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Fed and ECB “data dependence” is futile: how asset inflation will end this time

The lesson of history is that fine-tuning monetary policy, with the intention of pre-empting the passage of the business cycle from expansion into recession phase, is an example of what King Solomon described as the futility of futilities.  This lesson does not derive from a doom-premise of seven years of famine, following seven years of fat.   Rather, there is the inability of even the most gifted policy makers to assess accurately, in real time, the current state of an economy, and where it is headed; and even if such an assessment could be made, there are no precision tools in the monetary tool box which could improve reliably the outcome. 

A golden example

        Indeed, under the gold standard regime, which reigned from say the late 1860s to 1914, no one claimed (or now claims in retrospect) that the intricate set of in-built, automatic rules meant that monetary conditions would ease, ahead of the transition from expansion to recession.   The opposite would sometimes happen (as for example, when the demand for monetary base – largely gold coin – increased with economic and financial risks).  In any case, the sheer power of momentum in the journey of the economy from expansion to recession would likely defy “twigs” in monetary conditions, even if in the appropriate direction.

        The advocates of a sound money regime (of which the gold standard is the best example to date) make a different claim: the absence of monetary instability should result in a less violent business cycle, and that when recessions come, the invisible hands of recovery would operate more effectively.  (Of course, US economic history under the gold standard in the decades before 1914 has examples of severe business recessions – an inherent cause was a deeply flawed and unstable banking system, as created by the Lincoln Administration during the Civil War).  

Bogus claims of Powell Fed and Draghi ECB

     The claim of our modern monetary bureaucrats, pursuing their “dual mandate” or equivalent – in the case of the US full employment and perpetual inflation of 2 per cent per annum – is much bolder.  For the ECB, the dual mandate under the Draghi-Merkel axis is effectively perpetual 2 per cent inflation and doing whatever it takes, to keep Italy in the EMU.  Armed with the best and brightest of econometricians and interest rate manipulators they can fine tune monetary conditions, ahead of potential business cycle turning points – perhaps, a case of seeking utopia, to avoid a perceived dystopia. 

Source: Bloomberg

      Some top officials of the present 2 per cent inflation standard (notably, Fed Chief Powell) even boast that they have the elixir prepared in the new-Keynesian laboratory which will prevent this cycle ever moving on to its recession phase.  Ex-President Obama economics adviser, Professor Larry Summers, has buttressed this claim by pronouncing that, because the next recession would be so bad (given that central banks have little if any scope for monetary easing), it is imperative for the central banks to prevent this occurring (as if they could). 

    We now have the spectacle of the “central bank watcher community” (whether in the media or market-place) apparently fixated on the chief monetary bureaucrats, in Washington and Frankfurt, whilst implicitly accepting their claim to having mastered the art of fine-tuning monetary conditions to the business cycle.  The central bank chiefs tell us that their policy is data dependent. 

       The chiefs would have done well to follow the example of a recent (not the present!) Bank of Japan chief who, once appointed, made a point of re-reading Milton Friedman’s works.   They would have found an early essay documenting the three lags – first, between reality and when it shows up in the data; secondly, between that showing up and when the policy-makers respond; and thirdly, between the action and its impact. 

     On the basis of the data, ECB Chief Draghi last week announced that the overnight deposit rate is to remain at the present significant negative level (-40bp), into next year (gone all the chatter about a rate rise, before the chief retires later this year), and that monetary base expansion is to continue (reinvestment of income from bonds and who knows how much assistance to the weak banks through the new open-ended facility for banks up to 30% of their eligible assets, albeit that those are in part replacing facilities due to expire in stages). 

     It would be too simplistic to say that Chief Draghi is pursuing an agenda only of contra-cyclical policy, driven by concern at the apparent near recessionary situation, in the euro-zone.  He is also an Italian nationalist – devoted to the cause of keeping his country in the European Monetary Union.

     This is not the poetic nationalism of Manzoni, but the crony nationalism of sustaining the present elites (corporate, banking, political) and a range of zombie companies (small and large) in Italy who gain from the status quo, even though now under threat.  Too bad that his widely supposed ambition to become President of Italy has been thwarted by the Populists.

     Chief Draghi would never lead an economic renaissance (unleashing creative destruction;  to do so he would have to halt the drug train of cheap funds from Frankfurt and create an environment of sound money fostering free market capitalism), which could propel his country into an age of prosperity.     

