By Paul Singer at Elliot Management
Central bankers think they are the masters of the universe because the world is looking to them (and only them) to deliver continuous stability and prosperity. There is no reason to suppose that they understand the modern financial system and economy to any greater extent than they did in 2007 (that is to say, not at all). Nevertheless, they plow ahead, expressing total confidence that what they are saying and doing is wise and not dangerous drivel. These master chefs have but one vat next to them on the policy table, and it is labeled “QE.”
They seem to think that all they need to do is dip into this vat, ladle on some QE, and asset prices will rise, the economy can be supported, jobs can be created and growth can be achieved. With no side effects, no indigestion, and no other factor would make them put the vat away and demand other ingredients. The new Chairwoman of the Fed, moreover, has made clear that as far as she is concerned, ZIRP is perfectly fine despite the stock market and high-end real estate booms, and that it will last, maybe not forever, but for a long period of time. The U.S. economy is growing, unemployment (at least the way they report it) is 6.1%, but the right interest rate for Chairwoman Yellen remains zero.
The central bankers of the developed world (with the possible exception of Germany’s) have failed to tell their political leaders that QE and ZIRP are creating great risks and uncertainties for the future. None of them has actually called a halt to monetary extremism in combination with demanding policies, or set out any policy recommendations that their governments should pursue in order to create real sustainable economic growth. Even the exquisitely named and effectuated “tapering” in the U.S. is months away from actually suspending the printing of money, and the Fed promises to preserve interest rates near zero for an extended period. In Europe, short-term interest rates are currently declining (to below zero in some cases) because of a new promise to keep interest rates lower for longer, and a new scheme for the central bank to purchase all kinds of securities.
All of the major central bankers profess a dread and imminent fear of deflation. In reality, the only places where such concerns are legitimate are in the lower-performing countries of the euro bloc that are prevented from devaluing their currency and are being forced to lower wages in order to correct imbalances. Everywhere else, the present and future prospects for deflation are virtually nonexistent, given the authorities’ misguided determination to boost inflation to levels higher than are currently purported to exist.
We can state with a great deal of confidence (although it is a minority view) that neither we nor the central bankers who are orchestrating these policies on the world have any idea how this situation is going to end, despite their assurances to the contrary. We believe that global monetary policy is currently extremely dangerous, that the financial system continues to be opaque and overleveraged, that major financial institutions are still essentially dependent on government guarantees to protect them if there is a renewed financial crisis, and that an abrupt shake-up could occur at any time.
Since confidence in paper money, central bankers and political leaders is unjustifiable and out of line with reality, the loss of such confidence could conceivably occur at any time, leading to the next “run” on the global financial system. We believe that those great sages who think that countries in the developed world have decades to get their financial systems and entitlement programs in order are delusional. In reality, only the markets can determine when time has expired – not the politicians or pundits and certainly not the central bankers.
Signals between QE, consumer prices, asset prices, bond prices, stock prices and growth are completely awry because governments are pulling the strings to a degree never before seen in free enterprise systems. It is unlikely that these unprecedented and experimental government policies of such gargantuan scope will actually create the desired result and allow themselves to be able to be unwound without great shock and disruption to the global financial system.
We recently perused the annual report of the BIS (Bank for International Settlements). We were impressed by its cool-headed assessment of the risks of current governmental policy in the developed world. In the introduction to the report, the BIS said:
To return to sustainable and balanced growth, policies need to go beyond their traditional focus on the business cycle and take a longer-term perspective – one in which the financial cycle takes centre stage…They need to address head-on the structural deficiencies and resource misallocations masked by strong financial booms and revealed only in the subsequent busts. The only source of lasting prosperity is a stronger supply side. It is essential to move away from debt as the main engine of growth.
The report noted that an intense quest for yield is driving down volatility and interest rates regardless of credit quality. The BIS said that the report is a “call to action,” and that governments should do more to improve the safety and performance of their economies, labor practices, and banks, which should raise more capital as a cushion against losses. The report also said that rising debt levels in many countries increase the potential for trouble, but the report said that the risk of deflation is less than many think. The overall message is that the world is hooked on easy money and has forgotten the lessons of the financial crisis. The report said that “[T]he temptation to postpone adjustment can prove irresistible, especially when times are good and financial booms sprinkle the fairy dust of illusory riches. The consequence is a growth model that relies too much on debt, both private and public, and which over time sows the seeds of its own demise.”
We have been saying as much for some time now, but here is a prestigious international institution that is “telling it like it is” in a compelling and persuasive way. Naturally, we became curious about this institution and its members. Who are these insightful people? We were astounded to learn that the board of the BIS is comprised of none other than... the heads of the major central banks of the developed world! Yes – Yellen, Draghi, et al! So, these central bankers are simultaneously failing to tell their respective governments that (1) monetary policy has done enough; (2) monetary policy is causing massive risks and distortions; and (3) political leaders must grab the reins and make structural changes, these same central bankers are authorizing BIS reports that will enable them to say, after the coming multifactor crisis, that they told us about the risks. We wonder who from the Fed authorized the report, and why they haven’t shared these harsh views of Fed policy in the FOMC meeting minutes or the endless public speeches by Fed officials. It is duplicitous for the Fed to authorize the views in the BIS report yet keep quiet about them elsewhere. But then, the Fed has never accepted much responsibility for the 2008 crisis, despite its decisions to keep interest rates artificially low for an extended period of time, to do a poor job of regulating the banking system and to abet Fannie and Freddie in their utter irresponsibility. History rhymes. The Fed has created the fuel for another crisis, seems to know it judging by the BIS report, and yet is covering itself with an "I told you so" report from the BIS rather than changing course.
“More cowbell” is a reference to a Saturday Night Live comedy skit in which a celebrity music producer (played by Chris Walken) keeps telling the cowbell player (Will Ferrell) in a secondrate band to play louder in the hopes of creating a better sound. It did not work, but it was funny. “More QE cowbell” as the cure-all to what troubles the global economy is also not going to work. And it is not really funny.
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We continue watching with amazement the Fed’s magic act as it attempts to use quantitative easing and zero interest rate policy (QE and ZIRP) to create seemingly robust economic growth in the face of very poorly designed political, economic and fiscal policies, while keeping inflation within a narrow band. Substantial inflation is occurring in many asset classes and service sectors of the global economy, but is not presently recognized or captured by the traditional metrics upon which the Fed relies. This inflation is spreading in both scope and intensity. If and when it breaks out in an inescapably broad way, there will be a crowd of seriously confused policymakers making excuses and claiming that inflation does not in fact exist; it is not their fault; it was completely unpredictable; and/or it will actually be good for people.
We believe that if and when inflation goes from being something that affects only a particular list of assets (a growing list, presently a combination of things owned by the well-off plus a number of things that are basic necessities) to a widespread “in-your-face” phenomenon affecting the cost of living of almost the entire population, then the normal yardsticks of risk, return and profit may be thrown into the garbage can. These measures may be replaced by a scramble by citizens and investors to preserve value on a foundation of shifting sand, together with societal unrest that may make the current politically-useful “inequality” riffs, blaming the “1%” and attacking those “millionaires and billionaires” who refuse to “pay their fair share,” look like mere warm-ups for real class warfare.