Could someone contact Lehman Brothers and ask them for a little advice on this matter.“Whoooops”.
This week we have witnessed an unseemly, and extremely disturbing, race to the bottom in central bank policy. The ECB, the Fed and even the dear old Bank of England all appear to be, more or less, in full tilt panic mode.
They’re suddenly talking rate cuts, more QE and all manner of monetary shenanigans.
As a result, and rather unsurprisingly, we have seen an extraordinary collapse in risk-free yields over the past six months, which has accelerated in recent weeks. $12,000,000,000,000’s worth of bonds globally now has negative yields. What an earth is going on?
For sure we’ve had the odd slightly soggy sentiment number, but, in Europe at least, it’s nothing we haven’t known for months, if not years. The cunning combination of negative interest rates knackering the banks, austerity doing the same for the economic prospects of the periphery, and tech being regulated out of existence leaves the region with industries that are no longer cutting edge against a backdrop of ageing demographics. What’s not to like?
Yet for all this, European stocks are rising and the S&P 500 hit yet another all-time high of 2958.06 last night before ending 0.95% to the good.
Imagine the situation. You see the economic PhDs who run the global central banks running towards you screaming that the sky is falling, we’re all going to die. Yet investors are thinking, yep, you know what, let’s load up on spoos (the futures contract on the S&P 500).
And before you laugh too hard at these poor deluded Americans, 130 “brave” souls submitted more than €850 millions of orders for the subordinated debt of the “solidly CCC-rated” Greek bank Piraeus. I thought we were supposed to be panicking!
This is what ultra-easy monetary policy does! If you think you’re always going to get bailed out, you get very “brave”. If money costs nothing, the game becomes chasing gains in real assets or financial instruments over investing in the real economy with its boring, GDP-like returns.
Cutting rates is a fool’s errand. Without a functioning monetary transmission mechanism, the impact on the real economy is close to zero. Northern Europeans largely don’t need the money and nobody, except yield-chasing bond investors, wants to lend to the periphery.
Now you can see exactly why this is happening. Economists have (more or less) exclusive control over just one economic lever, monetary policy. They also, generally, have one mandated economic target, inflation.
It’s a bit like being a parachutist. You jump out of your plane and pull your rip cord. If it doesn’t work you pull it again, and again and again. After that you either call your loved ones or run a model that tells you that in theory you should now be gently floating towards the ground instead of being close to achieving terminal velocity.
The other levers are, of course, fiscal policy and structural reform. Let’s take the second one first, because I’m an awkward so and so. Structural reforms are generally supply-side issues, which in an environment where the problem is actually a lack of demand, are not as helpful as they might be in more “normal” times. Invariably they prove deflationary. Think Űber and its impact on the wages of ordinary taxi drivers. Nevertheless, there are certain countries where the need for reform is so great that we simply have to find a means of facilitating it and softening the impact of reform.
This brings us to fiscal policy. Despite the incontinence of monetary and quantitative easing, we are still very sniffy about government debt being used to prime the economy. The reason for this is unfortunately very clear. Politics! The “Right” has won the argument that the “Left” can’t be trusted with the purse strings, whilst the “Left” has successfully convinced everyone that the “Right” can’t be trusted to share nicely like most normal people would.
The unfortunate consequence for you and I (but especially the young and poor amongst us) is that fiscal austerity has become the default. Now we have seen some fiscal easing of late. Trump forced the issue in the US. BUT, in the EU we have the unedifying spectacle of the fiscal hawks insisting that Italy cut public spending because growth has turned out slower than originally predicted! That is Gold Standard deflationary economics.
So we have those few economists, the rock stars who run the global central banks, desperately attempting to deploy their parachutes to avert a collapse in inflation and actually making things worse in their panic. Yet alternative tools or strategies remain largely unused or unexplored.
But central bank culpability runs deeper than that. It is the lack of intellectual curiosity that is problematic! And BTW, for the avoidance of doubt, when I have a go at economists, these are the guys I’m generally talking about.
The economists who run the major central banks were very quick to ascribe the moderation in inflation in recent decades to the success of their aggressive monetary tightening in the 1980s “squeezing” inflation out of the system and lowering “inflation expectations”. But perhaps what really happened was that it was the supply side reform of globalisation, and the sudden jump in world trade, that caused the moderation. A former colleague has done some very interesting work on that.
That leaves us with the uncomfortable thought that perhaps the low interest rates that have become the norm, even prior to the financial crisis, had little impact in the battle to target inflation. Instead they served only to destabilise asset markets and inflate speculative bubbles.
And having cheerleaders such as Alan Greenspan and Eugene Fama decrying the significance of rising asset prices, simply made matters worse.
I’ve read two papers over the past week crowing about the success of central bank inflation targeting and how closely actual prices had been tracking their mandated levels. The second paper actually attempted to demonstrate this with a series of charts showing the two lines closely intertwined.
Yet what the charts also showed was an increasing divergence for the US, Canada and Europe since about 2013. Yet the text made no reference to this. Surely a little professional curiosity might have been in order?
The reason all this matters is that the losers in this game of monetary chicken are the young and the poor. As I’ve said countless times, old gits like me are the winners from easy monetary policy. My assets (house and pension) have risen strongly, whilst at the same time tumbling mortgage rates have gifted me literally hundreds of pounds a month of extra disposable income. Yet median wages, especially for those in their twenties and thirties, have fallen in real terms over the past ten years.
This inequality in rich countries risks imperilling the liberal political consensus that has given us the globalisation that has lifted literally billions out of absolute poverty.
Should that consensus break down, and the trade wars are the surest sign that it is distinctly fraying, we lose the most overwhelmingly positive thing capitalism has had to offer us.
Now some may view anything which arrests growth in India and China as good because it will slow the carbonisation of those economies. Realistically though, simply expecting those in emerging markets to bear the brunt of the war against climate change is not going to happen. The leaderships in both countries are running far ahead of their populaces in terms of their climate engagement. So anything which knocks these countries back economically is likely to see leaders refocus on the short-term economic imperatives over more global issues.
But even if the trade dispute is resolved in Osaka next weekend, a long shot, but humour me, we still have a problem.
The tech cold war is unlikely to be overcome so easily.
This morning a small tech company based in the Land of my Fathers (Wales), issued a profit warning. IQE finally recognised the impact America’s Huawei ban might have on its business and “slashed” its revenue and margin guidance. IQE’s shares are currently 37.65% lower this morning.
In any case, deflation is not always a bad thing. A few years ago, we had the EU complaining that China was dumping solar panels at extraordinarily cheap prices. Curiously though we hear less about that today! The fact of the matter though is that China, and its tech, is a vital component of delivering affordable alternatives to fossil fuels.
That same tech (not to mention the supply of rare earth elements) is why China is also crucial in filling the storage gap in the renewable market by helping to drive battery innovation.
So, you see, that when our central bank economists mess up and effectively deflate the economy that they are trying to inflate, it creates losers amongst the young and the poor in the West. This in turn threatens the prosperity that emerging economies are now only just beginning to take for granted.
And if those newly middle-class jobs in renewable tech in China suddenly disappear, we’ll all be losers, even those of us with cheap mortgages.
Can I interest anyone in $12 trillion of negatively yielding bonds?
Take care out there