World Risks ‘Perfect Storm’ on Capital Flows, Carstens Says

A “perfect storm” may be forming in the world economy as signs of a recovery spur capital flows to emerging markets and some advanced nations that may lead to asset bubbles, Banco de Mexico Governor Agustin Carstens said.

“Risk appetite among investors has returned and the search for yield is in full force,” Carstens said in a speech in Singapore today. “Concerns of asset-price bubbles fed by credit booms are starting to appear.”

The risk of a “currency war” has surfaced as monetary easing from Japan to the U.S. spurs demand for higher-yielding assets and boosts inflows into emerging markets. Russia warned last month that Japan’s currency-weakening policies may lead to reciprocal action as nations try to protect their export industries, while South Korea and the Philippines have said they’ll consider how to reduce the impact of such funds.

“There certainly are risks,” Jan Hatzius, chief economist at Goldman Sachs Group Inc., said at a briefing in Hong Kong when asked about Carstens’ comments. “Monetary policy is very easy and in that sort of environment you have to monitor what happens to financial stability.”

Economies with pegged currencies, such as Hong Kong and some Latin American nations, need to stay on alert for dangers such as asset bubbles, he said.

‘Massive Flows’

“My fear is that a perfect storm might be forming as a result of massive capital flows to some emerging market economies,” Carstens said. “This could lead to bubbles, characterized by asset mispricing, and then face a reversal in flows as the major advanced economies start exiting their accommodative monetary policy stance.”

Carstens said Japan is one country that is “actively pursuing a depreciating real exchange rate strategy.”.

Japanese Prime Minister Shinzo Abe’s campaign to expand monetary easing and revive his nation’s economy is driving down the yen, aiding exports of electronics and automobiles. The yen fell to a 2 1/2 year low on Feb. 1.

Panasonic Corp. this week reported an unexpected third-quarter profit, helped in part by the weaker currency.

“I wouldn’t go as far to suggest we’re going to go for a full-blown currency war, but I do think there will be tensions and frictions intensifying,” said Mitul Kotecha, Hong Kong-based head of currency strategy at Credit Agricole SA. “Obviously, Japan set the cat amongst the pigeons with its more aggressive stance on the yen.”

Bernanke’s Action

Federal Reserve Chairman Ben S. Bernanke has unleashed the power of the central bank to buy unlimited amounts of Treasury and mortgage-backed securities in a bid to end a four-year period of unemployment above 7.5 percent. The European Central Bank has pledged to buy unlimited quantities of government bonds if necessary to save the euro, while the Bank of Japan said last month it will shift to open-ended asset purchases next year.

“We have to live with this unconventional monetary policy in the largest economies,” Carstens said at the event organized by Singapore’s central bank. “We need to take care of the hazards that these inflows represent from the financial vulnerability point of view.”

Philippine central bank Governor Amando Tetangco said last month he’s studying more measures to counter excessive capital inflows lured by growth. South Korea should consider taxes on currency trading and bonds to help limit “speculative” inflows of capital, Deputy Finance Minister Choi Jong Ku said Jan. 30.

Competitive Devaluations

“We need to avoid competitive currency devaluations.” Ravi Menon, managing director of Singapore’s central bank, said today. Past episodes of currency friction “have only led to more misery and further downward spirals,” he said.

An avoidance of the so-called U.S. fiscal cliff, a gradual and steady progress of reforms in Europe and faster growth in China have helped improved market sentiment, Carstens said.

“A word of caution is in order, though,” he said. “Substantial vulnerabilities and downside risks still persist.”

Stocks in the world’s developed nations posted the best start to a year in two decades. The MSCI World Index of stocks in 24 markets rose 5 percent in January, the most since 1994, as individual investors pumped record deposits into mutual funds, U.S. profits increased for an 11th quarter, central banks kept interest rates at record lows and economic growth from Europe to China improved.

Economic confidence in the euro region rose to a seven-month high in January, adding to signs that the 17-nation currency bloc may be emerging from a recession. American employers added 157,000 workers last month, a government report showed last week.

Carstens, a former finance minister and International Monetary Fund deputy managing director who sought the organization’s top job in 2011, has led Mexico’s central bank since January 2010 and kept the benchmark rate at a record-low 4.5 percent throughout his tenure.

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