Anyone who has spent some time in a sailboat will have an appreciation for the ‘calm before the storm’. It is a brief moment that is simultaneously peaceful and unsettling; there is no mistaking it.
Everything slows down and the world around you gets reduced to a silence that competes only with the occasional clang of wilted sails and water splashing around as a reminder that you are a guest in an unforgiving environment.
With the Bank of Japan making a Halloween announcement that it will dramatically increase the scope of its accommodative monetary policy, I am getting that tingling sensation that my sails are losing wind and time is slowing down.
I have been a critic of the Fed’s QE program for some time now and have only watched with sadness as other countries have had to follow suit with their own central banks. I can’t say they had much choice but to simply react to the Fed – something that has not gone over well with some of our global neighbors. India and Brazil come to mind but other nations have taken notice as well. It may not be obvious to some, but we could be at the initial stages of what might end up as a full blown currency war – all done by proxy at the central banks. Brazil’s Finance Minister, Guido Mantega, said as much as early as 2010.
As I have mentioned before, there are massive externalities associated with accommodative monetary policies. The most significant being the currency flows between nations. The Fed’s QE program initiated a tsunami of money flowing out of the United States and into emerging markets – thus creating a boom in those respective markets that was partly, if not mostly, created through debt. Just like a tide going in and suddenly retreating, any change in monetary policy can quickly drain that emerging market of cash as investors flock back to the U.S.
Benn Steil wrote a piece in Foreign Affairs last July describing the effect that the Fed’s mere mention of tapering had on Ukraine’s ability to finance debt and the subsequent rift that ensued with Russia – the consequences of which are still playing out to this day.
“Ukraine’s financial problems had been mounting over many years, but it was the mere prospect of the Fed pumping fewer new dollars into the market each month that pushed the cost of rolling over its debt — that is, paying off old obligations with new bonds — beyond Kiev’s capacity to pay. Had the Fed stayed dovish, Ukraine could have at least delayed its financial crisis, and a crisis delayed can be a crisis averted. Yanukovych ultimately turned for help to Moscow, which successfully demanded that he abandon an association agreement with the European Union in return. Ukrainians took to the streets — and the rest is history.”
My concern is not just that accommodative monetary policy is beginning to unravel, but that the underlying weaknesses that persist throughout the global economy will come front and center with a vengeance – chiefly among them deflation and income inequality.
Deflation is one of those seemingly abstract concepts that many relegate to academia. Unfortunately, as is the case with many other economic ideas – and as John Maynard Keynes famously put it,
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
Deflation in the aggregate is a psychological impairment that can prevent large swaths of the population from engaging in normal economic activity. The simple act of purchasing a good becomes a ponderous task that brings with it doubt and uncertainty. Slowly, a vicious self reinforcing cycle takes hold and drives economic activity to a grind. Because deflation is rooted in a psychological sentiment that lives within each individual, it is the contrary actions of those same individuals from which deflation must be defeated – a task not be taken lightly.
One would not normally expect to see deflation during times of expansionary monetary policy but in fact it is exactly what we are seeing. Whether in Europe now or possibly in the United States, the prospects are evident and should be a concern for not only policymakers but businesses and consumers alike.
Income inequality is something that is receiving much needed attention lately but has been festering for almost three decades. The data is clear and more important – the sentiment is palpable.
Richard Wilkinson gave an excellent TED Talk that I recommend you listen to. See below.
What I am most interested in – and what worries me the most – is the overall feeling, whether warranted or not or correctly placed, of inequality that different groups around the world are expressing and how they are coping with it.
Inequality by itself is not something that stokes concern; however, when viewed from the context of a group that feels marginalized or excluded from participating in prosperous times, or when inequality is adopted within the framework of a social movement – therein lies the danger.
Will Durant wrote in The Story of Civilization that there are certain factors that condition civilization. Even though this beautifully worded and timeless work was written close to 90 years ago, his description of those factors that can negatively impact civilization are not only relevant today, but almost prescient – as if we are being warned.
“Certain factors condition civilization, any may encourage or impede it.
First, geological conditions. Civilization is an interlude between ice ages: at any time the current of glaciation may rise again, cover with ice and stone the works of man, and reduce life to some narrow segment of the earth. Or the demon of earthquake, by whose leave we build our cities, may shrug his shoulders and consume us indifferently.
Second, geographical conditions…. If the soil is fertile in food or minerals, if rivers offer an easy avenue of exchange, if the coast-line is indented with natural harbors for a commercial fleet, if above all, a nation lies on the highroad of the world’s trade, like Athens or Carthage, Florence or Venice – then geography, though it can never create it, smiles upon civilization, and nourishes it.
Economic conditions are more important. A people may possess ordered institutions, a lofty moral code, and even a flair for the minor forms or art, like the American Indians; and yet if it remains in the hunting stage, if it depends for its existence upon the precarious fortunes of the chase, it will never quite pass from barbarism to civilization.
The disappearance of these conditions – sometimes of even one of them – may destroy a civilization…. the relative smallness of the families that might bequeath most fully the cultural inheritance of the race; a pathological concentration of wealth, leading to class wars, disruptive revolutions, and financial exhaustion; these are some of the ways in which a civilization may die. For civilization is not something inborn or imperishable; it must be acquired anew by every generation, and any serious interruption in its financing or its transmission may bring it to an end. Man differs from the beast only by education, which may be defined as the technique of transmitting civilization.”
Emphasis is my own in the above paragraphs. While the average person is not necessarily involved in the ‘chase’ for food as our primitive ancestors once where, there is today a seemingly comparable ‘chase’ for financial stability that is in most cases the single most important factor in attaining even our most basic needs – food and shelter.
I cannot presume to understand what exactly Will Durant eluded to or meant by ‘pathological concentration of wealth’ but it nonetheless sparks my interest.
Lastly, his comments about the financing or transmission of civilization is something that resembles very much a warning that education is (or at least should be) a top priority. I will not comment on the state of education in the United States and much less so globally, but most should be able to walk away from that statement with a fairly clear understanding of how serious that subject is.
My primary complaint about QE has been that it served only to buy time or put off the inevitable – a deflationary environment that was setup from decades of stagnant wage growth and productivity gains that were disproportionately distributed to the top. If we are seeing bouts of deflation and weak economic growth now during unprecedented times of expansionary monetary policy, what can we expect when QE ends and the inflationary forces that come from it begin to subside? The Fed, along with similar attempts at other central banks, has tried and failed to bring inflation to their target 2%.
We live in a very complex and interconnected world and understanding and forecasting what might happen is no simple task. At best, we can try to piece together clues that might amplify our foresight and understanding of the events taking place. One clue I see as a possible silver lining is the skills shortage that persists globally coupled with declining population growth among the developed nations. I see this as one possible inflationary solution to what looks to be a coming period of slow growth and declining prices.
Of course, I am under no illusion to think that I KNOW what will happen; only that I am feeling a little uneasy in these waters and see some ominous looking clouds in my horizon.