From Jackson Hole to Beijing, monetary policy is in flux

Before I signed off for my long “summer recess”, I promised to return ahead of the annual economic policy symposium which is held at the end of August in Jackson Hole in Wyoming, and which is organised by the Kansas City Fed.  It truly is a Who’s Who in the world of monetary policy and what is said there has always been, for those of us with our feet in the interest rates and in the currency trading camps, of utmost interest. This is the week of Jackson Hole and, behold, here I am.

The theme of this year’s symposium – it begins on Thursday – is  “Structural Shifts in the Global Economy”. Those amongst us who have for some time been looking at the way in which those who make monetary policy appear to some extent to have been firing the wrong ammunition in the wrong direction are sitting there wondering why this was not what they have been focusing on before now? It is said that generals habitually spend their working lives preparing to fight the last war and a number of my fellow “teenage scribblers” have again and again raised the question why prevailing monetary policy appears to be geared towards countering the last recession, the last inflationary cycle, and the last financial crisis?

Structural shifts in the global economy are what launched the 2007/2008 Global Financial Crisis. How often has it been raised that Alan Greenspan at the Fed, Wim Duisenberg and subsequently Jean-Claude Trichet at the ECB and above all Mervyn King at the Bank of England never understood – or chose not to understand – the, pardon me, structural shifts in the global economy that had led to the period of disinflation during which their erroneous low-interest rate policy pushed us into the chronic over-indebtedness at both public sector and at household level and from which we continue to suffer today.  

So, the great and the good will be flying from all over the world to wherever they can catch a connecting flight to Jackson Hole and there they will be justifying themselves that the monetary policy they have been pursuing for the past two and a bit decades since the first big rate cuts in the aftermath of “9/11”, that’s late 2001, and the beginning of epic waves of quantitative easing in response to the 2007/2008 were correct and appropriate and that the time might be right for them to sit back and have a bit of a rethink. The horse, my friends, has not only bolted but it has in the meantime, the poor beast, also died of old age. I would contend that monetary policy has not only let us down in the few years since the outbreak of the C-19 pandemic and again since the explosion of inflation following Russia’s invasion of Ukraine, but that it already missed the boat when parochial monetary policy first met globalised trade flows.

Having ridden the benefits of a disinflationary global supply chain and having gathered the plaudits for supposedly bringing about what Mervyn King termed the “NICE” economy – non-inflationary constant expansion – the monetary authorities found themselves facing its effective reversal and cost-push inflation without an appropriately up-dated toolkit. As import prices of both raw materials, especially hydrocarbons, and manufactured goods rose monetary policy committees found that the playbook lacked comensurate measures and all they could do was to crank up the interest rate ratchet. I well recall suggesting at the time that raising rates would do nothing to affect the rising price of imported goods while at the same time critically increasing the cost of living for households which had in previous cycles of higher inflation never been quite as interest rate sensitive as they are now. the wage-price spiral has morphed into something akin to a wage-wage spiral.

As far as businesses are concerned, the near-fraudulent pursuit of “shareholder value”, the willy-nilly gearing up of companies’ balance sheets in order to inflate share prices, should have been stopped years ago. It must be going on 20 years since I first postulated that executive compensation should not only be geared to the stock price but also to the credit rating, the latter of which has been ruthlessly sacrificed at the altar of the former, but in the world of “I don’t understand bonds” this consistently fell of infertile ground. Trillions of pensioners’, widows’, and orphans’ funds found themselves committed in asset classes, the inherent risk of which was hidden behind smoke, mirrors, and a cabal of smooth-talking bar stewards. Leveraged beta was being marketed as alpha with fee structures to match and asymmetric risk profiles which assured that although the risk managers managed the risk, it was in fact almost exclusively borne by the investors.

All the while, the monetary authorities deceived themselves into believing that they had their fingers on the pulse when in fact they were measuring the tick-tock of the life-support system. The measure of success is not how easily the patient is breathing when connected to the machine but what will happen if, as and when he or she is taken off it. Will they continue to do well, or will they instantly splutter and croak? Nobody has until recently dared to find out. 

In the six weeks during which I have relearnt how to sleep until 7 o’clock – this morning I found to my detriment that to have been a big mistake – the most significant shift in sentiment has been that surrounding China. It has in the shortest amount of time been recast from what had been the locomotive of global economic recovery to the ticking time-bomb in the hold of the good ship Universal Prosperity. How it could have escaped all the PhDs, MBAs, and CFAs that the Chinese real estate boom was not all that much different from the one which had gripped Japan in the 1980s. I can remember as though it was yesterday how all and sundry admired “the land of the rising yen” and how the Japanese economic model was held up as the one to which we all should be aspiring. Oops! Now it looks as though it might be China’s turn.

