Central Banks Go from Saviours to Saboteurs

Central Banks Go from Saviours to Saboteurs

‘From historic opportunity to historic cock-up’, is how The Australian described it. But that was back in April — a lifetime ago when it comes to cataloguing the nincompoopery unleashed by central bankers worldwide. We’ve moved on since then. From historic cock-up to complete monetary mayhem.

The historic opportunity referred to was the government and central bank’s attempt to get unemployment below 4% by keeping interest rates ridiculously low. But inflation rose above 5% instead — the cockup.

Funnily enough, that means we’re right back to where we started on inflation targeting, as The Australian also pointed out:

Take out the distortions associated with the introduction of the goods and services tax at the start of the century, and the 5.1 per cent jump in headline inflation over the year to March is the highest since the mid-1990s, not long after the RBA adopted its 2-3 per cent inflation mandate.

Since the ‘90s, the Australian inflation rate has only remained between 2% and 3% while on its way much lower or higher. The central bank has been behind that almost every time.

But this time, it’s much worse, with an economic slowdown and inflation on the cards at the same time.

Over at the Australian Financial Review, they’re already focusing on the first round of mea culpas, even if it’s the Australian mortgage borrowers who’ll get flagellated by the RBA:

Reserve Bank of Australia governor Philip Lowe has admitted the central bank’s pandemic guidance that interest rates would not rise until at least 2024 was an “embarrassing” error and it “should have done better”.

Who pays for this error? Not Philip…

But he has got someone to blame, of course:

You’re faced with a global pandemic.

We were being told that it would take many, many years for vaccines to be developed, that people could be locked down for a long period of time.

That tens of thousands of Australians will die in the pandemic and that our hospitals would be full.

That we would have double-digit unemployment, perhaps 15 per cent.

That there would be deep scarring for years, perhaps decades.

That was the situation we were making decisions [on] in 2020.

It always amazes me when different arms of the government believe each other’s projections. They really should know better.

Anyway, after a decade of predicting a return to 2% inflation, but failing to deliver, central bankers around the world panicked about the prospect of deflation because of the pandemic, and promptly got run over by 10% inflation instead…

While the RBA is embarrassed by this, the Federal Reserve is busy slaying the beast, as the Financial Times describes in graphic detail: ‘Fed reaches for its “hatchet” to attack galloping inflation’.

Yes, a full 0.5% rate hike to 1% is a swinging hatchet for inflation…which is 8.3% in the US…

I’m sure inflation is petrified.

In my view, the Fed should be as embarrassed as the RBA about this piddling increase.

The UK’s Telegraph has been busy criticising the Bank of England. Its version of The Australian’s ‘historic cock-up’ article starts like this:

Bank of England repeatedly failed to spot the glaring signs of an inflation crisis

Threadneedle Street has kept its head in the sand, deriding those of us who warned serious price pressures were coming.

Having pulled their heads out of the sand and looked around at the consequences of their inactions, the Bank of England is busy burrowing again. Back to that in a moment.

Even the Bank of England’s own former chief economist piled on the criticism of their past mismanagement.

Having dissented from the eventual decision not to raise rates, Anthony Haldane is now twisting the knife:

Acting early would have saved the need for quite the degree of tightening that might now be needed to keep the lid on inflation.

And ‘I’m really the wrong person to ask about why they got it wrong’, because he got it right.

But the harshest criticism of central banks didn’t come from the media. It came from within the halls of power — from the very top, in fact.

I think we are not paying sufficient attention to the law of unintended consequences. We take decisions with an objective in mind and rarely think through what may happen that is not our objective. And then we wrestle with the impact of it.

Take any decision that is a massive decision, like the decision that we need to spend to support the economy. At that time, we did recognize that maybe too much money in circulation and too few goods, but didn’t really quite think through the consequence in a way that upfront would have informed better what we do.

We act sometimes like eight years old playing soccer. Here is the ball, we are all at the ball. And we don’t cover the rest of the field.

Impressive stuff. I wish I’d written those words. But they came from Kristalina Georgieva, director of the board of the International Monetary Fund.

Funnily enough, the criticism was directly aimed at the person sitting next to her — the former head of the IMF and the current head of the European Central Bank.

Having immolated Greece while part of the troika, Christine Lagarde is now imposing 10% inflation.

