Former Bundesbank Chief Axel Weber challenges FED & ECB – with best monetary analysis since 2008
By Christian Takushi MA UZH, 11 June 2015, Switzerland.
I believe that the former chief of the German Bundesbank (BuBa or German Central Bank) has put forward probably the best analysis any global leader has yet delivered on the “Global Crisis of Central Bank Policy” we currently face.
Mr Axel Weber, who reportedly quit his job out of protest against the huge bond-buying plans by the ECB, is back to the monetary policy debate. With a world facing a growing convergence of manifold challenges, Mr. Weber’s view is well received among independent economists and comes at a time the IMF has started a public debate on FED policies. Just within one week we have seen Mrs. Christine Lagarde (IMF) and Mr. Axel Weber (UBS) making public remarks critical of central bank policies.
Although I have to admit that my support for Mr. Weber’s analysis is somehow predicated by my own Classical Monetarist training, my overall support for his analysis goes beyond the “Monetarism vs Keynesianism” school-of-thought discussion. There is a sound balance of monetary theory and openness to new realities in Mr. Weber’s analysis. Which is refreshing. At this juncture all economists should be open to criticism, new perspectives and more holistic approaches. If we stick to consensus, we will fail to add value to society.
I just wrote a comment last Saturday supporting Mrs Christine Lagarde for opening a public discussion on the FED’s interest rate normalization. But this analysis of Mr. Weber is among the best I have seen in “monetary-policy terms” since the year 2008. He wisely avoids saying exactly what we should do, but he does give a clear direction that is sensible and that takes into account the dramatic failure of current monetary policy and the huge systemic and ethical risks it has introduced.
Historical background to why Mr. Weber’s analysis should be heeded
Those acquainted with my theoretical position on post-modern monetary policy know I developed it from going through the tough experiences of the Japanese crises from 1989 to 2003 and the Japanese Liquidity Trap. First as economist, then as a fund manager. From meeting leading economists, officials, corporate executives, workers and engineers over all those years I realized the treatment could not succeed, because the diagnosis was wrong. Although Japan’s labor force was in straight decline since 1998, the shrinking of the economy was attributed squarely at policy failure to print excessive money. Why would a mature economy like Japan (median age 46) try to grow as a younger economy like the USA (median age 36)? When asked why Japan’s policy makers were so incapable, I answered it is a mix of policy errors and unavoidable demographic realities, but mainly a failure to adapt monetary policy to the realities of an old and shrinking population. Furthermore I warned Japan’s lost decade is a good example of what lies before Europe. You can imagine how other economists and investors reacted to my remarks during the late 1990’s and early 2000’s, Europe was booming and they thought I was too cautious.
Old people can live happily in a shrinking economy, but if policy makers set unrealistic targets of 2-3% growth, a whole nation can be in collective depression and that in itself keep the economy in a negative spiral, forcing policy makers to introduce ever more unorthodox measures. Europe in 2015: Instead of adjusting policies to our new realities and shrinking labor forces, our policy makers are desperately trying to import more foreigners and depreciating the EURO to export more. We should export more if we have new technologies that meet peoples’ needs, not because we can sell more at the expense of somebody else – thanks to currency “dumping”. Both strategies are not just short-sighted and unsustainable, they have long term political, geopolitical and economic costs & implications that policy makers seem blinded to. It is feeding national fervor and even nationalism, the very thing that could destroy Brussel’s dream of a Federal European Union.
Making your currency cheaper might be a short term boost to this year’s GDP, shareholders and corporate bosses’ pay, but they are like a curse for your economy long term. A weaker currency removes a powerful driver of competitiveness and improvement. A strong currency is painful but a macroeconomic blessing, because it drives innovation and technological improvement. Only outright war can top that. Look at Singapore or Switzerland – their currencies have been strengthening for decades, making the surviving industries stronger and flexible. The short-sighted policies we see in the G7 and OECD realms are not just a zero-sum game, they are worse than that. Because of the gigantic side-effects.