     Anyone on their mark, in the US Congress, would be pressing the Administration to tackle this blatant exercise in currency manipulation.  In effect a beggar your neighbour devaluation is the contra-cyclical tool now deployed by the ECB; it is a non-precision tool, with considerable risk of back-firing (including US retaliation), albeit, well camouflaged behind the mantra of the 2 per cent inflation standard.  But who in Congress, these days, is on the case of sound money or international monetary reform?  This is just not in the programme of the America First Republicans or the now mainstream Progressive Democrats. 

Monetary inflation has ebbed, but its far-off danger has risen 

      Anyhow, the re-bound of equity and risky credit markets, since early this year, indicates that a dominant view around the world is that the central bankers in Washington and Frankfurt will succeed in re-fuelling the now spluttering economic expansion. 

      The overall strength of gold (despite a recent setback) does indicate, though, investor concerns about a pay-back further ahead for this success, in terms of inflation danger.  The huge US budget deficit and the soft money officials appointed to the Fed, by the Trump Administration, add to the concerns. For now, however, monetary inflation may have waned or even paused  

       How could that be?

       Can one really say that monetary inflation has waned or even died for this cycle when the ECB, Bank of Japan and Bank of China (in their various ways) are ostensibly pursuing radical monetary policies of ease (why is the Bank of China aiming for 3 per cent inflation, when official inflation is now one percent lower than that target – this point seems to have slipped the US negotiators)? 

        Moreover, the rate of core inflation, in the US, is around 2% year-on-year according to the various official measures (with the overall CPI in February up 1.5% year-on-year); surely that means monetary inflation is still active?

        The detection of monetary inflation in goods and services markets, however, should not overly depend on official consumer price trends, but include critically more sensitive measures.  These acknowledge the natural rhythm of prices, lags, and inertia.

        Under a sound money regime, there would be periods during which prices were rising or falling, on a sustained basis, albeit, that in the long run prices tended to revert to a constant mean. So, what would drive prices down – rapid productivity gains, fast-growing abundance of key commodities or accelerating technological change, amongst other factors.  If, during such periods, the central bank was endeavouring to thwart this downward drift (and so indeed prices were broadly stable or rising slightly), that would be evidence of significant monetary inflation.

        Inertia refers to a tendency of expectations to settle around a fixed number, perhaps the so-called inflation target.  Active monetary inflation would be present, if this inertia seemed to breaking to the upside under the influence of strong policy action by the central bank.  Finally, there is the problem of lags.  Today’s monetary inflation is likely to show up in actual price direction, only after some considerable period, if there is widespread long-term price contracting.

      Some top officials of the present 2 per cent inflation standard (notably, Fed Chief Powell) even boast that they have the elixir prepared in the new-Keynesian laboratory which will prevent this cycle ever moving on to its recession phase.  Ex-President Obama economics adviser, Professor Larry Summers, has buttressed this claim by pronouncing that, because the next recession would be so bad (given that central banks have little if any scope for monetary easing), it is imperative for the central banks to prevent this occurring (as if they could). 

    We now have the spectacle of the “central bank watcher community” (whether in the media or market-place) apparently fixated on the chief monetary bureaucrats, in Washington and Frankfurt, whilst implicitly accepting their claim to having mastered the art of fine-tuning monetary conditions to the business cycle.  The central bank chiefs tell us that their policy is data dependent. 

       The chiefs would have done well to follow the example of a recent (not the present!) Bank of Japan chief who, once appointed, made a point of re-reading Milton Friedman’s works.   They would have found an early essay documenting the three lags – first, between reality and when it shows up in the data; secondly, between that showing up and when the policy-makers respond; and thirdly, between the action and its impact. 

     On the basis of the data, ECB Chief Draghi last week announced that the overnight deposit rate is to remain at the present significant negative level (-40bp), into next year (gone all the chatter about a rate rise, before the chief retires later this year), and that monetary base expansion is to continue (reinvestment of income from bonds and who knows how much assistance to the weak banks through the new open-ended facility for banks up to 30% of their eligible assets, albeit that those are in part replacing facilities due to expire in stages). 

     It would be too simplistic to say that Chief Draghi is pursuing an agenda only of contra-cyclical policy, driven by concern at the apparent near recessionary situation, in the euro-zone.  He is also an Italian nationalist – devoted to the cause of keeping his country in the European Monetary Union.

