The Central Bank Conundrum
In the past week, Mario Draghi put through the policy of negative interest rates. He said the idea was to push savings out and into investment. This has had scribes scribbling around the world as to exactly what it means, but parsing through the writing it appears the most dreaded thing for central banks is asset deflation. It appears that we’ve hit a point in history where we just can’t let asset prices fall because too many things are tied into the prices as they stand, even if they are bubble prices. In other words, the whole Zero Interest – and now Negative Interest policy has been a desperate attempt to keep everything in their leveraged positions.
To this end, central banks around the world have been running what amounts to a price-keeping-operation, partly through printing money, partly through bluff, but also by buying equities. It turns out central banks have bought 29trillion in equities around the globe. ‘Abenomics’ in Japan has been running a gambit where pension funds have been buying equities at the behest of the government. 29 trillion is a lot of money when you consider the size of the US economy is 17trillion. No wonder investors around the world have looked at prices of shares and said a bust is due. Yet amazingly share prices of blue chips have kept soaring. Well,they would if Central Banks are buying them with printed money.
Now I’m not one of those people that bangs on about the failing of the fiat currency but any way you look at that situation and you have to ask, should equities be a one-way bet? But the Central Banks do this because they need share prices to stay high.
Zero Interest rates have been in place for many countries and the effect of that has been to amplify the carry trade where the US Dollar has surged out to ’emerging economies’ in search of yield as well as re-inflate the property bubble in places like California and London. Once again, asset prices are getting supported over just about any other consideration. So much so that a hypothetical interest rate rise of 0.5%would jeopardise US$13trillion worth of derivative products. Again, we’re not talking chump change here.
The problems of falling asset prices would be the banks being unable to cover all the positions. Take Deutsche Bank, which has 200trillion dollars worth of exposure to derivatives as an example. If asset prices deflate even a little, there will be massive movements in those derivatives and would easily wipe out Deutsche Bank. And if Deutsche Bank should fail, the fallout form that would be a whole bunch of banks going down with it.
And so we’re stuck with Central Banks busily trying to re-inflate asset prices whether they be shares or property or bonds. They’re printing money to do it, which means inflation is going on pretty hard out there somewhere. The proper analytical explanation of inflation is going to be too much money chasing around too few things. If you print enough money there are too few things by definition. If the printed money is then used to buy the share market, it seems the inflationary effect will be amplified. Similarly if money is printed to buy the bad debt derivatives from the subprime loans crisis, there will be too much money chasing around too few proper investment vehicles. What happens i the things that are affected the most are not houses and fancy commodities but things like grain and foodstuff? Doesn’t that sort of destroy the purchasing power of people living in the third world? Won’t this bring massive social stability around the globe? And still the Central Bankers are trying to re-inflate the asset bubbles.
It’s not the speculation that is the problem; it’s the process of simultaneously destroying value while preserving prices.
When the GFC came about, there was much discussion about moral hazard and the US TARP bill which was an emergency loan to banks to shore up their bottom lines. We threw precaution to the wind and supported TARP because without it, our banking and our superannuation accounts would have been shot. Since then banks have received the mos support from Central Banks in order to set their books straight. The bankers even drew up Basel II and Basel III agreements so that banks could be held to a standard to lessen systemic risk – or so the argument went. And yet the net effect of all this has bee the destruction of the middle class in America (with the possibility looming for Australia yet), with the super-rich getting ever richer. The guy on Main Street got taught a lesson moral hazard at his own expense, after having his life savings taken hostage. The guy on Wall Street simply got a green light to continue doing the stupid things that got all of us into such a sticky strait.
So 6years-going-on-7, I think it’s a good time as any to ask just how well all of this is working out. The debt of the world combined sits at 720trillion dollars. The world economy combined is somewhere around 70trillion. We’re not easily going to pay off that mountain any time soon. That being the case you wonder how long the whole charade is going to go on. We might have kicked the can down the road nicely back in 2008, but we’re running out of road.
One of the more pernicious things that has happened since sometime in the 1970s is that governments have changed the way they measure inflation. The net result of doing so has been to under-measure the real inflation out in the market place and claim inflation has been tamed. Again, this was particularly true in Clintonian America of the 1990s, where they invented some strange practices, which have since been adopted by the rest of the world as a ‘standard’. The basket of goods used to measure CPI has changed so much since the 1970s that it really bears no relationship to the figures that have come before. It’s been made to look more palatable by adding in luxury goods as well as items imported from overseas instead of items produced in the first world, which of course means we’re importing the deflationary pressure from the third world.
Obviously it works out much better for Central Banks and governments if they can turn around and point at lower inflation figures. The problem is that we are printing money in an awful hurry in many parts of the world, and at the same time China is running out of cheap labour which meas there won’t be a whole lot more deflationary force to be imported from China, the world’s second largest economy. In fact the Australian Financial Review had a headline in the last week saying just that; that the RBA has erred on the side of too low an official interest rate.
This is of course kind of ironic because on the one hand central banks the world over are fighting to have more inflation and no deflation on asset prices. If they simply went back to measuring the CPI the old way, they can probably see just how much inflation there exist sin the current system. Also, by under-measuring inflation, they’re setting themselves up for lower interest rates and thus looser monetary policy which of course does lead to more inflation. The longer the low interest rate regime runs, in a sense we’re making real a greater inflation without having the means to measure it. We’re already way too comfortable with the low interest rates. Even without the discussion on moral hazards, you’d think the central banks have got to figure they have one on their hands.