OECD: monetary policy must change now

Don't blame private equity firms for the risks now inherent in the global credit markets, says the OECD.

Adrian Blundell-Wignall, deputy director of the Organisation for Economic Co-operation and Development (OECD), has said that liquidity derived from fixing the price of money in Japan and China is the root cause of today's private equity boom. Speaking at the group's recent 2007 Forum in Paris, Blundell-Wignall stressed that buyout funds were simply taking advantage of excess liquidity created by these monetary policies and shouldn't be bear the brunt of bubble concerns.

Blundell-Wignall explained that excess capital and leverage were usually the result of distortions and accommodating monetary policy somewhere, and right now China and Japan were the culprits. He cited as the most basic causes of the credit boom excess saving in China, Japan and the oil producing nations, together with policies to peg exchange rates, or keep them at a low level via a zero interest rate policy in the case of Japan.

The OECD's second in command described these trends as echoes of the last liquidity-driven LBO boom in the late 1980s. The similarities included a weak dollar and the Louvre Accord that attempted to curb multiple currencies rising even further, in much the same fashion as Japan and China were doing now. However, “it's Economics 101 that you can't fix the price of money and control the quantity of it at the same time,” he said.

The excess of this liquidity, he explained, results in low interest rates, which had opened an enormous arbitrage opportunity for private equity firms to use debt to buy companies, thus inflating equity prices. “Innovative financial markets and globalisation facilitate the leverage process and look for the cheapest way to do things,” he said.

To blame private equity firms capitalising on the low cost of capital would be to “shoot the messenger”, Blundell-Wignall warned. He refuted the notion that the asset class was a newly arrived evil, stressing that the boom had merely alerted many constituencies to its existence.

He called on the governments in question to remedy to remedy the situation by focusing on “raising interest and exchange rates that are too low at present”. Domestic considerations would likely slow such a policy change, but without it, financial stability concerns would not go away, leaving the prospect of adverse consequences down the road.