     This is not the poetic nationalism of Manzoni, but the crony nationalism of sustaining the present elites (corporate, banking, political) and a range of zombie companies (small and large) in Italy who gain from the status quo, even though now under threat.  Too bad that his widely supposed ambition to become President of Italy has been thwarted by the Populists.

     Chief Draghi would never lead an economic renaissance (unleashing creative destruction;  to do so he would have to halt the drug train of cheap funds from Frankfurt and create an environment of sound money fostering free market capitalism), which could propel his country into an age of prosperity.     

     Anyone on their mark, in the US Congress, would be pressing the Administration to tackle this blatant exercise in currency manipulation.  In effect a beggar your neighbour devaluation is the contra-cyclical tool now deployed by the ECB; it is a non-precision tool, with considerable risk of back-firing (including US retaliation), albeit, well camouflaged behind the mantra of the 2 per cent inflation standard.  But who in Congress, these days, is on the case of sound money or international monetary reform?  This is just not in the programme of the America First Republicans or the now mainstream Progressive Democrats. 

Monetary inflation has ebbed, but its far-off danger has risen 

      Anyhow, the re-bound of equity and risky credit markets, since early this year, indicates that a dominant view around the world is that the central bankers in Washington and Frankfurt will succeed in re-fuelling the now spluttering economic expansion. 

      The overall strength of gold (despite a recent setback) does indicate, though, investor concerns about a pay-back further ahead for this success, in terms of inflation danger.  The huge US budget deficit and the soft money officials appointed to the Fed, by the Trump Administration, add to the concerns. For now, however, monetary inflation may have waned or even paused  

       How could that be?

       Can one really say that monetary inflation has waned or even died for this cycle when the ECB, Bank of Japan and Bank of China (in their various ways) are ostensibly pursuing radical monetary policies of ease (why is the Bank of China aiming for 3 per cent inflation, when official inflation is now one percent lower than that target – this point seems to have slipped the US negotiators)? 

        Moreover, the rate of core inflation, in the US, is around 2% year-on-year according to the various official measures (with the overall CPI in February up 1.5% year-on-year); surely that means monetary inflation is still active?

        The detection of monetary inflation in goods and services markets, however, should not overly depend on official consumer price trends, but include critically more sensitive measures.  These acknowledge the natural rhythm of prices, lags, and inertia.

        Under a sound money regime, there would be periods during which prices were rising or falling, on a sustained basis, albeit, that in the long run prices tended to revert to a constant mean. So, what would drive prices down – rapid productivity gains, fast-growing abundance of key commodities or accelerating technological change, amongst other factors.  If, during such periods, the central bank was endeavouring to thwart this downward drift (and so indeed prices were broadly stable or rising slightly), that would be evidence of significant monetary inflation.

        Inertia refers to a tendency of expectations to settle around a fixed number, perhaps the so-called inflation target.  Active monetary inflation would be present, if this inertia seemed to breaking to the upside under the influence of strong policy action by the central bank.  Finally, there is the problem of lags.  Today’s monetary inflation is likely to show up in actual price direction, only after some considerable period, if there is widespread long-term price contracting.

      Some top officials of the present 2 per cent inflation standard (notably, Fed Chief Powell) even boast that they have the elixir prepared in the new-Keynesian laboratory which will prevent this cycle ever moving on to its recession phase.  Ex-President Obama economics adviser, Professor Larry Summers, has buttressed this claim by pronouncing that, because the next recession would be so bad (given that central banks have little if any scope for monetary easing), it is imperative for the central banks to prevent this occurring (as if they could). 

    We now have the spectacle of the “central bank watcher community” (whether in the media or market-place) apparently fixated on the chief monetary bureaucrats, in Washington and Frankfurt, whilst implicitly accepting their claim to having mastered the art of fine-tuning monetary conditions to the business cycle.  The central bank chiefs tell us that their policy is data dependent. 

       The chiefs would have done well to follow the example of a recent (not the present!) Bank of Japan chief who, once appointed, made a point of re-reading Milton Friedman’s works.   They would have found an early essay documenting the three lags – first, between reality and when it shows up in the data; secondly, between that showing up and when the policy-makers respond; and thirdly, between the action and its impact. 

