Willem Buiter: ‘Markets Refuse to Acknowledge They Are Risky’
There are few entertaining economists, and fewer still work on Wall Street. Willem Buiter, the chief economist of Citigroup, is one of them. He is not only entertaining, but also outspoken—and his analysis of key economic trends and themes is second to none.
The Epoch Times spoke with Buiter about Federal Reserve (Fed) quantitative tightening and its impact on credit markets as well as about speculation in the stock market.
The Epoch Times: What do you make of the Fed’s goal to shrink its balance sheet?
Willem Buiter: There are political reasons to shrink the size of the balance sheet from the $4 trillion to $4.5 trillion that it is now, so roughly 20 percent share of GDP, back to something like $2.5 trillion and thereabouts. It started off at around $900 billion in 2006 before the crisis.
So even the new steady state balance sheet is going to be a lot larger than the old one. And I think there’s no reason why the Fed cannot live comfortably with the balance sheet of the current size. But clearly, it does not want, under normal economic conditions, to be actively engaged in credit subsidies, by first purchasing and then holding on to mortgage backed securities, right? It is not the task of the Fed to subsidize those who borrow to purchase property and that’s effectively what they’re doing.
So they want to get out of that business, and they probably want to get out of the huge balance sheet because they become too visibly a target for politicians who like to get their hands on the seigniorage.
Central banks in general like anonymity and this is simply a way for them to return to a less politically charged central bank.
The Epoch Times: How will this impact credit markets?
Mr. Buiter: It will affect them a bit, but remember Treasuries are the most liquid instrument in the world. It’s a global asset. The global demand for Treasuries is increasing roughly at the growth rate of the nominal GDP, so 6 percent.
There are about $15 trillion worth of U.S. Treasuries outstanding, 6 percent of that, you get $900 billion worth of additional demand, but the U.S. government is issuing new Treasuries and now the Fed does not renew Treasuries which mature.
But I think the impact under current orderly market conditions in the most liquid market, no financial crisis in sight, is going to be minimal. Very different from the Quantitative Easing 1 (QE1) that was expansionary, when it was massively important because of asset pricing in the United States after the financial crisis.
QE2, slightly less disorderly, less chaotic, less impact. QE3, even less impact. In a way, we are doing reverse QE3 now, although I think financial condition may be even more sedate than they were under QE3. So I expect very little of this.
Remember also, they are not renewing the holdings maturing assets. So these assets that are running off, and when they run off, they have zero duration. There is absolutely no discontinuity. In fact, if they were to renew the assets, they increase the duration of the balance sheet.
And that should be more disruptive than just letting them run off. Not quite the same for Mortgage Backed Securities, which are less liquid because they’re less widely held, and that has to be managed carefully.
The Epoch Times: What about the stock market, it’s expensive and keeps going up.
Mr. Buiter: I think easy financial conditions have a lot to do with it. There is a desperate flight into anything that offers to you a return. It has an impact on risk assets. Markets refuse to acknowledge that they are risky. That’s why we see things like the VIX and the short end of the yield curve, basically flat lining.
There’s underlying it a persistent tendency to overestimate long term future corporate earnings growth. We know globally, what the growth rate of future corporate earnings is going to be. It’s the growth rate of nominal GDP. I’ll give you half a percent more, if you believe that the share of capital is to increase.
But that gives me globally 6 to 6.5 percent, for the United States, 4 to 4.5 percent. And what tends to happen when there is a cyclical recovery of profits, then markets and all the pundits start extrapolating double digit, 30 percent, 40 percent growth rates in corporate earnings and shares prices all the time.
So I think there’s a significant element of overvaluation specially on this side of the Atlantic. In the rest of the world, certainly in Europe, it’s much less pronounced, this overvaluation in stocks.
It is possible to rationalize current valuations because we have very low risk-free real rates. But the future earnings growth that justifies those valuations isn’t going to be there, and the notion of the equity risk premium dying is also a difficult one to justify.
So yes, I think that as always when there is desperation for yield, you will get silly outcomes, and we are seeing that for the moment in risk assets generally.
Commercial real estate is another area where there is a boom. Asset valuations got away from any reasonable present value of future rental cash flows. So there is probably going to be some tension there.
The Epoch Times: When will investors change their mind?
Mr. Buiter: I have no idea. All you know about the unsustainable is that it can’t go on forever. But as one of my former colleagues said, “It will go on longer than you think is possible. And then when it ends, then it will be completely unexpected.”
The interview was edited for clarity and brevity