At school, I was taught Newtonian physics. Einstein didn’t get a mention despite having posited his theory on relativity some 60 years earlier and when much later I realised my education had been sorely lacking I wondered what else I hadn’t been told! That’s the trouble with “new” theories, the “old school” takes an eon to get around to changing the common narrative.
And so it is with economics although lets not pretend that it is a science or at least not in the conventional sense that a mathematical model can be created to explain the meaning of everything. Until Einstein, physics was fully understood and the position of the planets known (and unknown) could be modelled precisely; relativity gave us a whole new view of the universe. In economics the current belief system is based largely on Keynesianism although as with many religious texts the meaning is widely open to interpretation and a number of his creeds are conveniently overlooked.
Modern economics makes the heroic assumption that people act rationally in full accordance with the facts. Not true. Modern economics believes that it is possible to explain the myriad variables in the global economy and predict an outcome. Not true. If you don’t believe me look at the Federal Reserve Bank’s record on forecasting inflation. Comparing their forecast with the actual outcome you get a correlation of minus 0.6. For non mathematicians out there that means that they couldn’t have been much more wrong if they tried.
And having tried in many other disciplines and failed, notably quantitative easing, they are now resorting to making it up as they go along. You need go no further for proof than a statement made last year by Haruhiko Kuroda, the governor of the Bank of Japan. He said, “I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it’. Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions.”
“Pan’s” latest “solution” for Japan, and there have been quite a few since the Japanese bubble first burst back in the early 1990s, is negative interest rates. He’s desperately jumping on a growing bandwagon. Much of Europe has been on this path for sometime. Lead by the Swiss who wanted to dissuade investors from treating the franc as a safe haven and, more latterly, by the ECB in an attempt to persuade the banks to lend and thereby promote growth. Printing money (QE) has failed and now they want to penalise the banks for not making sufficient “sub prime” loans in contradiction to the stated aims of preventing a re-run of 2008. Prime borrowers don’t need bank loans; they either have tons of cash already or have been tapping the corporate bond market.
Banks are in fact tightening lending standards in the face of the fall out in high yield bonds and loans to the energy sector. By turning their income, from their reserves with the central banks, negative, this action is further weakening a banking sector, which already has enough problems to deal with. Over the past few weeks markets have begun to wake up to the fact that all is not well in banking world and we have witnessed the “great and good” being wheeled out to say that everything is fine which is very reminiscent of 2007 when they said much the same thing.
In the short term sentiment has reached a trough and as markets don’t usually go down in a straight line there will be a bounce, and quite possibly what might feel like a substantial one, but, short of the imminent announcement of QE4 by the Fed, that rally will suffer the fate of all the others we have seen over the last month or so. The central banks are losing the plot and the assumption they will support the markets, come what may, is being questioned. Even if they attempt to do “whatever it takes” the market knows that they are pushing on a string and will will probe and probe until the emperor is seen as naked.
We don’t yet have the technology to see dark matter, but it’s out there; this is not the time to be a market hero; except for Bowie fans, but just for one day…
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