Via Scotiabank's Guy Haselmann,
Markets need to retreat from dependency on central bank stimulus which they falsely believe provides the magical elixir that fixes all economic and financial market woes.
At some point during the past few years, central bank stimulus has gone from a net benefit to a source of financial market ailments. Investors who have rightly arrived at this conclusion have shifted from dip buyers in risk assets to sellers of up-ticks (see January 6th note ‘Down Side Up’).
With only limited tools, central bank ‘aspirin’ can only treat symptoms rather than root causes. Monetary policy stimulus healed some pain, but it is not a cure, nor is it able to concoct one. Moreover, too much ‘aspirin’ can produce undesirable side-effects.
There is plenty of evidence to suggest that central banks have over-promised what can actually be delivered. Certainly growth and inflation have under-shot expectations and forecasts every year since QE1 began in 2008. The stated and suggested words of “doing whatever it takes” now look more problematic for financial markets than do the benefits they may or may not be providing economies. The Fed hike in December was likely the result of the FOMC’s assessment that this ‘cost versus benefit equation’ had indeed tilted.
Market volatility in 2016 is a function of this action (reversal). The one-way quasi-coordination of global central banks from 2009 to 2014 has fractured, which in turn has fueled two-way trading and the resulting market volatility. While some central banks (e.g. ECB and BoJ) continue to ease rates, the central banks of the following countries have all hiked rates in the past few quarters: US, Brazil, Peru, Chile, Colombia, South Africa, Philippines, Paraguay, Iceland, and Paraguay, to name a few.
A few years ago, FOMC members stated that they were “the only game in town” and “did not want to look as if we were not doing enough”. FOMC members believed that help had to come from somewhere, as the political polarization in Washington was clear to everyone. Unfortunately, the ‘temporary relief’ has hidden the aggregating costs that mount under financial repression, market speculation, and debt issuance.
Most would agree that the primary cause of the financial crisis in 2008 was excessive debt levels. Yet today, public and private debt levels have risen to all-time highs of 185% of GDP in emerging markets and above 275% of GDP in OECD countries; over 35 percentage points above 2007 levels.
Keeping rates below the ‘Wicksellian natural rate’ (i.e., too low for too long) has allowed too much debt to accumulate, stolen growth from the future, harmed pensions and other savers, and subsidized over-capacity. The former Chief Economist for the BIS William White wrote in a recent note that in an attempt to prevent an Irving Fisher-type of debt-deflation spiral, the Fed may have increased the odds of one.
Aggressive central bank responses and the asymmetric bias toward easy money resulted from an urgency to address low prices and maintain growth. It is possible that low prices over the last three decades were simply the result of globalization, and of China and Eastern Europe entering the global economy. If this statement is more true than not, then central banks have over-reacted.
In addition, many critics have postulated that the Fed has contributed to increased income inequality by inflating assets prices. The wealthiest have certainly benefited the most. Debt issuance proceeds being used for share buybacks accentuated the impact. Perhaps, if the long-term unemployed received government sponsored new training or education, then structural unemployment would be lower. In the meantime, rising inequality is partially responsible for anti-establishment sentiment visible in political polls.
In doing the heavy lifting for elected officials, the Fed has enabled fiscal stalemate and political polarization. These same officials will likely blame the Fed as more troubles become exposed. Wild markets are certainly a circumstance of Fed policy. It is a current financial market problem that risks turning into an economic one. The answers and cures going forward should, therefore, not be provided by monetary officials.
Chair Yellen, during her testimony on February 10th, should re-focus the market’s attention away from dependency on global central bank stimulus as the cure-all, and alternatively use her testimony to argue that fiscal policy should play a larger role. Without clearer visibility on the economy, taxes, health care costs, and regulation, easy money will not flow into the capital spending that is necessary to increase aggregate demand and stabilize markets.
Nurse: “Doctor the man you’ve just treated collapsed on the front steps. What should I do?”
Doctor: “Turn him around so it looks like he was just arriving!”