30 August 2016

Jackson ‘Black’ Hole?


Central Bankers’ traditional end-of-Summer hideaway in Jackson Hole, Wyoming may be especially monumental this year. Whatever the nuances about US interest rates read into to Fed Chairman Janet Yellen’s headline speech, they are not the big takeaways. Rather the two messages coming from the Teton summit will be that low (and negative) interest rates have not worked and, more importantly, fiscal austerity is dead. Japan now looks to be the first developed economy to use ‘helicopter money’ (that is printing banknotes to fund fiscal spending) as a policy to end deflation. China already appears to be doing this. In Britain, the new Cabinet is similarly thinking about spending more on infrastructure, and both US Presidential candidates have come down firmly on the side of bigger fiscal deficits, should they win. Rather than ‘too much money’ being the problem, we have always believed that active Governments create price inflation. In contrast, active private sectors create price deflation, through boosting productivity and continually squeezing costs. It is fiscal and not monetary largesse that drives inflation. Austerity policies were, therefore, never going to work.

Looked at the other way, why have over five years of easy money policies failed to stir high street prices? There are three reasons: First, these associated austerity policies kept a lid on fiscal deficits. Second, Central Bank QE (quantitative easing) policies in many cases just substituted government bonds for government banknotes. This largely reduced the maturity, but often the effective size of overall public debt. Third, lower interest rates across the spectrum pushed more-and-more investors into scarcer government debt as they scrambled from the last few drops of yield. Money became hoarded in the financial sector and, consequently, not spent in the real economy. But differently, monetary velocity collapsed.

Looking ahead, these deflationary forces now look set to unwind. Yellen may or may not tease us with another American interest rate rise, but this is not the real message from Jackson Hole. Frustrated by their lack of success, but blasé in their false belief that they can control inflation, now policy-makers look set to take ever greater risks. Inflation may not be around the corner, but from high up in the Teton mountains you can see it on the horizon.

Michael Howell is managing director of Cross Border Capital