The Review has conducted an exclusive written interview with Dr. Leef H. Dierks, current Professor of International Capital Markets at Luebeck University of Applied Sciences in Germany. Before making a switch to academia, Dr Dierks worked as a strategist in Barclays and, following that, became Head of Covered Bond Strategy at Morgan Stanley. Considering this diverse and illustrious career path, we sought out his insights on our current global monetary and financial scene.
1) Before we begin I would like to thank you very much for agreeing to this written interview - given your success in business and academia your insight will no doubt be enlightening for The Review’s writing team and its readers. Considering this, what stimulated your academic interest in capital markets and made you move away from private sector finance?
My academic interest in capital markets was sparked by mentors like Federico Sturzenegger at Universidad Torcuato Di Tella in Buenos Aires, Argentina and Horst Siebert at the Kiel Institute for the Global Economy in Germany. As per today, I continue to be fascinated by the dynamics between capital and real markets. More importantly, however, I still have the feeling that I still learn something new every single day as our understanding of the interplay between finance, economics and human behaviour still is not particularly well understood.
Paradoxically perhaps, and notwithstanding the mostly challenging, demanding, professional and rewarding environment, living in the 'gilded cage of investment banking' comes at a high price, which, considering permanent early morning meetings, ridiculous face time, frequent red-eyes, endless travel, nocturnal calls and very little time for friends and family in a rather bleak market outlook, I became increasingly reluctant to pay. Apparently, there is a time in life for everything. So when the opportunity to become professor in what is my area of expertise presented itself in 2013, I did not hesitate too long. Needless to say, I took a hit in terms of compensation. But I believe that ultimately, living by the sea and having regained control over my calendar again, this is outweighed by a higher quality of life.
2) Monetary policy over the past 10 years has been characterised by the consistent breaking of established norms - with Western central banks providing trillions of dollars’ worth of liquidity to the financial system through Quantitative Easing (QE). Certain researchers at the OECD worry that this ultra-loose monetary policy has distorted the process of capital allocation by allowing inefficient 'zombie' firms to stay alive where they otherwise wouldn't have under a normal monetary regime. This in turn, the researchers claim, may explain part of the West's recent productivity stagnation. Is this a valid criticism of QE, and if so, does it outweigh QE's benefits?
The criticism is perfectly valid and 'zombie' firms are just one of the many unintended consequences of an excessively accommodative monetary policy, i.e. collateral damage. 'Zombie' firms alone, however, do not outweigh QE’s benefits.
As soon as the ECB engages in a rate hiking cycle (markets do not expect the ECB’s first 25bp rate hike before Q1 2019, though), refinancing conditions for euro area sovereigns, corporates and private households will tighten; ultimately triggering a series of defaults. Any such development will see the number of 'zombie' firms drastically falling. Going forward, any such (overdue) adjustment process will lead to a more efficient market and clear the path for productivity and competitiveness gains.
Yet, what troubles me is the question to what extent the ECB’s highly accommodative monetary policy, which is set to last throughout the better part of 2018 at least, has not already sowed the seeds for yet another financial crisis.
3) Further to this, many worry that asset prices, particularly in the fixed-income market, have been artificially inflated by central bank purchases. One of the main worries is that as stimulus is withdrawn – something that the Federal Reserve is already embarking on and the ECB is signalling towards – these asset markets will experience significant negative revaluations which will in turn weaken the macroeconomic environment. What are your thoughts on this?
At first glance, assets such as stocks, real estate and bonds indeed are expensive by historical terms. A correction of this ‘omnibubble’ appears overdue. But according to Economics 101, with real interest yields on safe securities being so low, asset prices should be high. Maybe not as rich as they are right now, yet it is far from obvious that they are in speculative territory. The question thus is whether the current environment characterised by both low real interest rates and low and stable inflation is set to last. No doubt, reflecting conditions in the real economy, rates will have to rise in the end. But we do not know when. As rates might well remain near current levels for years to come, asset valuations will continue to benefit from their support. In other words: a revaluation will occur, spreads will widen and curves will steepen – but most likely in a gradual and modest manner.
4) We live in an age of increasing scepticism over the merits of globalisation – with many Western politicians becoming highly critical of free trade and the free movement of people. Perhaps more for developing countries there is similar level of concern over the free flow of capital and how it can potentially destabilise their financial markets and economies. Do you think that global capital flows can compromise economic stability, and if so, what policy tools should countries employ to alleviate this?
Capital flows alone, particularly those of the 'real money' community, will typically not compromise economic stability. It is the speculative motive, which eventually leads to a misallocation of resources and could trigger mounting economic imbalances. Depending on the (institutional) investors’ risk tolerance, capital will always flow to where the expected return is highest. This implies that developing economies (typically featuring a higher risk of default) often attract capital inflows on behalf of the 'fast money' community, which, however, will be withdrawn literally overnight in case of mounting uncertainty. Nonetheless, assuming that (fixed-income) assets’ (e.g. sovereign bonds) yields are a good proxy for their quality in the absence of other information, these capital flows are a valuable indicator for market participants with regards to relative value investments.
Any intervention on behalf of governments to influence capital flows hence cannot be successful in the long run but will merely lead to distortion and a misallocation of resources. Confining capital flows will deprive markets of their signalling function. I would therefore strongly caution against any governmental intervention, as it would further distort market efficiency, which, with all due respect, cannot be in our interest.
5) Much has been made about the underdevelopment of capital markets in the EU vis-à-vis the United States – with some claiming that this explains part of why the US often exceeds Europe in economic growth and dynamism. What do you make of this position? Keeping this in mind, are capital markets superior to banks in financing beneficial investment?
Whereas capital markets in the US have developed over centuries (some claim they date back to 1790), the euro area did not adopt a common currency until 1999. Before that, European capital markets were largely national entities and, some 20 years later, are not as deep, liquid or homogenous as its transatlantic peer. This, paired with the heterogeneity of economic dynamism among the euro area member states, leaves its mark on financing conditions and, with the availability of funding being a crucially important input factor, ultimately on economic growth.
Banks act as intermediaries, so turning to capital markets directly to satisfy funding needs will typically lead to a more efficient outcome. However, this opportunity is not a viable solution for all market participants. SMEs, for example, often feature funding needs, which are just too small to justify tapping the market directly. They therefore rely on banks, which, particularly in the euro area, and most notably in the Mediterranean rim countries, still are in a process of deleveraging. Notwithstanding the ECB’s QE, this has reduced the availability of loans, thus hampering economic recovery.
So, in a nutshell, of course (capital) markets are more efficient than banks could ever be. But as not every market participant can tap markets directly and as alternative concepts still are in their initial stages, banks’ relevance within the monetary transmission mechanism should not be underrated.