     On the basis of the data, ECB Chief Draghi last week announced that the overnight deposit rate is to remain at the present significant negative level (-40bp), into next year (gone all the chatter about a rate rise, before the chief retires later this year), and that monetary base expansion is to continue (reinvestment of income from bonds and who knows how much assistance to the weak banks through the new open-ended facility for banks up to 30% of their eligible assets, albeit that those are in part replacing facilities due to expire in stages). 

     It would be too simplistic to say that Chief Draghi is pursuing an agenda only of contra-cyclical policy, driven by concern at the apparent near recessionary situation, in the euro-zone.  He is also an Italian nationalist – devoted to the cause of keeping his country in the European Monetary Union.

     This is not the poetic nationalism of Manzoni, but the crony nationalism of sustaining the present elites (corporate, banking, political) and a range of zombie companies (small and large) in Italy who gain from the status quo, even though now under threat.  Too bad that his widely supposed ambition to become President of Italy has been thwarted by the Populists.

     Chief Draghi would never lead an economic renaissance (unleashing creative destruction;  to do so he would have to halt the drug train of cheap funds from Frankfurt and create an environment of sound money fostering free market capitalism), which could propel his country into an age of prosperity.     

     Anyone on their mark, in the US Congress, would be pressing the Administration to tackle this blatant exercise in currency manipulation.  In effect a beggar your neighbour devaluation is the contra-cyclical tool now deployed by the ECB; it is a non-precision tool, with considerable risk of back-firing (including US retaliation), albeit, well camouflaged behind the mantra of the 2 per cent inflation standard.  But who in Congress, these days, is on the case of sound money or international monetary reform?  This is just not in the programme of the America First Republicans or the now mainstream Progressive Democrats. 

Monetary inflation has ebbed, but its far-off danger has risen 

      Anyhow, the re-bound of equity and risky credit markets, since early this year, indicates that a dominant view around the world is that the central bankers in Washington and Frankfurt will succeed in re-fuelling the now spluttering economic expansion. 

      The overall strength of gold (despite a recent setback) does indicate, though, investor concerns about a pay-back further ahead for this success, in terms of inflation danger.  The huge US budget deficit and the soft money officials appointed to the Fed, by the Trump Administration, add to the concerns. For now, however, monetary inflation may have waned or even paused  

       How could that be?

       Can one really say that monetary inflation has waned or even died for this cycle when the ECB, Bank of Japan and Bank of China (in their various ways) are ostensibly pursuing radical monetary policies of ease (why is the Bank of China aiming for 3 per cent inflation, when official inflation is now one percent lower than that target – this point seems to have slipped the US negotiators)? 

        Moreover, the rate of core inflation, in the US, is around 2% year-on-year according to the various official measures (with the overall CPI in February up 1.5% year-on-year); surely that means monetary inflation is still active?

        The detection of monetary inflation in goods and services markets, however, should not overly depend on official consumer price trends, but include critically more sensitive measures.  These acknowledge the natural rhythm of prices, lags, and inertia.

        Under a sound money regime, there would be periods during which prices were rising or falling, on a sustained basis, albeit, that in the long run prices tended to revert to a constant mean. So, what would drive prices down – rapid productivity gains, fast-growing abundance of key commodities or accelerating technological change, amongst other factors.  If, during such periods, the central bank was endeavouring to thwart this downward drift (and so indeed prices were broadly stable or rising slightly), that would be evidence of significant monetary inflation.

        Inertia refers to a tendency of expectations to settle around a fixed number, perhaps the so-called inflation target.  Active monetary inflation would be present, if this inertia seemed to breaking to the upside under the influence of strong policy action by the central bank.  Finally, there is the problem of lags.  Today’s monetary inflation is likely to show up in actual price direction, only after some considerable period, if there is widespread long-term price contracting.

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Executive Summary

Evidence suggests that US monetary inflation is waning, at present.  The main counter-evidence comes from asset markets – but history and principle suggest that inflation symptoms here do not persist long beyond their fading in goods’ markets. The ECB, last week, joined the Fed in taking pre-emptive action against a feared transition of the business cycle into a weaker phase (nearer to recession, it seems. at this point than the US).  It may well turn-out that this pre-emptive action is incapable of fulfilling its purpose.  Fine-tuned contra-cyclical monetary policies have no general record of success. Investment ideas, here, are negative on European currencies, positive on gold, positive on short and medium maturity fixed rate dollars and negative on equity/high yield credit.