Since 2010, May/June has seen the US Federal Reserve start to realise it would have to revise its optimistic New Year forecast that economic recovery was inevitable. As its deputy chairman, Stanley Fischer, noted last August
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”
2015 seems to be following the same pattern, with one exception. It was clear from the Minutes of the latest Fed policy meeting that its Governors are becoming quite divided on what to do next. A reader kindly forwarded the Alex cartoon above from the Daily Telegraph, which highlights this key issue as far as financial markets are concerned:
- Traders assume central banks will always supply more liquidity, so they never need to think about more complex issues such as supply and demand
- But now there is an increasing sense that the central bankers themselves are becoming quite unsure about the consequences of their stimulus policies
We saw this last week, in the uncertainty expressed by European Central Bank President, Mario Draghi, about whether current policies might cause ageing populations to save more, rather than spend. And then the Minutes of the latest Fed meeting reinforced this sense of unease:
“Participants judged that recent domestic economic developments had increased uncertainty regarding the economic outlook”
There aren’t many jobs where you are allowed to spend $4tn ( as the Fed has done), or €1tn (as the ECB is doing), and yet have no comeback when you still continue to fail to hit the key objective after 6 years.
The only central banker to publicly warn his colleagues about the 2008 financial crisis, Bill White, has also been raising the alarm in recent days, warning:
“The price of financial assets, just think of Bunds and equity prices, has gone through the roof as have property prices in many countries. Zombie companies are being kept alive by zombie banks and a sharp increase in Merger and Acquisition activity might also be contributing to growing “malinvestments”. Moreover, problems in the Advanced Market Economies have now spread to 6 of the Emerging Market Economies, with all of the BRIICS in deepening trouble. On the other hand, and note well that there is now another hand, the level of debt is now so high that deflation would no longer be a good deflation but a “bad deflation”.”
White’s concerns exactly match mine. As we argued in Boom, Gloom and the New Normal, deflation was inevitable due to the ageing of the population,. But this deflation would have been a positive benefit, not a problem, if central banks had left well alone, as it would have increased affordability.
Today, however, the McKinsey Global Institute calculates global debt has now reached $57tn – and it seems hardly possible this can ever be repaid. The problem is that policymakers are working with out-of-date economic models, developed when the population was much younger. In those days, reducing interest rates could potentially increase demand. But as I discussed 18 months ago:
“Economists focus on trying to identify the ‘average person. …they believe in the life-cycle hypothesis as set out by Franco Modigliani, who won the Nobel Prize for his work in 1985. This implies that individuals both plan their consumption and savings behaviour over the long-term and intend to even out their consumption in the best possible manner over their entire lifetimes”
When historians study the issue in the future, they will scratch their heads and wonder how such an obviously out-of-date theory could still be used as the basis for policy in 2015. It may have made sense when people died around retirement age of 65. But is makes no sense at all when the average 65-year-old can now expect to live for 20 years – and with only a pension rather than a salary to spend. As White notes:
“The economy is not a machine but a forest, a “complex adaptive system” like many other such systems that have been widely studied by biologists, botanists, anthropologists, traffic controllers, psychologists, sociologists, urban planners, military strategists and many other disciplines. Far from looking down on such people, economists could learn from them some exceedingly simple but important lessons.”
I personally prefer the biologists’approach, with their concept of ’competing populations’. It would not be difficult, with modern computing power, to develop economic models that simulated this type of major divergence. But anything would be better than the current fossilised thinking that passes for policy today.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 47%. “Sales are somewhat slower in Europe despite good summer demand into markets from construction and a weak euro boosting exports.”
Brent crude oil, down 38%
Naphtha Europe, down 37%. “The Asian arbitrage window is barely open, while European petrochemical demand has dried up”
PTA China, down 28%. “Buying sentiment from end-users was largely weak, with majority of them sitting on ample inventories”
HDPE US export, down 15%. “Domestic export prices moved somewhat higher during the week as processors added inventory for a few pennies below the expected increase”
¥:$, down 19%
S&P 500 stock market index, up 9%