The era of central banks could be over

A flaming, screaming man falls hundreds of metres into the stone streets of the world beneath him. Why? Because he was the last to catch on.

In the final Lord of the Rings film, Denethor, Steward of Gondor, remains cooped up in his palace, ignoring the warnings of wizards and warriors. Thus, he is the last to realise that the evil armies of Mordor are literally outside the gates of Minas Tirith, his city.

He panics, tries to burn his own son alive and then flees over the edge of the precipice which stands above the city.

Source: Pope Damasus and the Saints

Jerome Powell and his US Federal Reserve have just done the same thing.

Last night the Fed cut interest rates by a FULL percentage point. Between meetings.

Did it really think this would do anything other than cause panic?

Donald Trump’s Friday evening speech gave US markets a huge boost, about 10% in half an hour as I recall. I watched it with the Dow Jones index in a tab next to it, and it was truly remarkable viewing. And not just because he seems not to be able to read words longer than two syllables.

So perhaps the Fed wanted to capitalise on that, to go so big, that it could reinforce the bottom in American markets.

The trouble is, it’s wrong and foolish, and it’s also the last to realise that it’s wrong and foolish.

The Sainsbury’s fallacy

Let me give you another example.

Last Friday while working from home, I went to the supermarket to get a few bits for lunch, and maybe a pack of pasta and a few tins, just in case, ya know?

The scene in Balham Sainsbury’s of empty pasta sections, empty rice sections and just a few battered tins of chickpeas left me pretty cold, as I hadn’t anticipated it would be that bad.

The thing is, I wasn’t thinking straight. I had forgotten why people stockpile, and it’s not because they fear Mr Sainsbury running out of goods.

They fear other people stockpiling.

So when the email came on Sunday morning, from Mr Sainsbury himself (CEO Mike Coupe), I thought oh god, here we go…

It was a bit rambling but basically it said you’ve probably seen people are stockpiling. But don’t panic! We’ve got plenty and done a bit of extra ordering and if everyone behaves normally it’ll be fine.

What’s that? Things must be pretty terrible if the CEO himself is writing to all Nectar card holders (get me those points!) saying don’t panic.

What’s the rule, don’t say bomb on a plane and don’t say fire in a paper shop? Well don’t say stockpile in a Sainsbury’s is the latest version.

When you tell people, think of anything except bananas, what do they think of?

When you tell people that their primary local shop is being ransacked by panicking young city workers and spin class attendees, their immediate reaction is not I must consider the common social good, they (mostly) think, must get me some of that sweet sweet Andrex before it all runs out.

And so by Sunday at 4.45pm when I turned up, it was the emptiest I had seen it by far.

RIP the Powell Put

This is why the Fed’s move was so blasted annoying.

Aristotle famously said that the unexamined life is not worth living. And I think the Fed could do with a long hard look in the mirror.

Not only is it my firm belief that low interest rates and quantitative easing (QE) have not solved but merely delayed the worst of the crash, but I also think that low interest rates harm productivity, encourage excessive borrowing, contribute to inequality by inflating asset prices while stagnating wages… honestly I could go on for a while.

So a decade of stupidity, and apparently, not a moment of self-reflection.

When it announced an intra-meeting, quadra-cut, a common reaction was oh, markets will go up then because that’s all that matters. But that’s the opposite of what is happening!

The half-point cut did nothing a couple weeks ago for the same reasons.

People have given up using the Fed’s base rate to churn out discounted cash flow calculations (which all end up saying BUY FAANGS). They’re far too busy panicking.

They’re selling because they’re scared of the virus, and because they’re scared of other people being scared of the virus. And a whole host of other reasons too by the way, like massive overvaluations, a psychological unpreparedness for losses, margin calls and short-term capital needs.

The Fed is doing nothing but signal PANIC.

The most listened-to financial platform in the world is saying WE ARE PANICKING.

Just after Trump gave everyone a 10% rally to sell into!

Just like Mr Coupe, its measures to assuage the panic are nothing but massive flashing signs saying everyone is panicking, why aren’t you?

And Just like Denethor, mere custodian of the throne of Gondor, I wonder if it hasn’t put the nail in its own coffin.

Ten years of failure, followed by a couple of massive failures?

Not only is this a real world problem, it’s not (yet) a financial one (aka needs direct fiscal support, better testing, good strategy and everyone to behave sensibly, self-isolate, social distancing and all that). But it’s also too early. They’re like a World War 1 general ordering his troops to empty their weapons before going over the top.

