Forward Guidance?

Nonsense! Central bankers have no choice.

by DETLEV SCHLICHTER

After two decades of serial bubble-blowing, the world’s central bankers have maneuvered themselves into a corner. They created a monster in the form of an unbalanced global economy and a bloated financial system, laden with debt, addicted to cheap money, and in need of constantly rising asset prices. Now the monster is in charge and the central bankers dare not stop feeding it.

The US Fed did, of course, make some noises to the effect that the flow of cheap money may at some point slow and then even stop. How credible these projections really are is far from certain. Markets seem to take them quite seriously indeed, but the more they sell off in response – and in particular, the more yields and risk premiums rise – the more difficult it will be for the Fed to follow through. – And by the way, if the jobless rate does fall to 6.7 percent, or to whatever magic number Ben Bernanke, in his unlimited wisdom, has ascertained as being safe for a policy ‘exit’, and if he then indeed does withdraw the punchbowl– will the unemployment rate then rise again? – We may have to deal with that question some other time. The focus today is the ECB and the Bank of England.

Policy paralysis is the new strategy

Both central banks had their monthly policy meetings yesterday and did – nothing. Although, when you read the papers you get the impression they did quite a lot. They seem to have unveiled some powerful new policy tool: forward guidance.

Both stated that they were committed to leaving policy rates at ultra-low levels for very long indeed. The ECB added that it might even lower rates further. The Bank of England additionally chided the UK bond market for paying too much attention to what Bernanke says, and for evidently not supporting the national recovery effort enough. This was, of course, an attempt by both central banks to distance themselves from the Fed’s loose talk of potentially turning off the monetary spigot. There is nothing surprising about this. Both central banks are standing with the back to the wall.

Let’s face the facts: Years of relentless monetary doping have not solved anything – neither economy is anywhere near the self-sustaining recovery that Keynesian and Monetarist interventionists have promised us we would get in turn for all these monetary manipulations. For years, these central banks have been stubbornly sticking to the same game plan: inject unlimited new bank reserves into the banks and keep buying (or funding) bank asset so that the banks don’t fall over, and the credit house of cards doesn’t crumble, and the state and the banks can continue to fund themselves on the cheap. As the self-sustaining recovery remains elusive, they have no exit strategy. There is no way out.

Yesterday, the ECB and the Bank of England publicly admitted that they were boxed in and would remain so for the foreseeable future. They have no policy options, there is no (real) recovery, so they will keep rates super low, maybe even cut them again. Only in our bizarre modern world of relentless Orwellian Newspeak can this position of utter defeat be dressed up as the new policy program of ‘forward guidance’. To admit that you can’t move, to admit that your policy has not worked and is unlikely to work anytime soon – otherwise you would have to be ready for withdrawal of the stimulus, right? – is now presented as a skilful steering of market expectations and massaging of market psychology.

This was the first policy meeting under new Bank of England governor Mark Carney, the ‘most talented central banker of his generation’ to some, the most overpaid bureaucrat in the world to others. But credit where credit is due. Carney is a marketing genius. Not only when it comes to marketing himself, but also when it comes to selling policy paralysis as strategy. Never before has the phrase “What can we do? We can only stick to what we have done for years.”, so effectively been presented as at the BoE’s press conference yesterday. It is now called ‘guidance’, and it evidently requires a specific skill-set. The Wall Street Journal even described Mr. Carney as “one of the pioneers of guidance”, and I wonder if the chaps at the Journal kept a straight face.

Foreign Exchange markets and gold

The notion of policy divergence between the Fed and the other central banks has reawoken the foreign exchange markets. The dollar is rallying, and I think the speculator-community may try and run with this theme for a while. Divergence is naturally something that fx markets love but in this crisis it has never lived up to its expectations. Among the major nations, the similarities in terms of economic problems and in terms of policy responses are simply much greater than the differences. These countries are all pretty much in the same hole. This is a global crisis and I believe it is a global fiat money crisis. I cannot see that one of these paper monies is fundamentally better than the others. It is my view that any notion of divergence in economic performance and in policy will not last and market trends based on these notions will be short lived. I remain skeptical as to whether the Fed can really ‘exit’. (Again, the Fed SHOULD exit, in my view, as should the other central banks, but then again the Fed never shares my views.)

The idea of a Fed-exit is still a major problem for gold. I readily admit that I am baffled by what has happened here – and what is still happening. ‘Forward guidance’ from the Bank of England and the ECB has not helped gold, it has only strengthened the dollar versus pound and euro. The dollar is what matters. The dollar is the world’s leading fiat currency and gold its main opponent. It does not seem to matter much what the other paper money central banks do. As long as the notion of Fed-‘exit’ drives markets, and the threat of dollar-debasement seems to fade, gold continues to struggle. For obvious reasons, I do not believe this will last and I remain a gold bull. There could, however, be more pain in store first.

In the meantime, the debasement of paper money continues.