What if central bankers haven’t got the foggiest idea what they’re doing? They clearly dominate financial markets right now. And have been doing so for years. Investors continue to cling on to their every word, like drug addicts in a cult.
But what if central bankers themselves are completely making it up as they go along? Or if they’ve completely misunderstood how the economy, monetary policy and inflation actually work?
The question may seem perfectly reasonable to you these days. After all, central bankers clearly haven’t got much right over the past two years.
But I bet you’re not expecting a clear-cut answer to the question. Economics is so vague that it’s hard to comprehensively prove that someone is an idiot or an over-confident idiot (or, indeed, a genius who has yet to be proven right). And yet, we may at last have some pretty good evidence…
Strangely enough, it comes from a place where central bank bungling has been far rarer than in many other countries. Australia’s economy weathered the global financial crisis very well, and didn’t even have a recession in 2008-2009. The housing bubble there inflated, but not to the point where a bursting was inevitable… and inflation hasn’t cracked 8% in 2022, let alone double digits like the UK.
But today, the Australians are as furious with their monetary overlords as the rest of the world should be.
That’s because the governor of the Reserve Bank of Australia (RBA), Dr. Philip Lowe, (who may have been chosen primarily for his surname), repeatedly promised that that central bank would keep interest rates at levels that were absurdly… low until 2024.
Many Australians went on a mortgage binge like never before based on the promise that their repayments wouldn’t rise until 2024.
Unfortunately for these Australians, the RBA increased its official cash rate – which affects mortgage rates and many other interest rates – seven times in about as many months. The rises began on 4 May this year, with a 0.25% rise from 0.10% to 0.35%. Most recently, on 2 November, the cash rate was lifted by 0.25% to 2.85%.
In short, a long period in which the cash rate was low (and was promised to stay low) was followed by a brutal increase of 2.75% or, if you prefer, 275 basis points.
The interesting bit is that the RBA governor has apologised…
I’m sorry that people listened to what we said and then acted on that and now find themselves in a position they don’t want to be in.
Looking back, we would have chosen different language. People did not hear the caveats. I thought it was clear… but the community didn’t think it was clear. Well, they thought it was clear we weren’t raising rates until 2024. That’s a failure on our part.
The, “You shouldn’t have listened to me,” is a new excuse which neither of my daughters have had the shamelessness to try yet…
Of course, I personally blame Australians’ faith in the central bank in the first place. It’s not as if central planning works in any other context either. We wouldn’t stomach having politicians control watermelon, steel or electricity prices, would we? And we’d be able to clearly articulate why. They’d muck it up somehow, causing chaos.
But, for some reason, we believe that price fixers at central banks should set the interest rate. It beats me why…
However, it’s not the promise from Dr Lowe in relation to the trajectory of rates to 2024 that UK investors should be paying attention to.
Nor is it the apology. It’s this bit of the now infamous promise to Australians, with the crucial bit in bold:
“The [RBA] Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently.”
Now that inflation is more than triple the 2% target in Australia, we can examine whether it was wage growth that triggered inflation.
The answer is… no: Australian wage growth remained very low, even as inflation has spiked.
In other words, not only was the RBA wrong to promise interest rates would remain low until 2024 in the first place. It was wrong about when inflation would occur, and how much. It was also wrong about how and why inflation could occur at all.
This is a bit of a problem given that the RBA’s long (and rather vague) mission statement includes the management of inflation. The central bank appears not to know what causes it! Which is ironic because the Board would only have to look in the mirror…
Now, you might think that the people at the top of the RBA would take a breath, reconsider their assumptions and models, resign ignominiously (without pensions, or with inflation-unadjusted pensions), and shut down (or radically change) that institution. That’s what’d happen in the private sector, after all.
But that’s not how public institutions work. The worse things get because of their policies, the more there is for them to do. In this case, the more inflation they cause, the more they need to fight it. It’s a bit like the modern pharmaceutical industry, in that sense.
So, the RBA lured Australians into debt with promises that those borrowings would remain cheap until their wages went up, which wouldn’t be before 2024. Now we have inflation thanks to RBA policy, expensive debt thanks to RBA interest rate increases, and lagging wage growth relative to both. Meanwhile, the RBA’s attack on inflation consists of… keeping wages low!
To be clear, wages didn’t go up with inflation. And now the RBA wants to keep them low to fight inflation!
And by low, I don’t even mean keeping up with the inflation the RBA caused. Here’s how the governor put it: “If we all buy into the idea that wages have to go up to compensate people for inflation it will be painful, so best avoid that.”
In other words, real wages (wages adjusted for inflation) need to decline… to avoid pain…? I’m calling it the “Lowe wages policy” of the RBA. And it is outrageous.
When he says that it would be “painful” for people’s wages to keep up with inflation, I can only presume the governor is talking about his own painful embarrassment. Because I’m pretty sure wages that are going up by less than inflation is what is quite painful for the rest of us…
Of course, this fear of a wage-price spiral is what central bankers around the world now fear first and foremost. That is despite the fact that, once again, it has been disproven.
And so the governor of Australia’s central bank should take heart. He’s not the only central banker exposed as being clueless lately. None of them have the slightest idea of what causes inflation.
My favourite example, from the European Central Bank president, Christine Lagarde, is the quote that inflation “pretty much came about from nowhere”. This after expanding the ECB’s balance sheet by about US$5 trillion, almost doubling it, during the pandemic…
I’m not entirely sure, but she may have used the same “the money pretty much came out of nowhere” defence when she was criminally convicted for financial negligence during her time as French finance minister. She’d moved on to heading the International Monetary Fund by then of course. In that capacity she immolated Greece. The IMF has since apologised…
Over at the Bank of England, the chief economist admitted that the Bank of England’s monetary policy may have contributed to inflation. Yes, “may”.
But, as with the RBA’s wages mistake, mismanagement may be one thing. As is negligence. But being in the wrong ballpark completely is another. Which is why these headlines from Bloomberg about central banks’ flagship policy are especially fascinating:
Did the Fed Make a Fourteen-Year-Long Mistake?
Quantitative easing may not have been worth all the trouble it caused.
And the answer in another article:
It’s Now Clear That QE Was a Colossal Policy Mistake
There’s no convincing evidence that central banks’ purchases of trillions of dollars of bonds and other financial assets helped any economy.
Once again, gosh.
My point today is that the cult of central banks may still be dominating financial market performance. But the emperor clearly has no clothes. Their regular meetings, hosted by the US Federal Reserve at Jackson Hole, supposedly to discuss monetary policy, are nothing more than an imperial nudist colony. And now everybody knows it.
The question is what you should do about it. How can investors invest when the edifice making markets look investable (monetary policy) is looking like a cardboard cut-out with a very ugly reality lurking behind it.
The answer is to focus on the part of the market least dependent on “macro” issues like monetary policy. Instead, consider the fate of small individual companies that are looking to upend the economy, whether the central bankers muck it up or not.
Editor, Fortune & Freedom