have been made up of at least 780,000 banknotes.

Bangladesh Bank officials have said there is little hope of apprehending the perpetrators and recovering the money would be difficult and could take months.

Under the former development economics professor, the country’s foreign exchange reserves have increased four-fold to $28 billion and he also sought to ensure farmers and women entrepreneurs had better access to banking services and credit.

Rahman defended his record at the central bank, saying he was proud of his achievements there.

He described the heist as an “earthquake” and said the bank had promptly informed intelligence agencies in Bangladesh and abroad and also brought in international experts to investigate.

CCTV cameras at the branch were not functioning when the money was withdrawn.

Salud Bautista said that her firm was instructed by the bank branch to transfer the funds to a man named Weikang Xu and two casinos.

She said that $30 million went to Xu in cash. Guingona has said Xu was ethnic Chinese and a foreigner, but he was not sure if he was a Chinese national.

A tranche of $29 million ended up in an account of Solaire, a casino resort owned and operated by Bloomberry Resorts Corp. Bloomberry is controlled by Enrique Razon, the Philippines’ fifth-richest man in 2015, according to Forbes.

Silverio Benny Tan, corporate secretary of Bloomberry Resorts, told the hearing that the $29 million was transferred into a casino account under Xu’s name in exchange for ‘dead chips’ that can only be cashed in from winnings.

Casinos are not covered by the country’s anti-money laundering laws so it was not clear if the stolen funds could ever be recovered.

“The paper trail ends there. That is the problem,” he said. “Right now we are at a dead end.”

Conclusion of the US Financial Crisis Inquiry:  We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. There was a view that instincts for self-preservation inside major financial firms would shield them from fatal risk-taking without the need for a steady regulatory hand, which, the firms argued, would stifle innovation. Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding. The large investment banks and bank holding companies focused their activities increasingly on risky trading activities that produced hefty profits. They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products. Like Icarus, they never feared flying ever closer to the sun. Many of these institutions grew aggressively through poorly executed acquisition and integration strategies that made effective management more challenging.

Too big to fail meant too big to manage. Financial institutions and credit rating agencies embraced mathematical models as reliable predictors of risks, replacing judgment in too many instances. Too often, risk management became risk justification. Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences. Often, those systems encouraged the big bet—where the payoff on the upside could be huge and the downside limited. This was the case up and down the line—from the corporate boardroom to the mortgage broker on the street.

Our examination revealed stunning instances of governance breakdowns and irresponsibility. Five major investment banks—Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley—were operating with extraordinarily thin capital.

Too many of them were thinking alike. And the leverage was often hidden—in derivatives positions, in off-balance-sheet entities, and through “window dressing” of financial reports available to the investing public. The kings of leverage were Fannie Mae and Freddie Mac, the two behemoth government-sponsored enterprises (GSEs)..

Recently we permitted the growth of a shadow banking system—opaque and laden with shortterm debt—that rivaled the size of the traditional banking system. Key components of the market—for example, the multitrillion-dollar repo lending market, off-balance-sheet entities, and the use of over-the-counter derivatives—were hidden from view, without the protections we had constructed to prevent financial meltdowns.  When the housing and mortgage markets cratered, the lack of transparency, the extraordinary debt loads, the short-term loans, and the risky assets all came home to roost. What resulted was panic. We had reaped what we had sown.

German savings banks warn ECB on monetary ‘activism’

Hortense Goulard writes: Two days ahead of a key meeting of the European Central Bank, the chief economists of the German Savings Banks Association warned Tuesday that more expansionary monetary policy from the ECB “would barely have a positive impact on the economy” but could create problems in the long run.

“With hasty monetary policy, the ECB mainly achieves a crisis atmosphere and fosters a lack of trust in the eurozone,” economists from the association (Deutscher Sparkassen und Giroverband) stated in a press release. Most analysts expect Mario Draghi and the ECB board to take the Bank’s interest rates deeper into negative territory on Thursday.

Further lowering of key interest rates would harm financial stability, because of new risks and “huge side effects for the banks and the financial markets,” said Gertrud Traud, chief economist at the Landesbank Hessen-Thüringen.

The ECB instead should drop its goal of achieving an inflation rate close to 2 percent, according to the association’s economists.

“In a time of marked economic weakness as today, this goal is difficult to reach anyway,” said Michael Wolgast, chief economist of the DSGV, adding that the credibility of the central bank could be damaged if it kept missing its inflation goal in spite of its monetary measures.

Contrary to the ECB, the DSGV chief economists see little danger of deflation in the eurozone. They believe the inflation rates “should be near the goal of 2 percent in 2018 at the latest” without any additional monetary measures.

Capital Requirements for Banks Hotly Debated

Ben Chu writes:  A senior official at the Bank of England has been accused of misleading the public about the safety of UK banks.

He cited Bank of England estimates that a 1 percentage point increase in capital requirements across the board could knock around 0.6 per cent off GDP. “The costs will be borne by real borrowers in higher costs of funds and real savers in lower returns,” he warned. But Mr Brazier’s remarks drew a strong rebuttal from Professor Anat Admati of Stanford University, a widely acknowledged expert on the banking sector.

“I am alarmed by Mr Brazier’s speech because it confirms that important policy regarding financial stability is based on flawed claims and flawed research,” she said.

Ms Admati rejected the Bank’s estimate of the wider economic cost of banks using more capital and said one reason banks might find it more expensive to fund their balance sheets with more equity and less debt was because their de facto public subsidies from the taxpayer, such as being “too big to fail” and the tax deductability of debt, would have been eroded.

“It is disturbing that the Bank’s head of financial stability seems to be more concerned with supporting the banks by making flawed assertions that contradict fundamental principles of corporate funding,” she said.

The row comes at a time when the Bank is under serious pressure to reconsider its capital rules. The position of Mr Brazier, who was appointed to his current position last year, seems to be in line with those of the Bank’s Governor, Mark Carney. Mr Carney has repeatedly sought to assure bankers that there will be no additional capital requirements made on them in the coming years. Referring to the international “Basel” agreements on capital standards sealed in 2011, Mr Carney insisted in Shanghai last month: “There will be no Basel IV”.

In his new book The Age of Alchemy, Lord King takes a tough line on capital, saying it would be “a good start” for banks to have a minimum ratio of equity to total assets of 10 per cent. The Bank is currently planning to require them to have equity worth only between 3 and 4 per cent of total assets. For her part, Ms Admati says banks should have 20 per cent buffers.

“Their hatred of equity only confirms that the subsidies are substantial to their business model – but the subsidies come from the public,” said Ms Admati.

Focus on Finance

“The world has largely exhausted the scope for central bank improvisation as a growth strategy,” says Larry Summers, Harvard economist and advisor to Presidents. 

The new normal is low growth, rising inequality, political dysfunction and sometimes social tension.  Central banks have intervened.  Technical innovation has been transformative. And yet we are at a fork in the road.  Great New York Yankees baseball catcher Yogi Berra was fond of saying, “When you come to a fork in the road, take it.” 

Unfortunately we can’t have both forks.  Either we will get higher inclusive growth and genuine financial stability.  r we will get mired in lower growth with periodic recessions and the return of financial instability. 

We need to make better choices as households, companies, and governments.

WHen other policy makers were paralyzed by the world economic crisis in 2008-9, central banks stepped up.  The created a largely artificial growth path but the underlying engine of economic prosperity was not re-vamped. 

Central banks’ ability to pull new rabbits out of a hat is shrinking. 

The 17th century saw the creation of the first central banks in Sweden and then England.

Today the US Federal Reserve is the most powerful central bank in the world, but it was only created following a financial crisis in 1913.   The Fed’s mission is to “provide the nation with a safe, flexible, stable monetary ans financial system.”

The European Central Bank, representing 19 nations, is the second most powerful. It began to operate in 1999. 

We will present a series of articles on central banks.  They are based on Mohammed El Erian’s recent book, “The Only Game in Town: Central Banks, Instability and the Next Collapse.”

