Today’s thought bubble

Central bankers have become the DJs and transmission mechanism for government social policy.

They’ve been in the DJ booth since Alan Greenspan took over the economy with the quip that politicians should not beat themselves up about failing fiscal policy. He had a solution - exigent monetary policy in the form of quantitative easing (QE) could be used to solve all of the country’s ills.

But with all the current talk about topping, tapering and tightening and three to four potential rate rises in 2022 (already priced in with US 2 year bond yield at 0.89%) don’t forget that the long term themes are still very much in play.

These include decarbonisation/ESG, ageing population, disinflationary technology, eroding purchasing power of Fiat and the rise of crypto and a potential new layer of GDP in the metaverse.

So perhaps instead of there being any fundamental move away from accommodative policy, any upcoming taper and rate hike might prove to be another short term wave of infection on the dance floor of public policy - now controlled by the Fed as agent for the new publican.

Here’s some further thoughts with some help from another great 80s crew.

Art imitating life yet again

My Xer colleagues will remember the track, the ‘The politics of dancing’ by Re-flex.

It was beat mixed in at regular intervals on night club dance floors like the Red Parrot and the Underground, back in the day.

But it’s the song’s lyrics I keep coming back to when I look at the current role of, and reliance on central bankers.

We got the message
I heard it on the airwaves
The politicians
Are now DJs
The broadcast was spreading
Station to station
Like an infection
Across the nation
Though you know you can't stop it
When they start to play
You're gonna get out the way
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood
We're under pressure
Yes, we're counting on you
Like what you say
Is what you do
It's in the papers
It's on your tv news
Oh, the application
Is just a point of view
Well, you know you can't stop it
When they start to play
You're gonna get out the way
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood, yeah
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood
The politics of dancing
The politics of, ooh, feeling good
The politics of moving
If this message's understood

Re-Flex.

The central dilemma

On one hand, centrals need to be careful about how far they seek to calm the dancefloor by raising interest rates, given the levels of indebtedness that exist today.

Too high and there’s an increased risk of default. And there’s also the popping of the asset bubble to consider. That is, the world’s collateral which secures the world’s egregious debt stack is made up of bonds, equities, real estate and commodities.

The first three are likely to tank if the market expects material and sustainable rate hikes, and even moreso if both taps are turned off and the Negroni is withdrawn.

But given the still massive oceans of punchbowl they won’t stay down for long, and/or there may be a rotation.

On the other hand, today’s populist governments expect central banks to raise interest rates in an attempt to stave off inflation - if only to avoid having to answer embarrassing questions about runaway inflation and social exclusion, come election time. China’s in a different boat.

A conundrum.

Inflation is now the political hot potato and with governments still trying to work on the fiscal, central bankers are left to program the music, lights and dancefloor.

Lessons from the past - do they have a place?

But in the end, you have to think that centrals remember what happened in the past when their hawkish predecessors raised rates too quickly.

They must also have a good idea about what happens when QE is withdrawn - the sole objective of which is to increase asset markets to stimulate wealth and in turn, investment.

That was past-Chair Alan Greenspan’s theory - do QE, asset prices go up, investors feel wealthy, more borrowing and business investment, and then comes the trickle down into the real economy. Bernanke was, and so far Powell is, a disciple.

This time it didn’t work 100% - it just inflated asset prices and created (collateralised) unproductive debt.

And that’s the problem - it’s collateral that might be too big to fail, or at least would have been under a Republican administration. But what now?

In effect, the Fed and the ECB have a dilemma and they’re under pressure to ensure inflation does not become entrenched and at the same time find a track that allows a smooth transition from 160 beats per minute to 120 beats per minute.

Unfortunately, from my experiences in the DJ booth that’s not really possible, and even with pitch control it needs to be gradual, and hence the current volatility on financial dancefloors.

Finally, higher rates mean cratering collateral prices - and due to supply chain blockages, increases in interest rates may not necessarily reduce consumer price inflation. That’s the rub.

It’s all a punt as we still don’t know if inflation (wages inflation) will be sticky.

The politics of, ooh, feeling good COVID

So, this ongoing dance of dot plots and dove versus hawk and tightening versus accommodative policy is all messaging and politics.

And the infection, or message has resulted from lockdown and COVID supply blockages which may not be sticky.

But the inflation message seems to be ‘message understood’ by markets because it’s been priced in, rightly or wrongly.

I wonder what it all looks like when blockages are over if the Fed has raised rates/tapered? Reversal and backflip? A new normal?

No one knows, but until centrals leave the DJ booth, you’d be well advised to get out the way until the message’s clearer.

Mike