... When there's so much other money lying around?

Global Cash Glut
Fuels Investment Frenzy,
Pushing Up Rates

By John Fraher and Simon Kennedy
Bloomberg News Service
Monday, October 30, 2006

http://www.bloomberg.com/apps/news?pid=20601103&sid=azWr55nygFyE&refer=us

Markets around the world are awash in excess cash, fueling a frenzy of investment from London to Tokyo that may lead central banks to push interest rates higher than investors now anticipate.

Money remains cheaper than in the 1990s even after every major central bank raised rates this year, the first simultaneous tightening since 2000. The cash glut is reheating the U.K. housing market, while in Japan companies plan the most investment since 1990. China's biggest bank this month attracted orders for more than half a trillion dollars with its initial public offering of shares.

"Interest rates in the main economies have still not been raised enough," says Tim Congdon, visiting fellow at the London School of Economics and one of the "wise men" who advised the U.K. Treasury in the 1990s. "There is a buoyancy in asset prices one gets with high-risk monetary growth."

Without further tightening, central bankers may have new asset bubbles and inflation risks on their hands. The European Central Bank, whose officials voice the most concern, is convening a conference in Frankfurt next week on the role of money growth in guiding interest rate policy. Among participants: Federal Reserve Chairman Ben S. Bernanke, People's Bank of China Governor Zhou Xiaochuan and Bank of Japan Deputy Governor Kazumasa Iwata.

"When monetary growth is strong, the housing markets are very dynamic and the stock markets are vigorous, the probability of an inflationary episode within three or four years is very strong," says Jose Manuel Gonzalez-Paramo, a member of the ECB's executive board.

The ECB, unlike other major central banks, explicitly uses money supply to gauge inflation. Growth of M3, the bank's preferred measure for the 12 nations sharing the euro, unexpectedly accelerated to 8.5 percent in September, close to a three-year high. That added to pressure on the bank to add to its five rate increases since early December.

"It's a bit ironic, given that they are the ones who pay most attention" to money supply, says Thomas Mayer, chief European economist at Deutsche Bank AG in London.

While the ECB will probably leave rates unchanged when its governing council meets Nov. 2, President Jean-Claude Trichet said earlier this month that "liquidity in the euro area is ample by all plausible measures" and recommended "enhanced monitoring" of money-supply growth.

Charles Dumas of Lombard Street Research Ltd. in London calculates that money supply in the world's top economies is growing at an annual rate of 7.5 percent. Though down from a four-year high of 9 percent a year ago, "that's still pretty lavish," he says.

Tim Drayson, global economist at ABN Amro Holding NV in London, says major central banks will all have to tighten credit more than investors now assume.

"Money supply on a global basis is growing quite rapidly as is overall credit growth," says Drayson, a former U.K. Treasury economist. "We don't see much evidence that monetary policy around the world is restrictive."

Drayson expects the ECB to lift its benchmark rate to 4 percent or higher by the end of 2007. The Fed's target rate will reach 6 percent, from 5.25 percent; the Bank of England's will rise to 5.5 percent from 4.75 percent; and the Bank of Japan's will go to 2 percent from 0.25 percent, Drayson forecasts.

Those predictions are at odds with futures trading, which suggest most central banks won't raise rates much further, if at all, next year.

Other central banks including the Bank of England and the Bank of Japan are starting to share the ECB's view on money growth. That's a shift from a few years ago, when following money supply was deemed a relic of the 1970s. "There is something of a revival of monetarism," says Stephen Jen, London-based head of global currency research at Morgan Stanley.

One central bank that isn't joining is the Federal Reserve, which no longer sets a target for monetary growth and stopped publishing one measure of money supply in March.

"In the U.S., looking at monetary aggregates has gone out of fashion," says Jim O'Sullivan, senior economist at UBS Securities Llc in Stamford, Connecticut. "The Fed responds to the effects of asset prices, not to the prices themselves."

For central bankers, the threat is that overinvestment pumps up asset bubbles that lead to economic busts, just as the explosion of investment in U.S. technology companies did at the turn of the decade.

Available money is encouraging "barely profitable and highly risky" investments, French Finance Minister Thierry Breton said last month. The average interest rate of 10 leading economies adjusted for inflation is now around 2.8 percent, below the 3.2 percent average of the 1990s, Morgan Stanley estimates.

The Bank of England, which once shared the Fed's skeptical view of money supply as a policy guide, is now grappling with the fastest expansion of money in 16 years. After raising rates a quarter point in August, citing "rapid growth" of cash and credit, Bank of England officials are signaling a further quarter point increase when they convene next week.

Average home prices in the U.K. have climbed 2.3 percent since August, and inflation has topped the bank's 2 percent target for five months. In an Oct. 10 speech, Bank of England Governor Mervyn King noted monetary growth had "picked up."

"It is clear the governor is now quite worried," says Charles Goodhart, a professor at the London School of Economics and a former Bank of England policy maker. "The rates of monetary growth are worrying and unless reduced relatively soon will represent a significant inflationary pressure."

The Bank of Japan is also keeping a closer eye on liquidity, concluding a review in March with a pledge to gauge "longer run" risks to inflation. Corporate spending is being spurred by an overnight loan rate of 0.25 percent, the lowest among the Group of Seven nations.

"A significant increase in capital spending plans could prompt the bank to raise rates again this year," says Takuji Aida, chief economist for Japan at Barclays Plc in Tokyo.

Cheap cash means China may also be overheating. The country last year had 118 million tons of excess steel production capacity, more than the 112 million-ton output of Japan, the world's second-largest steelmaker.

Industrial & Commercial Bank of China Ltd. this month completed the world's biggest initial public offering, raising $19.1 billion and attracting more than $500 billion in orders, equivalent to twice Citigroup Inc.'s market value.

"This was massively oversubscribed," says John Fildes, managing director of Instinet Pacific Services Ltd. in Hong Kong. "There is a huge pent-up wall of money."

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