Alexander Friedman writes: Central bank policies have moved from supporting the markets to potentially destabilizing them. Now markets are turning to structural reform and fiscal policy for assistance. In this light, current price movements should be viewed through the spectrum of geopolitics. And it is not a nice view.

Nowhere is this more evident than in the oil markets, where prices have collapsed, with both Brent and Crude now hovering around the $30-per-barrel level.  In January, the correlation between crude oil prices and the S&P 500 reached the highest level since 1990.

It has become increasingly clear that supply dynamics, rather than falling demand, explain the drop from $110/barrel since the summer of 2014.

These supply dynamics are shaped by politics. Daily headlines about potential coordinated measures by the key oil-producing countries fuel oil-price volatility and define risk appetite across financial markets. Yet the politics is so confused that coordination appears unlikely, at best; the Iranian oil minister recently described a potential OPEC production freeze as a “joke.”

Currency policy remains confused, while newly introduced (and soon withdrawn) stock-market circuit breakers have accelerated market falls, as investors try to sell shares before liquidity disappears. Moreover, purchases by state-owned financial institutions, together with bans on sales by large institutional shareholders, cannot remain permanent features if the market is to be truly free.

Labile politics are increasingly driving outcomes in other emerging markets as well. In Brazil, the government struggles to balance its populist agenda with lower commodity prices, dwindling growth, and persistent inflation.

In Russia, too, politics has aggravated the negative oil-price shock. Western sanctions have contributed to an already slowing growth trajectory, and are threatening Russia’s ability to raise debt capital in global markets. The ruble has plummeted 130% since 2014 began, and GDP in 2015 contracted by 3.7%.

Yet Russia is a star performer compared to Venezuela, where President Nicolás Maduro’s government has overseen the economy’s total disintegration.

In Europe, the efficacy of the European Central Bank’s monetary policies is waning as the political scene becomes increasingly fragile.

Meanwhile, the migration crisis threatens Germany’s government; splits are now deepening within Chancellor Angela Merkel’s party.

In Southern Europe, Spain’s recent elections were inconclusive, and the absence of a stable government could derail an economic recovery that gained traction in 2015.

Turning to Japan, the strength in equities since Prime Minister Shinzo Abe took office has been founded on his “Abenomics” strategy’s “three arrows”: monetary stimulus, fiscal stimulus, and structural reforms. The Bank of Japan has launched one arrow, expanding the monetary base to ¥80 trillion ($710 billion). But momentum has faded considerably, as investors wait for the structural reforms needed for sustained improvement in economic, and market, fundamentals.

Financial markets, which seek stability and predictability, are struggling to find it in the politics of the world’s largest economy.

History may not repeat itself, but let’s hope it finds its rhyme. Back in the 1990s, the US economy stabilized and then surged forward, driven by accelerating productivity and abetted by sound monetary and fiscal policy. But economies may prove to be easier to mend than today’s dysfunctional politics, which may be part and parcel of the “new normal.”

Andrew Sheng-and Xiao Geng write: China’s ability to maintain stability depends on a multitude of interrelated factors, such as low productivity growth, declining real interest rates, disruptive technologies, excess capacity and debt overhangs, and excess savings. In fact, the current battle over the renminbi’s exchange rate reflects a tension between the interests of the “financial engineers” (such as the managers of dollar-based hedge funds) and the “real engineers” (Chinese policymakers).

Foreign-exchange markets are, in theory, zero-sum games: the buyer’s loss is the seller’s gain, and vice versa.

Nowadays, financial engineers increasingly shape the exchange rate through financial transactions that may not be linked to economic fundamentals. Because financial markets notoriously overshoot, if the short-sellers win by pushing exchange rates and the real economy into a low-level equilibrium, the losses take the form of investment, jobs, and income. In other words, financial engineers’ gain is real people’s pain.

In order to achieve these gains, financial engineers use the media to influence market behavior.

