From the ranks of FT Alphaville’s own AAA-list comes Mohamed El-Erian with a post about the three phases of governments’ involvement in global markets since the crisis.
Understandably, energy markets are focusing intensely on the price impact — now and down the road — of today’s IEA decision to release 60 million barrels from member governments’ precautionary stockpile. And with oil prices down sharply, other markets are naturally paying attention.
The IEA surprise announcement raises many interesting questions. Is this a one off decision? Are IEA members targeting a specific price level? How will oil producers react?
In addition to these important questions, there is another element that is intriguing and warrants attention. The IEA action is yet another example of governments (and central banks) getting pulled deeper into markets as portfolio managers, as opposed to regulators and supervisors.
This phenomenon has been very visible since the collapse of Lehman in September 2008. And it has gone through three distinct phases.
In the first phase (end of 2008 and all of 2009), policymakers intervened in markets with the objective of overcoming severe market failures and restoring normal functioning to highly disrupted, and in some cases paralyzed, markets. They succeeded, albeit at a significant cost in terms of shifting private sector liabilities to the balance sheets of the public sector.
The intervention in the second phase morphed. As detailed by Chairman Bernanke in his August 2010 Jackson Hole speech, the objective became more ambitious. It was to raise asset prices in order to energize private sector spending, economic activity and employment creation.
The intervention worked in generating a broad-based surge in asset valuations; but it failed to deliver a sustainable economic outcome. As an example, just witness yesterday’s unfavorable revisions by the Federal Reserve to its growth and employment projections for both 2011 and 2012. This was just the latest example of a series of downward revisions.
The intervention also slipped in another way: it delivered two types of asset price inflation rather than one: What the authorities regard as “good inflation” (higher bond and equity prices) that, in theory, provides a tailwind for investment and consumption; and “bad inflation” (such as higher commodity prices) that drive up production costs and take income away from consumers.
Now, we are in phase three where policymakers try to differentiate between good and bad inflation – namely, enhancing the former and countering the latter.
This explains the decision by IEA member governments to release supplies into the market in order to lower oil prices. It also speaks to several other actions, including the repeated hiking of margin requirements for certain commodities.
It remains to be seen how durable the impact of the IEA action will be. In the meantime, markets will have to internalize yet another item to the long list of policy influences – the growing involvement of governments as portfolio managers.
You do not need to be a disciple of Chicago’s Efficient Markets School, and I am not, to know that governments differ from private participants in many ways. Most importantly, they pursue by definition “non-commercial” objectives when they intervene in markets.
Unless this new phase of government involvement is credibly and quickly signaled as temporary, it will alter the functioning of markets beyond the immediate impact. At the minimum, we should all expect even greater volatility; and we should pay more attention to identifying potential sources of unintended consequences.
With this, and given what else is going on in today’s fluid global economy, it is a good time to give that seat belt an extra pull.
The writer is CEO and co-CIO of PIMCO. Some of El-Erian’s earlier commentaries for FT Alphaville are available here.