The signs that China’s residential real estate sector might sink President Xi’s dream of eternal growth have been here to see for some time. Prudent observers long believed the troubles which affected Evergrande to be symptomatic of the sector as a whole and never bought into Beijing’s official line that they were idiosyncratic. How one could believe that if the nation’s second largest property developer is in deep doodoo, the largest one with a near identical business model could be sailing along with alacrity escapes me. I can’t remember when I first declared China to be “uninvestible” but of a sudden the blind belief that the CCP would ensure that nothing could go wrong is looking more than just marginally naïve.

The Peoples’ Bank of China is now frantically easing, and making a big thing of it, although in the face of an imploding real estate sector which has for decades driven the country’s epic growth, it looks to have turned up with a knife to a gunfight. President Xi, having pretty ruthlessly swung himself into a position of unassailable power, now looks like the epitome of a polar bear sitting on an ice floe headed south. Having one cornered rat in Moscow is more than enough and the prospect of another one in Beijing can barely fill anyone with optimism.  

And then we have the West’s central bankers assembling in the Rockies to collectively reflect on “Structural Shifts in the Global Economy”. They helped to bestow upon their populations a fantasy of eternal, recession-free growth, and ever-expanding prosperity for all. They happily created an image of there existing an authority above the fray of party politics which floated on a cloud of righteousness. Now, with pre-pandemic and pre-invasion model of a seamless global supply chain lying in tatters and inflation having shifted from price-push to wage-driven, they have finally decided to review whether existing monetary policy tools are either appropriate or effective. And if the answers were to be “No”, what then?

By the time we return to the grindstone after next Monday’s Late Summer Bank Holiday here in the UK and the USA fires up again after the Labor Day weekend, most of these questions should have been articulated, albeit of course that no answers will have been found. Far be it from me to suggest that illegal immigration and environmental issues are not important, but it would be naïve not to also acknowledge that they also make good headline grabbers when it comes to the political classes dodging the thorny and intractable issue of the ongoing risk of stagflation. It is a social, just as much as an economic problem. Bond yields might be all over the place but as they continue to rise – US 10-year notes are trading at the time of writing at 4.30%, up by 46 bps on the month – the yield curve remains stubbornly inverted. Bond markets don’t lie and as much as the market talk is of a soft landing, a yield curve sporting a 2s/10s inversion of 66 bps speaks for itself. This might be a lot less inverted, or flatter if you prefer, than it was a month ago, but we remain a good 150 bps away from what one might deem to be a more or less normal yield curve.

It is hard to argue against the assumption that the prolonged period – over 20 years – of artificially low interest rates has encouraged a divorce of the price and the value of assets. That bunny might have been powered by Duracell batteries and they might last longer than ordinary alkaline ones but they too, at some point, will begin to run out. Markets will in all likelihood for the four and a bit months, between now and the end of the year be driven by the search for a new and more appropriate paradigm for both monetary policy and for the valuation of assets. I am not optimistic that a result, were it to be found, would be to most people’s liking. Can we sail on in the belief that ultimately it’ll all be all right on the night? Can we afford not to?  Enter, stage left, the erstwhile Muppet in Chief Jean-Claude Juncker, former president of the European Commission who immortally declared during the eurozone crisis “We all know what to do, but we don’t know how to get re-elected once we have done it”.

If I were to be asked what I think lies ahead, I would likely suggest the end of the age of the disruptor. Disrupting is fine and dandy but the fundamentals of how businesses and economies function cannot be changed by willpower alone. The seemingly inevitable final collapse of WeWork is a case in point. Sure, the pandemic and the rise in working from home rather than assembling in the city, even in a decentralised workspace, has not helped but WeWork tried to sell renting good old desks and chairs as something of a lifestyle decision. It’s not. A ping-pong table and a communal soda fountain do not make a business of itself successful. That was WeWork’s USP and not a lot else. At a point in time in which anything with the title disruptor, just as dot.com had in the last years of the 90s and up until the beginning of the century, meant cool and must-have, WeWork was a no-brainer. Once one had, however, applied a brain to the no-brainer it was quickly exposed as a whopping hype. And there are many more of those out there waiting to go wrong.

When getting rich quick and picking investments that will double overnight is the order of play, then companies that make things for steady but spectacular margins will not be in high demand. After the dot.com craze it was financial businesses and residential real estate. Then the GFC. Next it was cryptos. Now it is AI. Price and value? A week ago, I took a trip to the City where I was kindly given lunch by one of my readers who earns his crust in wealth management. In acknowledging that nobody seems to have any idea where markets are going, he did conclude that whatever happens people will go to Sainsbury’s to buy food and then clean their teeth with a Unilever product. The search for spectacular returns might be about to hit the next set of skids but the end of the world is not nigh. 

As I noted on Friday, the coming months could well prove to be a lot more interesting than any one of us might want them to be.

So, off we trot into a new week. We are coming to the end of the summer season. News flow remains variable and there is little more for me to do than to congratulate the ladies of Spain on carrying home the World Cup. Here in England the soul-searching will surely go on for some time to come although I suspect that it will be hard to escape the conclusion that on the day the better team won. Felicidades. 

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