As the melt-up in global asset markets continues, today we ask the question: Are central bankers’ egotistic hooligans blinded by their own intellectual arrogance? You can probably guess the answer to that one.
We’ll also have a look at the bidding war going on around Warrnambool and show you why the ‘winning’ bidder could ultimately prove to be the biggest loser.
On the question of central banks, an article by David Bassanese in today’s Financial Review got us thinking about it. Here’s the introduction to the article:
‘It is time Australian policymakers took a stronger stand against the extremely loose monetary policies still being pursued across Europe, the United States and Japan. With the global economy gradually recovering, monetary policy is well behind the curve, which is already distorting both currency valuations, but risks soon distorting equity valuations also – not to mention local house prices.
‘Ostensibly, these global policies are in place to fight off the lingering risks of deflation – or falling prices.
‘…Australia has been caught in the crossfire of this stimulus war, with uncomfortably low interest rates and an uncomfortably high exchange rate – an unbalanced mix which risks leaving economic growth over the next few years overly reliant on only a few engines, such as the housing sector.’
There is no doubt that Australia is suffering the effects of the global currency war. But as a small, open economy, we have always been affected by the policies of the major economic powers. And it’s not as if we can do anything about it…or take a stronger stand as Bassanese suggests. Besides, it’s not all bad. China’s stimulus and credit boom saved us from the fallout of the GFC…or at least delayed Australia’s day of reckoning (take your pick).
At one point back in 2010, national income growth was running at an annual pace of around 10%! A natural consequence of such strong growth is a strong dollar. It helped to keep a lid on the pace of expansion in other sectors, which in turn kept inflation at bay.
The problem for Australia now though is that national income growth is extremely weak (and will turn negative if the terms of trade revert back to historical levels). That’s why interest rates have fallen so low. But our currency remains stubbornly high, thanks largely to the ongoing currency war between the major global powers the US (and via the currency peg) China, Europe and Japan.
We’ll get back to Australia in a moment. But first, let’s consider what’s behind the currency wars. As Bassanese says, ‘ostensibly, these global policies are in place to fight off the lingering risks of deflation – or falling prices.‘
Falling prices? What falling prices? As far as central bankers are concerned, the only prices that matter are consumer prices. They completely ignore asset prices in the inflation/deflation outlook.
Apparently, consumer price inflation is still weak in the US and Europe, raising ‘concerns’ about those economies slipping into outright deflation. Deflation is bad apparently because it magnifies an economy’s real debt burden. Inflationary economic growth is good because it reduces the debt burden.
But to encourage economic growth central bankers encourage people to go further into debt. To complete the idiocy, it’s this ever increasing debt pile that brings about the prospect of deflation which the central bankers are working so hard to avoid.
Meanwhile, incoming Fed Chair Janet Yellen says QE will continue because the Federal Reserve has ‘more work to do‘. Which is an interesting way of looking at it. Because as far as we can tell, the ‘work’ done so far by the Fed and other central bankers has created a huge amount of asset price inflation and little to no consumer price inflation.
In fact, you could argue that the Fed’s policy of QE has further undermined confidence in the economy and exacerbated deflationary risks. That’s because the Fed’s attempts to get money into the real economy are not working. Instead, the Fed’s debt monetisation program ensures that the newly created liquidity remains within the financial system and only leaks into the real economy via hugely inflated high end real estate prices in the financial centres of New York and London, not to mention off the scale prices for art works.
Now, if that were an experiment we were conducting, we would probably hesitate to say we needed to do more. On reflection, we might humbly concede we needed to do something different. But not so the egotists tinkering with their academic models.
–There’s nothing surer in life (apart from constantly rising Aussie property prices) than the fact that a central banker will claim more needs to be done to fight deflation. When more is not enough, well, it simply wasn’t enough. Do more.
What we find galling is that after such obvious evidence to the contrary, the mainstream financial press continues to treat these people with reverence. These central bankers believe you must spend your way to prosperity. They punish savers and reward speculators and debtors, yet still society collectively worships their profession.
Savings…as in excess production saved and not consumed…are the foundation of genuine economic growth. Without saving you cannot have investment. And without investment you cannot have sustainable economic growth.
With these hooligans at the helm, today you have too much saving and investment in some places (China) and not enough in others (the US). Central banks ‘manufacture’ savings by crediting commercial banks’ reserves and by monetising government debt. As a result, the economic imbalances that led to the GFC in 2008 are still there, made constantly worse by the need to always ‘do more’.
Meanwhile, in Australia we’re back to relying on swapping houses amongst each other to prop up economic growth. The currency wars and insane central banking dogma has got us to a point of relying on rising asset prices to stave off a recession.
Rising asset prices are a product of economic growth and prosperity, not a cause of it. Australia’s strong house price performance since 2008 is in some ways justified, thanks to the high rate of national income growth – a consequence of the China boom that is slowly turning to a bust.
But now we’re relying on rising house prices to attract investment, while national income growth stagnates. That’s about as insane as the Fed fighting consumer price deflation by causing asset price inflation. But when did insanity stop anyone from doing anything?
Never. So we’ll continue to watch as this thing plays out. But with central banker credibility still riding high, it seems like there’s plenty of damage still to be done. Great.
Speaking of damage, whoever wins the battle for Warrnambool Cheese and Butter Factory (ASX:WCB) is going to do some damage to their balance sheet and future returns. We’ll explain why tomorrow…
for Markets and Money