If prudential and fiscal policies were properly organized, we would not need to rely on central banks so much. But that doesn’t mean central banks should be inactive. The BIS does explicitly argue for a strong monetary policy role. However, they think that role should look different than it does today.
One big change they suggest is to rely less on inflation targeting. Stubbornly low inflation is what has kept policy accommodative ever since the 2008 crisis. In hindsight, it may have been better to tighten interest rates back toward “normal” (whatever that is) long before inflation rose back to “normal” (whatever that is)..
It’s hard to say how this approach would have worked in practice. Looking back, by 2011 the US was out of recession and stocks were doing well, but unemployment was still stubbornly high. Unable to drop rates any further, the Fed launched quantitative easing instead. The ECB is now doing something similar but even more aggressively.
For three or four years, the Federal Reserve used the excuse that unemployment was unacceptably high; and then when unemployment got close to the “normal” range, they simply refused to pull the rate-hike trigger. They worry about stock markets more than they worry about the imbalances they are creating. They are in danger of losing their credibility, which would be damaging to all of us.
One way or another, says the BIS, “We badly need policies that we will not once again regret when the future becomes today.”
Losing the Narrative
My friend Ben Hunt writes one of the more thoughtful letters I read. I’m going to summarize what I believe to be his views – perhaps because they reinforce my own.
Ben talks about the power of the Common Narrative, the things that we all know and believe. Much of this is what we learned growing up about our countries or religions. These narratives (and there are more than a few of them) shape our prejudices and our actions. This is not necessarily bad, as more often than not these narratives can encourage socially beneficial behavior.
More specifically, Ben talks about the narrative surrounding the central banks. We tend to imagine that they have a great deal of power to drive markets, especially with quantitative easing and their ability to raise and lower rates. We have come to the point that we actually think that the Fed creates value, apart from the income generated by businesses. In fact, it is increasingly a problem (a problem in my mind, at least) that investors are relying more and more heavily on central banks to continually stoke the market, rather than valuing and investing in the market in an old-fashioned Graham-Dodd way. And as long as enough of us believe in that narrative, it becomes a self-fulfilling prophecy. Says Ben,
What I care deeply about, however, is how the Narrative around these events is being shaped and reshaped, because that Narrative will determine the path and outcome of every election and every market on Earth. And what I can tell you is that I am shocked by the diminishing half-life of status quo protecting Narratives, by the inability of Big Institutions and Big Money and Big Media and Big War and Big Academia to lock down an effective story that protects the State, even when their competition is primarily comprised of clowns... There’s a … tiredness … to the status quo Narratives, a Marie Antoinette-ish world weariness that sighs and pouts about those darn peasants all the way to the guillotine….
Why are the status quo protecting Narratives faltering so badly? I think it’s because status quo political and economic institutions – particularly Central Banks – have failed to protect incomes and have pushed income and wealth inequality past a political breaking point. They made a big bet: we’re going to bail-out/paper-over the banks to prevent massive losses in the financial sector, we’re going to inflate the stock market so that the household sector feels wealthier, and we’re going to make vast sums of money available for the corporate and government sectors to borrow really cheaply….
The result, or so the thinking went, of all this pump-priming or bridge-building or whatever metaphor you please would be for all four basic sectors of the global economy – households, corporations, governments, and financial institutions – to consume more and invest more and fail never, which would in turn create a virtuous, self-sustaining cycle of risk taking, real growth, and real wealth creation.
We all know what happened when the narrative surrounding the price of housing and subprime debt collapsed in 2008. You don’t have to be much of a historian to come up with many examples of collapsing narratives. War in Europe is impossible, we were told as late as 1913. And more recently, the British wouldn’t actually vote to leave the EU.
Central banks around the world have pushed the limits of what their credibility can actually deliver. I truly worry what will happen when we enter the next recession and everybody realizes that the Federal Reserve, the ECB, the BOE, and the BOJ are shooting blanks and the emperor has no clothes. Given the mood in countries all over the world and the frustration of the Unprotected class with the seemingly impervious Protected class (which will be compounded if we have another protracted income recession), the level of uncertainty regarding future events is at least as high as it has been at any time in my life.
The next recession, whenever it comes, will result in a completely different type of global crisis than we have seen in the experience of those alive today. Oh, there will certainly be some things that rhyme with history, but I think we would have to go back to the ’30s to find a period roiled with this much social upheaval.
