Central banks and the end of consequences

All eyes on Janet Yellen this week.

Yellen, if you’ve never heard of her before, is the Chair of Federal Reserve – the US central bank (essentially the American Bank of England, except much more influential).

This Thursday, Yellen will announce whether interest rates in America will rise, or stay on hold. She’d been expected to raise rates. But now, following the panic in China last month, things are little more up in the air. She might keep the easy money flowing. She might not. The world holds its breath.

At least, I assume some of the world does.

So keep an eye out for heightened and dramatic coverage of the decision in the press as we get closer to Thursday.

As we’ve been trying to explain in C&C in recent weeks, there’s a bigger story going on here than what happens this Thursday. It’s a story that’s been rumbling away in the background since 2009.

Put in really simple terms, it’s a story about central bankers like Janet Yellen becoming increasingly and overbearingly involved in the economy and the financial markets.

Keep in mind: when QE and zero interest rates began, the world was still suffering the after-effects of the financial crisis. Central bankers could claim to be ‘fighting’ a genuine problem. You could argue their response was misguided. But it was understandable, given the circumstances. They had to try something.

But as we’ve got further out from the crisis itself, their policies have warped from an ‘emergency’ response, to something else entirely.

Think about it like this: if Yellen doesn’t raise rates because there was a market panic, what does that say about her intentions? The panic started in China. China’s stockmarket had doubled in a year, fuelled in large part by speculators punting their money on the Shanghai Stock Exchange instead of in Macau.

That was the primary trigger

But it wasn’t the only thing compelling investors to whip their money out of the markets. Chinese growth figures disappointed. Commodity prices have been dropping all over the place. In short, there were some pretty good reasons for the markets to fall back.

As we’ve said countless times, these things are all signals. They help investors understand what’s going on in the world and react accordingly.

If Yellen keeps the easy money flowing in an effort to ‘steady’ the markets after a tough month, she’s distorting that signal. She’s blocking out the bad news and giving investors something to cheer about.

The problem is, bad news is important.

People need to know the consequences of their actions, whether good or bad. Otherwise our perception of reality is warped.

The example I always give for this is a runner with an injury. I run a lot of races. And I regularly see people popping painkillers or rubbing creams and gels into various parts of their bodies. Sore knees or calves or hamstrings.

It’s common. It can also be dangerous. Blocking the pain you’re experiencing in your knee might help you compete better on the day. But it also blocks the feedback you need to know when something is seriously wrong. You need that information. Blocking it out can lead to you pushing too hard and making the injury much worse.

Ever heard of the medical condition congenital analgesia? People suffering from it have an inability to feel pain. They trip in the street, break their ankle and don’t even realise it. The negative feedback loop is broken. And it can lead to huge difficulties. People with the condition live in fear of things like appendicitis – where nothing is visible externally, and the pain you feel is the only signal something has gone wrong.

There are tonnes more examples.

But the bigger point is this: it might not be pleasant, but we need to know when things are going wrong. We need to feel the consequences of our actions, whether that’s a painful experience or not.

When central bankers try to block out the bad news and keep the markets happy in the face of very real problems, they’re fundamentally distorting the reality of the world you’re investing in.

In the long term, that’s much more dangerous than a falling stockmarket.

Nick O'Connor's Signature

Category: Central Banks

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