Economics focus

The mandarins of money

Central banks in the rich world no longer determine global monetary conditions

In August 1977, The Economist published an article by Alan Greenspan, the former chairman of America's Federal Reserve, who was then a private-sector economist. It listed five economic “don'ts”. One of these was: “Don't allow money-supply growth to spiral out of hand.” Yet that is exactly what central bankers have done in recent years. The bubble in credit markets that now seems to be bursting and the frothiness of so many asset prices was encouraged by loose monetary policies which pumped liquidity into financial markets.

Many economists blame that excess liquidity on Mr Greenspan himself for keeping interest rates too low for too long when he headed the Fed. After the dotcom bubble burst in 2000-01, the Fed slashed short-term interest rates to 1% by 2003. The European Central Bank (ECB) and the Bank of Japan also cut rates to unusually low levels, pushing the average interest rate in the big rich economies to a record low. The real short-term interest rate is now above its long-term average for the first time since 2001, suggesting that global monetary policy is no longer loose. So why did financial markets remain exuberant for so long? One reason is that the world's two most important central banks, the Fed and the ECB, have not been the main sources of global monetary liquidity.

Many economists in investment banks and international institutions mistakenly assume that “global” monetary conditions are set by the central banks of the rich economies. Yet over the past year, a staggering three-fifths of the world's broad money-supply growth has flowed from emerging economies.

Their mints are working overtime. Goldman Sachs reckons that growth in China's M3 measure of broad money has quickened to 20% over the past year. In Russia money supply has grown by a striking 51% and India's is up by 24%. Indeed, the broad money supply in emerging countries has increased by an average of 21% over the past year, almost three times as fast as it has in the developed world. Adjusted for inflation, their money growth has accelerated alarmingly (see chart). As a result, the entire world's money supply is growing at its fastest for decades in real terms.

One would expect emerging economies' money supply to outpace that of the rich world, because their GDP growth is faster. But their surplus money growth over and above the increase in nominal GDP (a crude measure of the excess money available to be invested in financial assets) is also far bigger. Their interest policy has been timid: over the past three years, as monetary policy has been tightened in America and the euro area, average rates in the emerging world have barely budged. China and India have real interest rates among the world's lowest, even though they have the fastest-growing economies.

A decade or so ago, speedy monetary growth in emerging economies was of little concern to the central banks of the developed world: a monetary deluge in Brazil, say, simply caused hyperinflation there. But today these economies play a larger role in the world economy and cross-border financial flows are much bigger. Inflation remains low, so the liquidity pumped out by central banks is flowing somewhere else, namely into global financial markets. For instance, huge purchases of Treasury bonds by these central banks have reduced bond yields, and so spurred excessive borrowing in America.

The policies of the People's Bank of China (PBOC) or the Bank of Russia are likely to have an increasing impact on developed economies in future as capital controls are reduced and markets become more integrated. This prospect becomes more alarming when one considers that, unlike the Fed and the ECB, most central banks in emerging economies are not independent, and thus free to set interest rates in the best long-term interest of the economy. They are still firmly under the thumb of politicians.

Yes, Minister

According to conventional wisdom, monetary-policy mistakes such as those that caused the Great Inflation in the 1970s are much less likely today because central banks in the rich world are now independent of politicians. Yet few of the main central banks in emerging economies enjoy full legal independence, and thus often face pressure from politicians to hold interest rates low to boost growth and jobs. Their monetary independence is also constrained by governments' desire to hold down exchange rates. This forces central banks to engage in heavy foreign-exchange intervention, which inflates money supplies.

A recent IMF study ranked 163 central banks according to their political autonomy (based on factors such as how officials are appointed, the length of their terms and whether interest rates have to be approved by the government). Emerging central banks have become more independent since the 1980s, but they remain much less so than the ECB or the Fed. Some of the central banks that have been pumping out the most money, notably those in China, India and Russia, are among the least independent. The PBOC is under the sway of the Communist Party. The Reserve Bank of India would have raised interest rates more aggressively last year were it not for political pressure. Controversially, the study reckons that both central banks are more independent than the Bank of Japan—another country where its own cheap money policy has created a flood of liquidity outside its borders, through the carry trade.

The days when central-bank watchers could just focus on the Fed and perhaps the ECB in order to assess “global” monetary conditions are over. They no longer control the amount of money sloshing around the world and, as financial markets become ever more linked, analysts will need to pay more attention to central banks in the emerging world. They may even have a bigger role to play in stabilising the global economy if the squeeze in the credit markets becomes more acute.

