Albert Einstein defined insanity as doing the same thing repeatedly and expecting different outcomes. The crazy gang at the Federal Reserve should heed those words when debating how much more market manipulation to inflict on the world of fixed income.
The worrisome thing about so-called quantitative easing -- a concept still novel enough to mean whatever the Humpty-Dumptys in central banking want it to -- is that its consequences remain unquantifiable, and the perceived need for more central-bank purchases of securities should make investors uneasy.
Fed Chairman Ben Bernanke said in an Oct. 15 speech that it’s difficult to work out the “appropriate quantity and pace of purchases and to communicate this policy response to the public.” He also said that “nonconventional policies have costs and limitations that must be taken into account in judging whether and how aggressively they should be used.”
Imagine a surgeon telling her patient she wasn’t sure what size scalpel she’d be using or what the likely outcome of the procedure might be. Or an architect admitting to a planning committee that he wasn’t confident about his stress calculations or the durability of the newfangled materials he was using.
“Nobody understands QE,” says Fred Goodwin, a strategist at Nomura International in London. “We have no idea how inflationary it really is. A patient juiced up on QE wants to party and it does not matter what anyone says. Don’t worry about what central banks are worried about; worry about unintended consequences.”
Fed skeptic Thomas Hoenig of the U.S. central bank’s Kansas City branch called it “a very dangerous gamble” in a speech this week. “We risk the next crisis four or five years from now.” Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co., said the bond-buying program “will have costs and unintended consequences.”
The Fed’s role as buyer of first resort has completely distorted the government-bond market. An innocuous report in the Wall Street Journal yesterday said the Fed would avoid the “shock and awe” tactic used in the initial $2 trillion buying spree and limit itself to “a few hundred billion dollars.” This managed to drive the 10-year Treasury yield up by 10 basis points to a five-week high of 2.7 percent.
Bernanke at the Fed, Jean-Claude Trichet at the European Central Bank and Mervyn King at the Bank of England are more powerful than any of their predecessors, given how much reliance their political masters are placing on their stewardship of the economy. Leaving the fortunes of the nation in the hands of unelected central banks, though, strikes me as an abdication of responsibility by government.
Buck Stops Where?
U.K. Chancellor of the Exchequer George Osborne was asked on Oct. 21 if he had a plan to fall back on if the government’s attempts to reduce the budget deficit to 2 percent of economic output by 2015, from more than 10 percent now, smothers the economic recovery.
“There is, of course, the freedom for the Bank of England to deploy monetary-policy tools,” was his complacent, the-buck-stops-over-there-somewhere reply.
Central bankers tend to be academics, and academia’s usefulness in solving real-world problems is limited at best; Bernanke’s theoretical work, made famous in the November 2002 speech “Deflation: Making Sure ‘It’ Doesn’t Happen Here” that led to him being dubbed “Helicopter Ben,” is butting heads with harsh reality, and coming off second-best in the contest.
Former Bank of England policy maker and Bloomberg columnist David Blanchflower calls QE “the only show in town,” and it’s possible that the outlook would look much worse if we hadn’t had any bond purchases. While repeatedly rolling out the crash cart, screaming “clear!” and slapping on the electric paddles didn’t manage to stir the comatose patient, maybe death was averted.
A contrary suggestion might posit that central banks are now one-trick ponies, stuck in a financial groundhog day with no fresh ideas. Their willingness to sacrifice their principles not only undermines their hard-won independence, it also allows their political masters to avoid the hard work of structural reform that might generate a genuine recovery. Instead, we are relying on transfusions of artificial central-bank liquidity.
The guardians of the world economy still seem to think the answer to too much debt is yet more debt. Imagine the response, though, if you had asked any of the current crop of central bankers five years ago about the inflationary consequences of pumping trillions of dollars into the financial system.
Nomura’s Goodwin says there is no reason why the U.S. inflation rate couldn’t surge to 6 percent by 2015 from its current 1.1 percent pace. Lending to the U.S. government by buying its 1.25 percent note repayable in September 2015 at its current yield of about 1.3 percent might not be the smartest trade a bond manager could make.
When the law of unintended consequences kicks in, the nasty surprise is, almost by definition, unforeseen and unpredictable. I struggle to see how this movie won’t end badly.
(Mark Gilbert, author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable,” is the London bureau chief and a columnist for Bloomberg News. The opinions expressed are his own.)
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