China’s growth slowdown and the rise of non-performing loans are being discussed as exclusively negative developments. But they are also necessary pains on the path to supply-side reform aimed at eliminating excess capacity, improving resource efficiency, and jettisoning polluting industries.

China’s authorities have long understood that a stable renminbi exchange rate is critical to national, regional, and global stability. Indeed, that is why they did not devalue the renminbi during the Asian financial crisis. They saw what most analysts missed: leaving the US dollar as the main safe-haven currency for global savings, with near-zero interest rates, would have the same deflationary impact that the gold standard had in the 1930s.

In the face of today’s deflationary forces, however, real engineers in the world’s major economies have been unwilling or unable to reflate. The United States, the world’s largest economy, will not use fiscal tools to that end, owing to domestic political constraints. Europe’s unwillingness to reflate reflects Germany’s deep-seated fear of inflation (which underpins its enduring commitment to austerity). Japan cannot reflate because of its aging population and irresolute implementation of Prime Minister Shinzo Abe’s economic plan, so-called Abenomics. And China is still paying for the excessive reflation caused by its CN¥4 trillion ($586 billion) stimulus package in 2009, which added over CN¥80 trillion to its own debt.

Meanwhile, the consequences of financial engineering are intensifying. Zero and negative interest rates have not only encouraged short-term speculation in asset markets and harmed long-term investments; they have also destroyed the business model of banks, insurance companies, and fund managers.

Financial engineers outperformed the real economy only with the support of super-financial engineers – that is, central banks. Initially, balance-sheet expansion – by $5 trillion since 2009 – provided banks with the cheap funding they needed to avoid failure. But bank deleveraging (brought about by stiffer regulatory requirements), together with negative interest rates, caused financial institutions’ equity prices to fall, leading to further pro-cyclical destruction of value through price deflation, increasing illiquidity, and crowded exits.

Past experience has taught China’s real engineers that the only way to escape deflation is through painful structural reforms – not easy money and competitive devaluation.

The US dollar is a safe haven, but savers in need of liquidity still lack an impartial lender of last resort. Depositing in reserve currencies at near-zero interest rates makes sense only if the banker is not funding financial speculation against the depositor.

China’s G-20 presidency this year offers an important opportunity to emphasize that renminbi stability is important not only for China, but also for the global financial system as a whole. If the US dollar enters into another round of revaluation, the only winners will be financial engineers.

Kemal Dervis writes: The Economist recently asked of monetary policymakers. Stephen Roach has called the move by major central banks – including the Bank of Japan, the European Central Bank, and the Bank of Sweden – to negative real (and, in some cases, even nominal) interest rates a “futile” effort that merely sets “the stage for the next crisis.” And, at the February G-20 finance ministers meeting, Bank of England Governor Mark Carney reportedly called these policies “ultimately a zero-sum game.” Have the major advanced economies’ central banks – which have borne the burden of sustaining anemic post-2008 recoveries – really run out of options?

It certainly seems so. Central-bank balance sheets have swelled, and policy rates have reached their “near zero” lower bounds.

But policymakers have one more option: a shift to “purer” fiscal policy, in which they directly finance government spending by printing money – a so-called “helicopter drop.” The new money would bypass the financial and corporate sectors and go straight to the thirstiest horses: middle- and lower-income consumers. The money could go to them directly, and through investment in job-creating, productivity-increasing infrastructure. By placing purchasing power in the hands of those who need it most, direct monetary financing of public spending would also help to improve inclusiveness in economies where inequality is rising fast.

Helicopter drops are currently proposed by both leftist and centrist economists.

Even with such an approach, however, major central banks would have to coordinate their policies.

Success also hinges on the simultaneous pursuit of fiscal expansion worldwide, with each country’s efforts calibrated according to its fiscal space and current-account position. The expansion should finance a global program of investment in physical and human infrastructure, focusing on the two key challenges of our time: cleaner energy and skills for the digital age.

Economic orthodoxy and independent actions have clearly failed. It is time for policymakers to recognize that innovative international policy cooperation is not a luxury; sometimes – like today – it is a necessity.