Hindsights

The New Colonialist Power

China's hunger for natural resources is causing more problems at home than abroad

It is not an exaggeration to say China is hungry for commodities.The fact is that it accounts for about twenty (20) per cent of the world's population, but it gobbles up more than half of the world's pork, half of its cement, a third of its steel and over a quarter of its aluminium. Indeed much of its spending, estimated at 35 times as much on imports of soya beans and crude oil as it did in 1999, and 23 times as much importing copper—indeed, to point this out China, as a matter of fact, swallowed over four-fifths of the increase in the world's copper supply since 2000.

But worse is yet to come as China is getting ever hungrier. Although consumption of petrol is falling in America, the oil price is setting new records, because demand from China and other developing economies is still on the rise. The International Energy Agency expects China's imports of oil to triple by 2030. Chinese demand for raw materials of all sorts is growing so fast and creating such a bonanza for farmers, miners and oilmen that phrases such as “bull market” or “cyclical expansion” do not seem to do it justice . Instead, bankers have coined a new word: supercycle.

Not all observers, however, think that China's unstinting appetite for commodities is super. The most common complaint centres on foreign policy. In its drive to secure reliable supplies of raw materials, it is said, China is coddling dictators, despoiling poor countries and undermining Western efforts to spread democracy and prosperity. America and Europe, the shrillest voices say, are “losing” Africa and Latin America.

This argument ignores the benefits that China's commodities binge brings, not only to poor countries, but also to some rich ones, such as Australia. The economies of Africa and Latin America have never grown so fast. That growth, in turn, is likely to lift more people out of poverty than the West's faltering aid schemes. Moreover, China is not the only country to prop up brutish regimes. Witness the French troops scattered around Africa, some of whom recently delivered a shipment of Libyan arms to Chad's embattled strongman, Idriss Déby.

A new nuance or a new Global Power?

China as a power broker could—and should—use its influence to curb the nastiest of its friends, including the governments of Sudan and Myanmar. And from its diplomatic posturing as noticed,it has ceased to resist the deployment of United Nations peacekeepers in Darfur, and is even sending some of its own military engineers to join the force. Wen Jiabao, China's prime minister, has called publicly for democracy in Myanmar—which, even though Chinese officials' understanding of democracy is different to Westerners', is a bold step for a government that claims not to meddle in other countries' internal affairs.


Still, China's hunger for natural resources is creating plenty of problems. Most of them, though, are in China, not abroad.

As a country moves from Light industries to heavy industries.... environmental problems begin.

China is hoovering up ever more commodities not just because its economy is growing so quickly, but also because that growth is concentrated in industries that use lots of resources. Over the past few years, there has been a marked shift from light manufacturing to heavy industry. So for each unit of output, China now consumes more raw materials.

That may sound like a minor change, but the implications are dramatic. For one thing, it has encouraged the sort of foreign entanglements that are now causing China such embarrassment. More worryingly, it is compounding China's already grim pollution. Heavy industry requires huge amounts of power. Steelmaking, for example, uses 16% of China's power, compared with 10% for all the country's households combined. By far the most common fuel for power generation is coal. So more steel mills and chemical plants mean more acid rain and smog, not to mention global warming.

These are not just inconveniences, but also an enormous drag on society. Each year, they make millions sick, cause hundreds of thousands of premature deaths, sap agricultural yields and so on. Pan Yue, a deputy minister at the government's environmental watchdog, believes that the costs inflicted by pollution each year amount to some 10% of GDP.

No fire without smoke

It is no wonder, then, that pollution is the cause of ever more protests and demonstrations. There were some 60,000 in 2006 alone, by the authorities' own count. Some are led not by impotent peasants but by well-organised burghers from Shanghai and Xiamen, a development that must horrify China's rulers. And the potential for even more disruptive environmental crises is great: northern China is already running out of water, and the glaciers that feed its dwindling rivers are melting, thanks to global warming.

The government is aware of these problems, and is trying to address them . It has used this month's People's Congress to raise the status of Mr Pan's agency to a ministry. It has increased fines for pollution, reduced subsidies on fuels and scrapped tax breaks for heavy industry. It is also promoting cleaner sources of power, such as windmills and natural gas. Yet despite frantic efforts to clean up Beijing in time for the Olympics in August, athletes still doubt the air will be fit to breathe. The world's fastest marathon runner, for one, has threatened to drop out of that race because of pollution.

All the government's green schemes are being undermined by an artificial abundance of cheap capital, and by bureaucrats' enthusiasm for channelling it to grubby industries. Chinese banks, with the government's blessing, pay negative real interest on deposits and so can lend to state-owned firms very cheaply. Many of those firms also benefit from free land and pay negligible dividends to the state, leaving lots of money to invest in more dirty factories. Chinese depositors and taxpayers are subsidising the very industries that are slowly poisoning them.

China is bound to consume enormous amounts of raw materials as it develops. But given how polluted the country already is, and how much unrest that pollution is causing,It should be considering on a lot of factors among them, less wasteful development strategy which could be a healthier one.