A mirage in the desert

Some more comedy relief to start us off today.

This statement comes courtesy of the European Central Bank (ECB), via its Twitter account:

ECB asset purchases have reduced inequality in the eurozone, our research shows. They have especially benefited low-income households, which suffer the most from unemployment.

Perhaps the good fellows at the ECB should take a trip to Paris and explain just how well they’ve reduced wealth inequality to the protestors in yellow vests. Having claimed that their purchases of financial assets reduces inequality, I’d be fascinated to hear what they claim selling those assets will do…

But the chances of the ECB reducing its balance sheet and “returning to normal” vanishes further into the horizon by the day. One reason in particular stands out.

Mario Draghi is once again speaking of further monetary stimulus and is set to become the first governor of the ECB to never have raised interest rates. My colleague Nick Hubble says (only half in jest) that he’ll be the last governor of the ECB to consider raising them.

I expect Germany will enter a recession this year (causing untold additional mayhem for the euro project), but for Italy it’s now official. The figures came in yesterday, and Italy’s GDP growth for the last two quarters of 2018 was negative, putting the country down firmly in the economic dumps.

Claims that the ECB will be able to normalise its extreme monetary policy in this environment are the dreams of a dreamer – a mirage in the desert.

The Federal Reserve is the only central bank to have really committed to normalisation, but this too may be illusory. Jerome Powell, who shocked the markets in December by raising rates, has expressed “patience”, in his rate hiking, and that the Fed may use its balance sheet (print money) to deal with a downturn.

Some investors take this action to mean that a “Powell Put” has now been born, meaning that if the US stockmarket crashes, the Fed can be relied upon to run in and save the day.

I’m not nearly so confident – some problems cannot be fixed with a printing press.

I had a chat with the devout Austrian economist and gold bug John Butler yesterday. During our discussion, he said the American economy cannot endlessly chug forward while everyone else is in dire straits. While the US managed to keep booming while the rest of the world floundered in the early 20th century, eventually the negative vibes came home to roost.

That was then – in our now globalised world, such reactions are faster, and cast ripples further afield. State intervention to solve domestic economic problems has international consequences, and sometimes yields little economic benefit. But for now, the cult of the central banker now reigns in the minds of investors.

Market historian Russell Napier has boldly claimed that it’s not the Fed who pulls the global economic strings, it’s the People’s Bank of China (PBOC). His reasoning is shrewd but simple: if central banks base their actions take action based on the rate of inflation, then whomever creates global inflation, controls those central banks.

From The Solid Ground:

When the time comes to answer the question, ‘When did the US Federal Reserve cease to be the world’s most important central bank?’, historians will probably answer 1994. They will then probably add that it was though a truth not universally recognised until 2019. When it was recognised, the world changed suddenly.

Today the death throes of the old monetary regime, in which China links the RMB to the USD, are having deflationary consequences in China and beyond. However, ultimately, when China moves to an independent monetary policy, through adopting a flexible exchange rate, it will bring inflation to the world. The greatest risk for investors, in the dying deflationary days of the old regime, is in the Eurozone where more disinflation or deflation threatens the stability of the financial system and ultimately the existence of the Euro…

It does of course sound silly to suggest that the US Federal Reserve is not the most important central bank in the world, when the USD is clearly the dominant reserve currency. As all emerging market investors know, changes in US monetary policy have profound impacts from Ulan Bator to Uruguay. However, the Federal Reserve itself sets its monetary policy in relation to its expectations for US inflation. It thus follows that if there was another central bank that was ultimately determining the US inflation rate, then the US Federal Reserve would not necessarily be the most important central bank in the world; it could be more following than leading.

In the eyes of Napier, it’s the rigidity of the euro system that dooms it to failure. Unable to adapt quickly to the global economic flux, the euro unable to bend, will break. The pound’s flexibility to change gives it a great advantage over the shackles of the euro.

My colleague Nick Hubble thinks the day of the central banker is long from gone. I’m not so sure. I reckon they’ve one last hurrah left, before we reach the end of their celebrity era – more on that next week. Until then, just remember: there’s mirages aplenty amidst this desert, and few oases.

Wishing you a good weekend,

Boaz Shoshan
Editor, Capital & Conflict

Category: Central Banks

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