We are indeed living in interesting times, not least
regarding the way policy responses have evolved in recent years.
This is especially true for monetary policy in the developed world.
Policy design has come a long way since the seventies and
the associated big lessons for central bankers.
We have experienced ‘goldilocks’, the ‘taming of inflation’ and the
‘Great Moderation’, until the credit crisis hit in 2008 and everything went
into ‘emergency mode’.
Then the provision of financial heroine by central banks was
‘legalized’ by governments. That was justifiable at the moment, as is the use
of heroine on warzone victims for medical purposes.
However, concern about the effects of subsequent addiction was
‘postponed’ for later—much like the ‘fiscal cliff’-related measures have been
‘kicked down’ to be dealt with in 2013, in line with standard political practice
these days.
The recent era of ‘low and stable’ inflation in the
developed world has been credited with providing the backdrop for healthy
economic growth.
This was largely achieved through a policy approach of 'inflation
targeting' (explicit or implicit).
However, we are now witnessing a gradual departure from this
framework on the part of central bankers towards ‘doing whatever it takes’—even
substituting for the lack of proper fiscal policy initiatives.
In this context, the amount of money printing that has taken
place (and will likely continue to take place—see, for example, the FOMC’s latest policy statement)
is unprecedented.
The route taken by ‘Helicopter Ben’ and ‘Super Mario’ is almost guaranteed to lead to severe inflationary pressure buildup—not necessarily ‘hyper-inflationary’ like doomsayers preach—going forward. It is likely a matter of when, not if. Talk of the ability/tools to ‘mop up’ the excess liquidity at the right time, smoothly, etc. is just unrealistic.
There is a growing (largely implicit, for now) willingness by central
bankers to subordinate inflation as a policy concern in the name of boosting
employment and growth.
See, for example, this article in the Financial Times (“King signals inflation not primary focus"):
Sir Mervyn King has given his clearest admission yet that he no longer believes price stability should be the Bank of England’s sole objective, arguing that central bankers should be flexible with inflation targets to head off future financial crises”...
…Sir Mervyn said it would be sensible to
recognise that sometimes it was right to “aim off the inflation target for a
while” to moderate the risk of crises.
“Monetary policy cannot just ‘mop up’ after a
crisis,” he said, adding that the intellectual framework underpinning monetary
policy needed to be reassessed.
The first irony is this. The once overarching goal of price stability, which made (a sense
of) prosperity possible, is now gradually becoming
subordinated to what could be summed up as ‘the incapacity of
governments to get their act together and conduct proper fiscal policy’.
What is often not being stressed, however, is that this
environment of price stability made fiscal irresponsibility possible in
the first place. A higher-inflation era is shaping up to be the price paid for
this behavior.
The second irony relates to a contrast between developed
and emerging/developing economies—China in particular.
As Jonathan Ruffer correctly points out in his latest
commentary:
“The point of
inflation coupled with interest rates below that rate of inflation is to
transfer wealth quickly and effectively from the saver to the battleground of
the borrower”.
Indeed, negative real interest rates act to subsidize the
borrower at the expense of the saver. Is this not what has been going on for a
long while in China…which is now attempting to ‘rebalance’? Has this change not been
encouraged by Western governments for years?
However, it seems that the tables may be turning: at the
same time that China has vowed to rebalance its economy away from this
distortion, the western world could be looking into an era of financial
repression and runaway inflation.
For now, markets have been in ‘impromptu mode’, adopting a
stance of appearing ‘politely thankful’ for the promise of enormous liquidity-pumping. But are they really? Should they be? Or is this just a moment of inertia?
Markets will certainly have to do a lot more improvising down
the road, in what is a very fine balance of risks that will become clearer when the longer-term
consequences of this policy ‘path’ eventually start receiving more focus (especially after the US election).
Although these may still be early days, the higher price of
gold and recent outperformance of gold mining stocks vs. the broad market may be sniffing investor concerns.
As Ruffer puts it: “The
markets, the inflation rate, the experts and the populace remain quiescent –
but sooner or later that will change – and suddenly.”