For 2 decades policy makers do the same – ever more aggressively, but expecting different results
After all the view attributed to Mr. Bernanke “I got Japan figured out, trust the FED” propagated an almost condescending attitude of superiority in the USA and Europe over Japan and rising Emerging Economies. Japan’s Crisis and stagnation was simply a policy error – they weren’t aggressive enough”. Nothing we should be worried about.
Japan doesn’t bode well for Europe: During 15 years I urged Japanese economists to re-think their policies, aim at Nominal GDP per capita and avoid trying to engineer artificial inflation. They said, “Mr. Takushi, you’ve got a point, but this is the global consensus among the most famous economists and leaders”. I ask, how well has this consensus served Japan or Europe? And why are they still doing it with ever more aggressive tools? A leading U.S. bible teacher, Mr. Andrew Wommack, has said that “a definition of insanity is to keep doing the same again and again and yet expect different results”. It may sound funny, but it kind of hits the nail on the head. I think FED, ECB and BOJ policy makers are leaning on well-elaborated theories, but they need to realize that a growing number of independent economists, business leaders and citizens are seeing their unyielding closed-ranks behavior with concern and would appreciate a broader discussion on current monetary policy. Policy makers’ behavior is eroding trust in the Central Bank System. That is highly dangerous, because our paper money has no gold-backing since 1974 and is now also debased, thus its value hinges merely on a tenuous “trust”.
A decade later the US and Europe are in a Liquidity Trap of their own. Somehow even worse than Japan, because Japan never artificially supported asset prices to boost consumption and engineer a recovery. Western policy makers continue to overlook – in the case of Japan then, and Europe today – the powerful factor of demographics (the combination of a shrinking labor force with an aging population), the serious de-linking of the banking industry from the real economy and the Balance Sheet Recession. The latter well exposed by a leading economist, Mr. Richard Koo. A Balance Sheet Recession is a serious phenomenon: as individual companies react too late and simultaneously do the right thing by cutting excess debt, they bring distress and deflation to the broader economy. That herd-behavior is acutely widespread today: the smart move at the corporate level brings distress to the overall economy, reinforces deflation and deepens the Liquidity Trap. And of course this shock at the macro level will come back upon all individual firms, prompting them to do more cost cutting. Such a type of recession shows the big difference between business administration or business economics on the one hand and macro economics on the other hand. We need both for a balanced policy assessment.
Could FED, ECB and BOJ targets be out of date and misleading?
Mr. Weber rightly points at the risks of getting misleading signals by an obsession with CPI inflation by policy makers and investors. This chart shows policy makers thought they could print money recklessly as long as CPI prices would not rise. Actually they may only jump once the crisis has begun to unfold, as happened in 2007-2008.
As I wrote last June 2nd and June 9th: Policy Makers are aiming at out-dated targets: maximizing real GDP and aiming at 2% CPI inflation. These targets are rather optimal for younger economies with dynamic and growing labor forces – their bank balance sheets are growing organically at healthy rates in line with GDP. Western economies, especially Japan & Europe (but also China, South Korea, Thailand, Taiwan etc) are mature, somewhat saturated & fast aging demographies with shrinking labor forces.
As someone asked recently, how many more cell phones and gadgets can a saturated Japanese own? Such mature economies should aim at a broader set of targets. Beginning with Nominal GDP per capita, a broad set of inflation indices and qualitative targets. If there are 10% less people, shouldn’t GDP shrink somehow too? It is vital to stop throwing all our resources at unattainable and dangerous Inflation targets, totally obsessed with a CPI inflation of 2%, although inflation in other areas of the economy is rising beyond 3% p.a. According to politicians and central bankers for years now there is no inflation, rather deflation. Thus the cost of living should be falling or basically unchanged. Ask any housewife in the UK if the overall cost of living has remained practically the same or stable over the past ten years as official CPI statistics kind of suggest. Not at all; essential cost items doubled in the last decade. The fact is CPI baskets are helpful but highly political constructions. CPI is too narrow a target, just as Mr. Weber has rightly stated.
In a desperate effort to achieve an illusory 2% inflation despite natural (demographics), internal (new technologies etc) and external forces (Asian economies exporting deflation to us), central banks are printing gigantic sums of paper money, not only failing to achieve sustainable growth and inflation but ..
– keeping governments from really having to address big structural issues: the excessive liquidity pushes up financial assets which in turn support consumption (GDP) via a wealth-effect. We have thus still a government-sanctioned excess consumption.
– debasing our Paper Currencies beyond remedy, thus rendering the inherent value of the money in our wallets close to zero and our Global Monetary System highly vulnerable to any shocks. Making a Global Currency Reform a necessity soon or later.
– Incentivizing firms to borrow money to speculate and buy back their shares in order to prop up the value of their shares (and corporate executives’ bonuses), with the result that few firms have any incentive to really invest and hire people, they are busy with financial engineering and profit enhancements. Central banks once incentivized banks to behave like that, now they incentivize all types of firms to play with money to create nominal wealth for so-called shareholders. Because of that, shareholder value is no longer a respected term, but a by-word for government-sanctioned enrichment at the expense of other stake holders. And those with access to newly printed High-Powered Money have almost printed money at no risk (FED-aided) since 2009. Policy makers are the biggest source of moral hazards in the global economy.
– Finally, zero interest rates send a very dangerous signal to all agents in an economy: a sign of maximum distress and emergency level. Why should consumers and producers really spend and invest as long as central banks tell them the whole system is at maximum risk? It only opens the door to people wondering why our governments would like to keep our economies in a constant state of crisis. It has indeed opened the door to unhealthy conspiracy theories.
It is thus for macroeconomic, political and ethical reasons that the extreme “zero rate” policy of the FED has to come to an end. We need to begin normalizing rates before the current business cycle enters into its down-leg or a recession. To enter a recession without being able to cut interest rates is like landing on a beach head without any ammunition.
Implications for investors: (only for professional investors and decision makers)
Latest events support our Global Outlook and Strategy, but the constructive tone to take corrective measures also increases the likelihood of our 2nd scenario
I’m convinced that these public figures are (1) already beginning to distance themselves from the policy consensus ahead of a difficult period in order to benefit from the shake-up that is coming. But looking at the constructive tone, they (2) might be doing this also to proactively help correct ill-fated policies and shape new policies.
If the former is correct, this serves as another confirmation that we are on the right track with our Global Outlook. If the latter is correct, then our alternative scenario of continued rise in financial markets and economic revival would gain traction. This would mean that any major volatility spike could trigger short-lived bond and equity market sell-offs.
Should these leaders challenging the FED (Lagarde, Weber, Blanchard etc) manage to open a constructive debate and engage the FED & ECB, then we might see corrective measures. That would mean that the coming correction in financial market prices will be less than what we currently expect (25% to 50%, in our main scenario). Those corrective measures could lessen the correction to just 10% to 25% – with a shorter window of opportunity to buy into weakness. That would make a big difference. In the 2nd scenario, markets may recover swiftly to continue rising for 1-2 more years. The final long-term price correction (historic peak) then would not be just a massive correction, but probably the beginning of a multi-year bear market cycle. That interestingly may coincide with what some technical analysis specialists are also warning of. But since that is not an area of expertise of mine, I simply mention it as a possible coincident indicator. The 3rd scenario shouldn’t be ruled out yet: With no change of heart, unrepentant & shrewd policy-makers would introduce new rules and tools to interfere in the markets and artificially manipulate bond or stock prices to keep them high. You may think that couldn’t be, but the current yield curve and Treasury prices & yields are “managed” by the FED. No one cries foul, because investors interests are aligned with the FED’s.