But let’s not make this personal for the lady who was criminally convicted of financial negligence for her time as French finance minister. Actually, let’s. Because she’s in charge of the worst of the lot, the European Central Bank, which still hasn’t raised interest rates!

Inflation in the Netherlands? Almost 10%.

In Greece? 10.2%.

In Germany? 7.8%.

The ECB’s mandate? Less than 2%.

ECB monetary policy? Continued quantitative easing and their first-rate hike is only present in the German board members’ imagination.

Things are so bad at the ECB that its own staff are revolting over the combination of inflation and a lack of pay hikes!

This isn’t a historic cockup, my fellow investors. It’s a complete f**k up.

After a decade of predicting inflation would return to 2% but failing to deliver, central banks panicked about deflation because of the pandemic, didn’t see the inflation coming instead, and didn’t do anything about it until it overshot their mandates by multiples (some still haven’t done anything). Now, as we’ll dig into below, they’re forecasting both a recession and inflation — the worst of both worlds.

Even I’m impressed.

Back to Australia specifically for a moment, because the persistently excellent MacroBusiness blog has an additional interesting insight.

Not only did the RBA capitulate on its 2024 interest rate promise, it also defaulted on promises to wage earners.

You see, the RBA, rather than focusing solely on inflation, added a bundle of implicit mandates to its list of considerations. Namely, the RBA made it clear that they wouldn’t raise interest rates until longer-term inflation hit the RBA’s target of 2–3%, and wages were growing 3% too.

This is the big mistake because it presumes relationships between these variables. Namely that inflation couldn’t surge past 5% with wage inflation still in the doldrums.

The Germans understand this mistake very well, having done a better job of making it than just about anyone 100 years ago. That’s why they insisted the German and European Central Bank only have one mandate — inflation.

The rest of Europe, however, has spent the last few decades watering this mandate down faster than the American’s have diluted their constitution.

Back to the RBA again. Having stated it wouldn’t raise rates until 2024 until inflation was sustainably back in the 2–3% range, and until wages were growing at 3%, the RBA promptly raised rates when it got none of the above.

No wonder they’re embarrassed!

But it’s all about to get a lot worse. Because you can add causing a recession into mix.

As part of his hatchet of an interest rate increase, Fed Chair Jerome Powell declared there would be ‘some pain’ and ‘hardship’ for the US economy, but it wouldn’t lead to a recession. Well, the US economy already shrunk 1.4% annualised in the first quarter of 2022, before the hatchet rate hike, so how is a recession even avoidable?

Over in the UK, the Bank of England is being a bit more honest about the recession risks, but that hasn’t stopped them from continuing to raise rates. The UK’s Telegraph sums up the dire situation:

The Bank of England’s decision to hike interest rates to 1pc came alongside the bleakest economic outlook since it gained independence in 1997. Only its outlook in November 2008, as the world was grappling with financial meltdown, competes with its predictions this week.

Yikes.

But wait a minute. They’re hiking interest rates with a GDP outlook, which has only been worse once — in 2008?

Double yikes.

Imagine being a central banker and raising interest rates to induce a recession deliberately while claiming otherwise. You look malicious, incompetent, and clueless, all in one fell swoop. This makes embarrassing look good. No wonder the Europeans are sitting on their hands while the euro burns.

But here’s the real shocker. The central banks aren’t even expecting inflation to plummet back to their target as a result of their incredibly brave recession-inducing monetary tightening. For example, the Bank of England expects it to increase to more than 10%!

Given the choice between a cost-of-living crisis and a recession, central banks are endeavouring to secure both by raising interest rates enough to trigger a recession, but not enough to bring inflation down.

They haven’t made this mistake since the ‘70s when we called it stagflation.

It’s remarkable to me that central banks are actually forecasting inflation to remain far above GDP growth despite also including their policy into that projection. I mean planning to fail may be a plan, but you’ll still fail.

Stagflation was supposed to be a historical anomaly. Now it’s the base case and thereby what central banks are trying to achieve.

Of course, this shouldn’t come as a surprise. Everything else that governments do is a complete debacle. Why would monetary policy be any different?

If we charge a central bank with keeping inflation between 2% and 3%, what should we expect but inflation below and above that band?

It’s not like we trust governments with providing passports, housing policy, or imposing pandemic lockdowns, and those parts of our society are functioning perfectly…

Until next time,

Nick Hubble Signature

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend