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By Jeremy Glaser | 05-14-2013 10:00 AM

Sri-Kumar: Time for a Central Bank Exit Plan

Aggressive easing policies, particularly in the U.S. and Japan, are creating a global currency war and establishing the foundation for a possible worldwide recession, says Komal Sri-Kumar.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm pleased to be here today with Sri-Kumar. He is the president of Sri-Kumar Global Strategies, and he is also the chairman of the TCW comprehensive asset allocation committee. We’re going to talk about central bank actions and its impact on the fixed income and equity markets. Sri, thanks for joining me today.

Komal Sri-Kumar: Good to be with you, Jeremy.

Glaser: So let's start in the United States and talk about the Fed. They've recently indicated that they might have some more flexibility in terms of their mortgage-backed security buying. They might increase it or decrease it based on economic indicators. Do you think this is a sign that we're going to see even more Fed action or there's going to be a pullback soon, or is this just more of trying to get the markets thinking that's going to happen, but that the Fed is really going to stick with their current plan?

Sri-Kumar: Good timely question, Jeremy. I think we have a very dovish Fed chaired by Ben Bernanke. And while they've been giving messages including over the weekend that they could increase or decrease the amount of bond purchases, I think the move is likely to be one-way at least for the foreseeable future, namely, they either keep up their current $85 billion per month, or even increase it if they don't get economic recovery of a sufficient magnitude out of it. I don't see them going down. The reason for that, it is as if you've had a drug addict for the last four years and you've been increasing the amount of drug and suddenly you say, do you want to reduce it, do you want to go through the risk of how the patient might react? And it's the same thing with the economy. The economy seems to be growing at a very miniscule rate. Provided the QE is on, why would you want to tamper it? That's not my view, but that I think is where the Fed is coming from.

Glaser: The Fed, obviously, isn't the only central bank that's in expansionary mode right now. The Bank of Japan has announced some new plans for the last couple of months for a very aggressive expansion of the monetary base. What do you think Japan is trying to do there, and what do you think about that program?

Sri-Kumar: I think that are two separate issues. I think the Japanese have been trying now for over 20 years to get an economic recovery since the stock market collapsed in early 1990, and they don't have it. So this is their latest effort, but Jeremy, the Japanese issue is much more troubling to me. Let's see why. Japan's GDP is about one third that of the United States, roughly, and Japan is buying about $80 billion worth of bonds, Bank of Japan, every month, roughly similar to the Fed's $85 billion worth every month.

And for a country which has a debt/GDP ratio of 230%, in Japan's case, and a much smaller economy, it is really troubling that they would go to the extent of increasing money supply. Why? The risk is that there might be a flight from the Japan government bonds; the 10-year yields were as low as 38 basis points in early April. They've surged to over 70 basis points a month and a half later. They've more than doubled. What happens if it goes to 1.5%, 2.0%? The Japanese government might think it indicates economic recovery, but equally it might be a flight from Japan. So it's a very fine line that the Japanese are really going across right now.

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