Going forward the Global Currency Allocation will be crucial for investment strategy. As you may know I advice all global investors to stop using a single reference currency. In today’s complex world of interacting geopolitics, economics and financial markets every global portfolio should be monitored in USD, EURO, CHF and your country’s currency. That would keep you from being misled to think you are doing great. Only if you are doing well in all three currencies (USD, EURO and CHF), your portfolio is probably doing well. You can keep a single currency as your personal reference, but for professional investment strategy you should think and monitor in these three currencies. You will be able to keep your two feet on the ground, be less prone to illusion and be less tempted to chase investments that boost performance only in one currency. We live in a era of debased currencies and competitive currency depreciations.
Some of you may know that I see the USD as vulnerable and the EURO as oversold. many investors are so obsessed with “carry trade” that they only want to buy more USD as US rates rise. It might be a bit too late. Fact is US rates have already risen substantially versus Europe in relative terms, even more so if you add to it the 33% rise in USD (trade-weighted) and the sharp decline of value in the EURO. Markets are underestimating the potential for EU Treaty reforms in order to avoid a UK Exit. Something Germany will fight to for to avoid a UK exit. A UK Exit would put an end to the EU as geopolitical heavy weight, and possibly induce an exit of Germany too. Any EU Treaty reform would allow the EURO to recover at least 10% vs the USD. Longer term though, I see the USD – or its successor currency – stronger, because the USA will be the most dynamic major economy in the world, distancing herself from the G7 and BRICS after 2024. China will fail to overtake the USA as global superpower. (please, see separate reports). The biggest risk to this US superiority shall be rather home-grown risks and potentially devastating natural catastrophes. The current FED policies are holding the US economy back from living her true potential. By trying to shield real economies at any cost from recessions, policy makers have made more damage than good.
With Mrs Yellen (FED) now challenged by Mrs Lagarde, Mr. Blanchard (IMF) and Mr. Weber (UBS) publicly, volatility at bond markets could rise rapidly, followed by volatility in equity markets. Depending on economic data and policy-making response, equities might actually be able to benefit from bond outflows. But for now my expectation is that they will follow bonds lower.
The world has been living with bond yields and volatilities that did NOT reflect the overall level of inflation in world economy (look at prices of services, real estate, bonds, equities, arts etc) nor the high level of risk and uncertainty (all demanding higher risk premiums). Soon or later interest rates will have to rise, bond prices fall, equity prices fall etc. Excess Consumption supported by the artificial wealth effect will disappear and GDP shrink to its normal trend. While some people see this as a horrible scenario, I don’t. It is overdue since the year 2000 (not 2007) and it is healthy. Yes, the financial system is in worse shape than markets may suggest, but the world economy is more resilient than what the IMF dares to say. Last but not least, the US economy will be again the first and fastest to adjust and recover. If you remove the highly toxic FED & ECB policies that incentivize businesses to play MONOPOLY (financial engineering and profit enhancing for shareholders only) with borrowed money instead of “adding value, investing and hiring again”, you will see how dynamic the US and other economies can be. We would also see many more technology breakthroughs and qualitative improvements. That would support not just GDP growth (quantities), but the quality of life of millions of people. Yes, I believe we’d have more cures for illnesses like cancer if our economy stops being injected overdoses of worthless paper money that perpetuate our obsession with quantities (GDP growth) rather than quality of life, services and products. People might feel less peer-pressure to work 60% instead of 100% to spend more time with their kids or aging parents – that time never comes back. A more flexible economy would rise that would seek a more optimal balance between quantities and quality. Schools would also have to adapt and shift away from peer-pressured performance to creativity.
I will be monitoring this very closely, checking with our panel of independent researchers/specialists/thought leaders and updating you.
Christian Takushi MA UZH, Macro Economist, Thursday 11 June 2015, Switzerland.
Bloomberg’s article on Mr. Weber’s paper:
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