Investors are going to require a different type of portfolio management and structure. You really need to rethink your commitment to a long-only portfolio, especially if you are over 50 years old. I know that’s difficult to contemplate, because the Federal Reserve and the ECB have made normal fixed-income investing impotent. But moving out the risk curve today is fraught with peril.
Las Vegas, Maine, NYC, and Montana
We leave Thursday for Las Vegas, where I’ll give a few speeches at FreedomFest and catch a few shows but also spend a lot of times with friends and take in some of the presentations. Back home on Sunday, I don’t leave Dallas until the first few days of August, when I will go to Grand Lake Stream, Maine, for the annual fishing trip with my youngest son, Trey, and several dozen economists, analysts, and newspeople. It’s an economic Bacchanalia, and we’ll have plenty to chew over this year.
I will go from Maine to New York City for two days of media and meetings before I head across country to be with my friend Darrell Cain at his home on Flathead Lake, Montana. I know, I’m supposed to be home working on my book, but Darrell tempted me with five experts on space technology and technology in general who will also be there. Long story, but it’s a chance to spend a few days with real rocket scientists, mining the makings of a chapter on our future in space and kicking around other interesting ideas. That’s an opportunity I don’t want to pass up. Besides, I actually wrote the final chapter and finished editing Code Red three years ago at Darrell’s home. So I will be working…
I know I complain about absurdly low interest rates, and they do affect all of us who would prefer to have more fixed income in our portfolios; but many of us also benefit from low rates. Two years ago I actually bought a home (technically an apartment in a high-rise) for the first time in 20 years, benefiting from low rates. There was actually a bidding war for my mortgage business. Who knew that banks actually got into a bidding situation over a mortgage? That was my first clue that things had changed. The next clue came a few months ago when my banker at Capital One bank, Clinton Coe, who was one of the losers in the last bidding war, called and asked me if I would like to refinance my mortgage for no points at ¼% lower.
I would have been silly not to, so I told him to go ahead and get the paperwork done. I had originally done a 5-year, 30-year amortization, ARM (adjustable-rate mortgage) at 2.75%, expecting that there would be another recession within five years and that I would get to refinance my mortgage at what would probably be a lifetime, if not generational, low, at which point I would tell them to back up the truck and give me as much money as they could for as long as they could.
This new refinance just extended my option on a recession an extra two years, except on better terms. The fascinating thing is that, as we were sitting down a few weeks ago to sign the paperwork at my home, we came to the page with the actual interest rate and costs detailed, and Clinton pointed out that he had assumed that I would want an additional 1/8% less, and so he did the paperwork that way. I don’t think I can ever remember a banker agreeing to a price and then coming in at a lower rate. I am not that big or important a customer at Capital One. I barely make their cut-off for business activity. That just tells me that the world of bank lending has truly changed. It has truly turned upside down. Oh, the final rate? 2.375% for five years. Clinton tells me they are doing the mortgage for their own “book,” which leads me to wonder what kind of return on capital banks are actually trying to procure these days. I shake my head.
Oh, yes, I still have my mortgage hedged in yen. The yen has gone way down and then back up since I put that trade on, back to about where it was. But is was a ten-year option, and I am patient.
Staying home this summer has allowed me to get in much better physical shape, and I’m actually losing some weight, down some ten pounds in the last six weeks or so. But the mirror tells me we are only about halfway there. And everyone knows that the last ten pounds is the hardest to lose. I see a reduced-calorie diet and more gym time in my future. At least I’m back up to 60 push-ups at a time.
And with that, let me wish you a good week as we all consider the implications of the tragic events here in Dallas. I live quite close to downtown, but the skyline (which is quite beautiful at night) kept us from realizing what was going on, except for the number of helicopters. We were actually sitting reading when we began to get numerous texts from friends asking if we were okay. While we were only a half mile away, it almost seemed as though the shootings must surely be happening on the other side of the planet. How could something like this happen here in Dallas? It’s not a pleasant thought to close on, but that is what is on my mind. It is just not the narratives of central banking that are in danger of imploding.
Your thinking about how the zeitgeist is shifting analyst,
John Mauldin
John Mauldin is editor of Mauldin Economics' Outside The Box.
This article was originally published at Mauldin Economics.