The rebuilding hasn’t started yet! The Fed is so blatantly trying to fix the stockmarket it hurts!

(I’m not supposed to use exclamation marks in writing, apparently it looks bad, but this morning I am agitated!! Doubled up there for effect.)

I think it might irrevocably break the popular idea of central bank power.

Every big bull run has a phrase which pushes it to its peak, and this time it was the idea that central banks were omnipotent and would be able to print their way out of any small market correction.

The Powell Put, the Fed will save us, blah, blah, blah.

The failure of that idea is the scariest thing I’ve seen so far, in the financial world at least. Because that’s what kept our old friend Wile E Coyote floating, yards after he’d passed the precipice. Denethor sadly had no such powers. Gravity worked its magic on him right away.

I’ve been saying for a while that since the crisis, central banks have been more important than politicians, because the low interest rate environment has done more harm to society than any Conservative government.

Friends further left on the spectrum to me absolutely hate this idea. They desperately want to blame homelessness, inequality and a crumbling NHS on the Conservative government and austerity, and they will certainly have a point.

But low interest rates have helped people who already owned assets, pushing stock and house prices up, while disincentivising real growth because borrowing money is easier than improving your business to generate it organically.

So the rich get richer and no one else does any better. And because it’s about debt and financial assets, everything and everyone moves to London, accentuating the gap between the capital and the regions. It’s the interest rates that are the problem.

But now, it’s possible that central banks will lose their crown.

The agreement about the failure of QE and low rates is increasingly strong, and the latest episodes of failure will only sharpen the view that central banks are backward-looking, slow to react, overly nervous.

So I’m wondering whether it’s possible that the central banks will lose their crown as the most important people in the world… Perhaps their powers will be curtailed. Or perhaps everyone will just ignore them. Yes the price of money, especially in the US, is really important but they’ve proved they’re no good at wielding that power, so limits may be placed upon them.

Who will replace them?

Perhaps it’s government’s time to shine again. Fiscal stimulus is the most likely response to this crisis, as the real economy gets the boost it really needs. Funding for infrastructure like solar and wind plans, high speed rail, education and health.

Instead of bailouts for banks or bankrupt shale oil companies.

What does that mean? Inflation.

The sucker punch

I’m really sorry, but it gets worse.

Because I think that everyone is wrong in thinking recessions cause market crashes. I think it can be the other way round too.

And there’s a double whammy coming. How might that happen? I’ll be back in touch on Wednesday to explain how.

But before I do, as that was all very bleak – and I’m sorry about that, you probably have plenty enough to worry about already; really I am an optimist at heart, but that Fed thing just got me – here are a few optimistic bullet points to sign off:

  • China is reporting single- or double-digit new cases of the virus each day now, which means that in China where it began, it has pretty much been contained.
  • South Korea too has shown it’s possible to have a rapid outbreak and get it swiftly under control without draconian, authoritarian measures. Lots of testing, getting people on board, social responsibility, and more testing. Oh yes and more testing too.
  • Japan, where they are naturally very hygienic and bow instead of shaking hands, has managed to flatten the curve. No one else has, but it shows it is possible. Just another positive for that wonderful country.
  • This will soon be the buying opportunity to end all buying opportunities. Stay calm, think about what you really want to be invested in for the next decade or the next cycle, and slowly get ready to snap those companies up at much lower prices than you could’ve a few weeks ago. I don’t know when that time is, and never will, but think a strategy of slowly, bravely filtering in small bits of cash.
  • Finally, we are good at change. The world will change because of this, we might travel less, wash our hands more… in chaos, opportunity. New business models will emerge. Quarantine is a great chance to really get tonnes of reading done, which is often something that falls by the wayside in our busy lives. For example, I read the whole of Oil Fall by Gregor Macdonald over the weekend, an absolutely brilliant triad of books on the energy transition, looking specifically at California and China. I’ll say again that this is a space well worth learning about, and Oil Fall is a great place to start.

Remember, as calamitous and agitated as financial writers like me get, it’s far more important that we keep our heads, that we keep calm.

And remembering a few positives about the virus, and about the markets, are a good place to start.

So I hope you’re keeping very well, and I look forward to writing to you again on Wednesday.

Very best wishes,

Kit Winder
Investment Research Analyst, Southbank Investment Research

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