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Global Macro
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What Are The Biggest Problems of Using Monetary Policy?
It Can't Solve Everything
Central Banks may have finally moved into quantitative tightening, but there are aspects of inflation that monetary policy may not be able to solve.
Unlike in Japan, the UK, US and now the EU are in all rates lift-off mode. With reluctance, Central Bankers have implicitly admitted their previous policy error of not raising rates sooner. But was this mistake deliberate? Or unpredictable? Last week, Asset allocators were searching for answers to these two questions in our Multi-Asset feed.
On the one side, strategists and economists at asset management firms have a certain sympathy for central bankers. They could be forgiven for not predicting:
1. A prolongation of the supply chain crisis, induced by COVID and exacerbated by China's zero-policy.
2. The actual arrival of Russian Troops in Ukraine and the resultant food and energy crisis, causing prices to spike.
3. A labour market crisis where vacancies are outstripping the unemployed.
But can Central Bankers be forgiven for:
1. Maintaining the mantra that inflation is transitory, for so long.
2. Accepting inflation as lesser evil than recession.
3. Continuing to believe that the Covid, Ukraine-Russia and Labour market crisis will simply go away soon.
Interestingly, both sell-side and buy-side economists are also suffering from the same delusions of central bankers. You just need to compare their forecasts for the path of rates and inflation to see that consensus is lacking, and hope has taken hold.
The biggest problem with monetary policy is that it cannot solve non-monetary causes of inflation, the likes of which we are seeing today, i.e. the ones the Milton Friedman afficionado's did not experience in the 80's or 90's, 00's, or 10's.
The other problem is that the developed world has been hooked on debt by the same Central Bank pedlars of low interest rates and liquidity, for so long. If these same pedlars now use their monetary tools to control the sources of inflation that they can control, namely consumption and investment, the price is recession or prolonged stagflation. Something which is harder to solve.
In the meantime, central bank errors are reverting too slowly back to the mean of reality, but the electorate is assuaged. One question remains: For how long will this softly softly approach work?
Global Macro
We see danger ahead. Markets are still too high, and protection is expensive in an increasingly nervous world; common sense suggests one should invest conservatively, and in safe assets. In a world where people find themselves without the ability to pay commitments as they arise, forced selling drives prices. Among risky assets like equities, one of the counter-intuitive things in a liquidity crisis is that securities perceived as safest and most liquid go down sharply, because investors are forced to sell what they can, not what they want to. We therefore regard plentiful liquidity in the portfolio as overwhelmingly attractive; it allows us to make the most of the opportunities that arise in the aftermath of a crisis. But first we have to get through the storm.
The thought that central bankers can do much to change the broad sweep of inflation is, in my view, far-fetched. Lowering interest rates and keeping them down ensured that, in the aftermath of the 2008 crash, the world escaped a dislocative deflationary recession, and experienced instead a reprieve from deflation. Their actions, however, had an inevitable consequence: the onset of a virulent inflation. This was perfectly predictable at the time, and, indeed, we predicted it.
There was, however, no money to be made from the insight that money had lost stability post-2008 – the car would swerve maybe towards deflation, maybe towards inflation, but the final result would certainly be inflationary, because the authorities’ obsession was (and is) to avoid deflation. The game changer was to be rightly prepared for inflation, and for the last ten years, we have been. To call it too early is, in our book, to call it on time.
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