Anyone else ever feel, even just for a moment, that this is all getting a bit mad .... and not in a

ref :- "Frustrated central bankers cast around for fresh thinking" , Michael Mackenzie's Long View, FT Weekend

Mad ? Really ? Well, it depends on how you look at it ....

It's another big week for central banks, in particular for the US Federal Reserve who announce their monetary policy decision on Wednesday. As we know, a cut of 25 basis points is the likely outcome with more to follow before year-end. The rationale behind a cut/cuts centres on insuring against a slowdown in growth prompted by the trade war and economic headwinds imported from outside the US, against a background of a benign inflation scenario. Everyone has their own priorities when it comes to extending the long economic expansion, and Fed Chairman Jay Powell believes that further solid growth is required to benefit those on the margins of society who have yet to see any gains. Looked at in that light, a dose or two of monetary easing seems pretty reasonable ..... worthy, even.

On the other hand, as Irwin Stelzer pointed out in the Sunday Times Business Section yesterday, the Fed are about to start cutting rates at a time when the economy is still growing at a respectable rate of over 2%, unemployment is at or near 50 yr lows, wages are rising fast and retail sales are the strongest in five years. Whether the inflation equation has changed for good or not (it surely has, but nobody's quite sure how), in times past the idea of rate cuts against that sort of background would have been considered pretty off-the-wall.

Times change, and of course thinking has to change with them .... and yet for many the concept of negative rates and the ever-easier monetary policies being pursued around the world remain a little surreal and distinctly unsettling.

To clarify ..... anybody should be able to understand why in extreme adverse economic conditions and in pursuit of a measure of healthy inflation, ultra-low or even negative rates could be in order. For companies and individuals they encourage investment and spending over saving. But surely nobody really thought that such policies would be in place for so long. The European Central Bank (ECB) imposed negative rates in 2014, and stretching a long way down the yield curve (over 20 years in places like Denmark) there are now over $13 trn of bonds with negative yields.

And now after a short-lived period of robust growth has given way to weaker data and fading inflation expectations, the ECB has signalled further monetary easing ..... very probably both in the form of cutting rates further below zero and a resumption of Quantitative Easing (QE), the bond-purchasing programme that drives bond yields lower. This was NOT part of the plan, even a matter of months ago.

It's not as though the massive combined brainpower of the ECB decision-makers are unaware of the downsides of ultra-low and negative rates, but they take the view that the risks of further easing are outweighed by the risks of doing nothing. Nevertheless, just for good order's sake we 'll remind ourselves of a few of those downsides :

  • It weakens the profitability of banks essential to recovery, and is the last thing the banking system in Europe needs

  • It punishes savers .... which is why it is so unpopular in parts of the Eurozone that consider themselves financially "responsible" (e.g. Germany)

  • It keeps dying companies on "life-support"

  • It fuels surges in corporate debt

  • It fuels surges in asset prices, with both stock and bond markets in particular breaking records simultaneously

These last two factors may prove to be the most important, and the most dramatic. "Glass half empty" types are quick to warn of over-leverage and asset bubbles reaching bursting-point. Of course some of them said that when things were a lot cheaper, but it's a reasonable point of view to state that these days central bank monetary policy seems to have much less of an effect on growth and inflation than it does on driving markets and asset prices, which of course is the wrong way around.

There are other complications .... monetary easing, even when undertaken with the best of intentions, generally weakens one's currency and that's a particularly sore bone of contention for a White House that rightly or wrongly (okay ... wrongly) sees widespread currency manipulation at the expense of the USA. And "carry" trades which sell low-interest rate currencies to buy other, higher yielding alternatives can cause bubbles in emerging market currencies that are extremely vulnerable once things turn volatile.

To be fair, the central banks know that monetary policy on its own does not cut the mustard but more rate cuts and QE by the ECB for example does open them up to slightly lazy applications of Einstein's definition of insanity (you know the one ... doing the same thing over and over again and expecting different results). Thus the ECB and others are calling for significant fiscal stimulus to go alongside their own monetary policy moves. After all, one great upside of ultra-low yields is that it would cost any government next to nothing to borrow money to invest in infrastructure etc.

Trouble is , we're now on political ground. Germany, whose super-powerful manufacturing and exporting base is under such pressure at the moment, would benefit enormously from a big dose of infrastructure spending but both at state and national level the authorities are obliged to run a budget surplus by the constitution. We can see how such legislation came to pass in such a fiscally prudent nation post-financial crisis, but to maintain the status quo in these circumstances ? Well, some might call that madness of a sort.

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