Central Banks Vulnerable to the Next Recession

Central bankers are either academic incompetents or comics.

Deflation is headed our way.

China’s legendary growth is a fraud.

Share markets are overvalued, and heading for a seismic collapse.

Solving a debt crisis with more debt accords with Einstein’s definition of insanity.

Negative interest rates are the dumbest idea since someone thought of putting an ashtray on a motorbike…perhaps negative rates are even dumber.

I’ve no doubt my ‘glass half empty’ view of the world makes eyes roll and people think, ‘here he goes again, off on a doom and gloom tangent’.

The ‘glass half full’ view is:

‘Doesn’t he know the US share market is near an all-time high? Property markets in Australia and other highly priced capital cities have not collapsed as predicted. Employment data looks OK. Global growth — while lower than predicted — is still positive.’

‘Why doesn’t he (me) just accept that central bankers have done a good job, giving credit where credit is due? After all, they’ve kept the global economy afloat since the collapse of Lehman Brothers eight years ago.’

The reason I know eyes roll is because these thoughts — in one form or another — have been put to me (politely and not-so politely) over the past few years.

Seeing the world differently to the majority is far from easy. Firstly, there’s the risk (not to mention embarrassment) of having a lot of public egg on your face. Secondly, and far more importantly, you’ve missed an investment opportunity.

The events of 2008/09 were triggered by a debt crisis…subprime lending. People of dubious credit quality were given loans to prop up the US housing market. This money-for-nothing-backed-by-nothing mania went global — Spain, Ireland, Iceland, Greece, Portugal, and Italy all joined the party.

Boom. It then imploded. After the day of detonation, 15 September 2008 (the day Lehman Brothers filed for bankruptcy), central bankers unleashed their secret weapon: unconventional monetary policies.

Now, a layperson’s interpretation of un-conventional is: ‘this is not the normal response…things must be bad to warrant the use of unorthodox methods.’

So that’s the background to my relatively simplistic view of the world for the past eight years.

With each passing year, the unconventional has morphed into the conventional.

Interest rates go lower and lower (into the negative) for longer. Central bankers — the world over — keep upping the ante with more expansive and expensive quantitative easing programs. Outright manipulation of markets is now accepted as orthodox. Direct and indirect financing of government deficits is somehow seen as OK.

Remember way back when ‘the wealth effect’ — increasing asset prices and watching the well-to-do share the love around — was going to ignite economic growth? This was, and has, proven to be nothing more than an academic furphy.

These unconventional — which are now considered conventional — monetary policies have pushed the Dow to record levels; they’ve put air into and kept the air in a select group of capital city property markets; they’ve created billionaires from apps that make no money; they’ve produced an increased number of lower-paid part time jobs; they’ve financed the building of factories and mines that produce far more than there’s demand for; they’ve provided ultra-cheap financing to businesses to invest in automation; and they’ve managed to reduce the value of retirement savings to virtually zero.

At least that’s the way I see it.

Pointing out the long term danger (and stupidity) in these unconventional monetary policies can be seen by some (or many) as a case of the boy who cried wolf.

When there’s apparent danger ahead — even if it is a speck on the horizon — do you keep quiet to the potential harm, or do you warn others?

After eight years of unconventional monetary policies, the systemic risks to the global economy and financial markets are coming more clearly into sight.

The boy is no longer the only one crying wolf. There are more highly credentialed elders who have also joined the chorus.

This weekend I’d like to leave you with two such warnings to ponder.

Claudio Borio, Head of the Monetary and Economic Department at the Bank for International Settlements (BIS), and Anna Zubai published a paper in July 2016, titled ‘Unconventional monetary policies: a re-appraisal’.

Here’s an extract (emphasis mine):

They were supposed to be exceptional and temporary — hence the term “unconventional”. They risk becoming standard and permanent, as the boundaries of the unconventional are stretched day after day.

Following the Great Financial Crisis, central banks in the major economies have adopted a whole range of new measures to influence monetary and financial conditions… But no one had anticipated that they would spread to the rest of the world so quickly and would become so daring.

This development is a risky one. Unconventional monetary policy measures, in our view, are likely to be subject to diminishing returns. The balance between benefits and costs tends to worsen the longer they stay in place. Exit difficulties and political economy problems loom large. Short-term gain may well give way to longer-term pain. As the central bank’s policy room for manoeuvre narrows, so does its ability to deal with the next recession, which will inevitably come. The overall pressure to rely on increasingly experimental, at best highly unpredictable, at worst dangerous, measures may at some point become too strong. Ultimately, central banks’ credibility and legitimacy could come into question.

Central bankers are fast running out of options. This means that when, not if, the next crisis hits — which will make 2008/09 look like a Sunday school picnic — we are going to bear the full brunt of the market’s corrective forces.

And a month later, on 24 August 2016, former Federal Reserve Governor Kevin Warsh published an article in the Wall Street Journal titled:

‘The Federal Reserve Needs New Thinking’, with the subhead: ‘Its models are unreliable, its policies erratic and its guidance confusing. It is also politically vulnerable’.

Here’s an extract (emphasis mine):

The conduct of monetary policy in recent years has been deeply flawed.

U.S. economic growth lags prior recoveries, falling short of forecasts and deteriorating in the most recent quarters.

The economics guild pushed ill-considered new dogmas into the mainstream of monetary policy. The Fed’s mantra of data-dependence causes erratic policy lurches in response to noisy data. Its medium-term policy objectives are at odds with its compulsion to keep asset prices elevated. Its inflation objectives are far more precise than the residual measurement error. Its output-gap economic models are troublingly unreliable.

The Fed seeks to fix interest rates and control foreign-exchange rates simultaneously — an impossible task with the free flow of capital. Its “forward guidance,” promising low interest rates well into the future, offers ambiguity in the name of clarity. It licenses a cacophony of communications in the name of transparency. And it expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.

If, as is more likely, the economy is closer to recession than resurgence, the Fed is poorly positioned to respond with force, efficacy and credibility. The Fed is vulnerable. Its recent centennial as our nation’s central bank should not be confused with its permanent acceptance in the American political system.

This was a damning article from one of the Fed’s own.

The performance of markets and the economy over the past eight years has been a fraud.

The problem is, most people don’t see it that way. They think the unconventional medicine is conventional…because the (over)dosages being administered are from trusted economic doctors.

When the fraud is revealed, the Fed and all other central bankers will be vulnerable. The public backlash will be seen, heard and felt around the world.

Belatedly, the hidden meaning in the central bankers’ monetary policy will be revealed to all…un-CON-ventional.

Take heed of those who are far brighter and better connected than me.

Don’t fall for the confidence trick.


Vern Gowdie,
For Markets and Money

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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