Things That Make You Go Hmmm... Like The End Of Central Bank Innocence
Take a long, hard look, Janet," warns Grant Williams, "the landscape over which you cast your eyes when you accepted the poisoned chalice prestigious role of Fed Chair changed last week." Just two days before you were confirmed in a rather lovely ceremony, in an interview in Mumbai, Raghuram Rajan (one-time Chief Economist at the IMF and current Governor of the Reserve Bank of India) rather UNceremoniously dropped something of a bombshell that went largely unreported (perish the thought, in this era of dogged journalism) but that most definitely queers your pitch in a major way:
(Bloomberg): India central bank Governor Raghuram Rajan warned of a breakdown in global policy coordination after the Federal Reserve further cut stimulus, weakening emerging-market currencies from the rupee to the Turkish lira.
Rajan, a former chief economist at the International Monetary Fund, called for greater cooperation among policy makers weeks before finance chiefs from the world's top developed and emerging markets gather in Sydney. The Fed's Jan. 29 statement made no mention of developing economies. "International monetary cooperation has broken down," Rajan, 50, said yesterday in an interview in Mumbai with Bloomberg TV India, noting how emerging markets helped pull the global economy out of crisis starting in late 2008. "Industrial countries have to play a part in restoring that, and they can't at this point wash their hands off and say we'll do what we need to and you do the adjustment."
Now this is going to be a problem, Janet.
Potentially, a BIG one.
The standout feature of central bank policy over the last five years has been the spirit of cooperation amongst the men ("And women!" — Sorry, Janet, "and women") in charge of the world's central banks.
Whilst this spirit of cooperation has been somewhat unwilling in a few cases (yes, Glenn, I'm talking about you), it has been vital to establish a unified message that would give investors the sense that these guys ("And girls!" — Sorry, Janet, "and girls") were talking (a) to each other and (b) to us from a common perspective, that perspective being low rates and free money forever.
Then came The Taper.
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The emerging-market countries that have seen strong inflows as the Fed's QE program sent billions of dollars their way in search of returns, are now in a bit of a fix, as the chart below demonstrates:
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Yes, folks, central bankers lie. The job demands it. That means that they join politicians in the category marked "cannot be trusted," and yet investors the world over are not only relying on the promises made by these individuals but also trusting them to be both transparent and honest when the job demands they be neither.
Given that they lie to us, and given that they are making two key representations to us, should we not perhaps take a moment to think about the two inputs to this particular equation?
Politicians across the globe are assuring us that (amongst other lies things):
1) The "recovery" is either here or right around the corner.In fact, it is neither.
2) Remaining in the EU is the best option for Greece, Spain, Italy (and France).It is not.
3) Soaking the rich is the answer to a multitude of problems.It isn't.
4) Raising taxes will generate the necessary revenue without having a negative effect on the economy.It won't.
5) Future promises of entitlement payments are solid.They aren't. Defaults are inevitable.
Meanwhile, the central bankers of the world are promising us that:
1) Interest rates will remain low for a very long time.In the end, it's not central bankers' choice to make.
2) Quantitative easing has no ill effects and can be withdrawn at will without causing any problems.It can't be.
3) Printing money will not translate into higher inflation.It will. It just hasn't yet.
4) They will do "whatever it takes," and that will be enough.There is a limit to what they can do, and it will ultimately not be enough.
5) They are all in this together.They're not. It is every man for himself now, and the Fed will screw them all.
So here we are.
Having established that, like politicians, central bankers are required to lie to us in order to be able to do their jobs, we are left facing a couple of crucial questions. First, IS tapering tightening, or not? Secondly, what does all this chaos in emerging markets in the wake of The Tighten Taper mean, and where does it take us from here?
Fortunately, the great Albert Edwards of Soc Gen fame took the words right out of my mouth this week:
(Albert Edwards): Tapering is tightening, which inevitably ends in recession, bailout and tears.
Our warnings throughout last year that an unraveling of emerging markets (EM) was the final tweet of the canary in the coal mine have still not been taken on board. The ongoing EM debacle will be less contained than sub-prime ultimately proved to be.
The simple fact is that US and global profits growth has now reached a tipping point and the unfolding EM crisis will push global profits and thereafter the global economy back into deep recession. Our thesis on how EM would be pushed to crisis was simple, especially as we saw close parallels with the 1997 Emerging Asia currency crisis.
We saw yen weakness further undermining an already weak balance of payments situation in the emerging world as a direct replay of 1997. A strong dollar/weak yen environment is typically an incendiary combination for EM, and so it has proved once again. Having reached tipping point the yen will often rally strongly as it has now and as it did in May 1997. This may or may not delay the impending EM implosion for a few weeks. Indeed the Thai Baht, the first domino to fall in the Asian crisis, briefly rallied strongly (vs the US$) in early June 1997, reassuring investors just ahead of its ultimate collapse.
There has never been any shadow of doubt in my mind that tapering = tightening, and I marvel that the Fed convinced anyone otherwise. A Fed tightening cycle inevitably plays a key role in triggering the next crisis (see below). Plus ça change, hey?
1970 Recession/Penn Central Railroad1974 Recession/Franklin National Bank1980 Recession/First Penn/Latin America1984 Continental Illinois Bank1987 Black Monday1990 Recession/S&L and banking crisis1997 Asian currency collapse/Russian default/LTCM2007 The Great Recession/Collapse of almost the entire global financial system2014 Emerging Market collapse/deflation/recession/another banking collapse etc.
Albert is right, of course.
Not only is tapering most definitely tightening (don't listen to what they say, watch the results), but we have likely seen just the beginning of the fallout from the Fed's new course.
Will they stick to it? No. They won't be able to. They MAY taper another $10 bn in March when Janet Yellen's first rate decision is announced, but I suspect that by then markets will be in such a state of disrepair that excuses will be made as to why the taper has been suspended. You can bet your bottom dollar that there will be some frantic calls put in to Ms. Yellen's office by her peers around the world between now and March 20, all of which will be begging calling for an end to The Taper.
Ultimately, QE will continue to be expanded until it implodes in a fireball the like of which has never been seen before. There's no choice, I am afraid, because the alternative would involve the telling of some very harsh truths by politicians and central bankers and the bestowing of some serious pain on an electorate that already holds them in contempt.
Think those truths are going to be volunteered?
Me neither.
The splintering of central bank policy is just the beginning.
This is the end of the innocence.
Full must-read Grant Williams letter below:
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