Three little birds – When lawyers run central banks
Get up this morning
I smiled with the rising sun
Three little birds
Location near my door
Sing sweet songs
Pure and true melodies
Sayin ‘, “This is my message to you-or-or:”
Singing: “Don’t worry about nothing, worry about nothing, oh!
Every little thing will be fine. Do not worry!”
Singing: “Don’t worry about anything” – I won’t worry!
“Because every little thing will be fine”
– Bob Marley and the Wailers
Jay Powell, Christine Lagarde and Haruhiko Kuroda are the three little birds of the central bank singing the sweet songs of unlimited money. They want you to believe that there is nothing to worry about when it comes to inflation or the stock market. Powell is the chairman of the US Fed, Lagarde is the chairman of the European Central Bank, and Haruhiko Kuroda is the governor of the Bank of Japan. It is important to note that they are our main decision-makers on economic policy, but are professional lawyers (Kuroda is in fact both a lawyer and an economist), and for the first time it seems that a PhD in economics is less important for economic policy making than a doctorate in law. . Between the three of them, they have authorized trillions of asset purchases over the past few years and have basically funded the operations of highly leveraged governments, and they would like to persuade you that this is still the right line of business. conduct. Hearing Powell speak to other lawmakers in his recent testimony, we could see the clear benefit of a lawyer speaking convincingly to other lawyers.
Market participants are however quite worried as they see the inflation statistics skyrocketing. The recent CPI (Consumer Price Index) was above 5% and the PPI (Producer Price Index) was above 7% year on year (Source: Bloomberg). Inflation certainly does not appear to be transient. Stocks, bonds and real estate markets are at record prices. Central bank leaders are clearly committed to persuading the public that “economic facts” justify these actions.
I have a lot of lawyers in my own family, and having grown up in a family full of lawyers, I have a perspective on how lawyers establish and use “facts”. My grandfather was a lawyer, as were my father, three of my aunts, an uncle and my wife. I’m the black sheep of the family sort of dropping out of law school (I was a little over a year late in evening class at Chapman University before going on permanent leave to run my business) . So I have a beginner’s training in persuasive arguments and how to tilt them to sell my point of view.
Law professor Roberta Mann, in her paper “Economists are from Mercury, Decision Makers are from Saturn: The Tax Policy Implications of Communication Failure,” illustrates the communication gap between economists and lawyers which includes interpretation of data. In the context of central banks, where the staff is mainly made up of PhDs in economists, a quote from his article is relevant: “Sometimes decision-makers rely on economic analysis to make decisions. Sometimes policymakers use economic analysis to support decisions already made. The decision to keep buying bonds and keep interest rates at zero and negative is a use case of economic analysis to support commitments already made, which is why there is an increasing fixation on the central bank on one or two elusive numerical targets (“eight million jobs lost”, “2% inflation target”, etc.). In his 2010 book “Proofiness”, Charles Seife calls this use of numbers “the dark art of mathematical deception”.
As my readers know, I am a physicist by training. The difference between scientific arguments and legal arguments is that scientific arguments are primarily “informative” while legal arguments are primarily “persuasive”. The lawyer’s goal is to weave the “facts” for the benefit of his client and to persuade the judge or jury. In a mock court, I had the chance to practice both sides of the argument using the same facts, showing how facts can be interpreted to serve the client’s purpose. Same facts, different sides of the argument.
The persuasive discourse, which Powell, Lagarde, and Kuroda, as lawyers, adhere to, consists of three classic elements: logos, pathos, and ethos. The next time you listen to a testimonial or hit Q&A, pay attention to those. Logos refers to the formulation of logical arguments, and why, given the information and the set of logical arguments, supplemented by “proof” numbers, the conclusion must be true. Pathos refers to the emotional appeal to make the listener feel a certain way, to accept the argument. Finally, ethos refers to establishing credibility with the public, which is easy to lose if one sticks to an invalid argument. It is well known that moderate amounts of repetition can lead to increasingly strong persuasive arguments. But very frequent and unvaried repetition creates an aversion to the repeated term. I feel the market is approaching the point where the word ‘transient’ has been used so many times by Powell and others that the market is no longer convinced that the Fed knows much about the actual dynamics and trends of inflation.
Why would the Fed and other central banks want to persuade the rest of the world that interest rates need to stay low and that assets still need to be bought, even in light of booming markets? The simplest answer is that the size of the debt load is so large that they just don’t have a choice. In order to keep debt servicing costs manageable in the short term, interest rates and bond yields must remain extremely low. As inflation soars, keeping nominal yields low to keep debt servicing costs low means that real yields (real yields equal nominal yields minus inflation) are forced into territory. deeply negative. For example, with ten-year notes in the United States earning around 1.3% and inflation at 5.4%, the effective real return is minus 4.1%! Ten-year TIPS real real yield is minus 1% because the Fed bought out most TIPS, forcing real yields down. Investors who buy the ten-year nominal note at 1.3% are forced to lose more than 4% a year in value – we are talking about being slowly boiled alive. And when real bond yields are negative, they divert money from safety to risky assets, like stocks, to compensate for the loss of yield due to rising prices.
So if we agree that we are persuaded to buy a view of the data of the three little birds / lawyers / central bank chiefs, what are we supposed to do?
I think the simplest answer is probably the best. Whichever way I see it, more asset purchases are in the cards because we are trapped in debt. Tightening policy now would mean markets deepen, leading to another round of asset purchases and accommodative policy; whereas no tightening means a further rise in asset prices and then a subsequent fall in asset prices mainly due to the force of gravity, which would again lead to asset purchases and an accommodative policy. In other words, in any case, the next step for central banks is to make another round of asset purchases. In economic terms, the asset buying strategy “stochastically dominates” all other strategies. Bubble or no bubble, it is better to keep buying assets today than not to buy them and have to buy them later! This is why central banks are so convincing to justify continued asset purchases.
Second, if debt sustainability forces governments to borrow more money to keep interest rates low, investors should rationally do as government does because sovereigns have a printing press. Investors should also borrow long term and buy assets with central banks, but control exposure so that a severe shock to lending rates does not force them to liquidate. Smart companies are already doing this. The borrowed money can be used to buy more assets, or maybe used as precautionary savings, or just used to spend. Firms are buying back their stocks or other high-market companies using stocks as currency as mergers and acquisitions begin to move into record territory again. Recent news (“Buy, borrow, die: how rich Americans live on their paper”) Show that this is exactly what many high net worth investors do as well; instead of selling their assets and incurring tax debts, they borrow from banks to meet their expenses.
Of course, this active watering route is not without risk. If central banks change their mind and pivot again, the outcome for the market could be very different. The lawyers in charge of central banks think they know how to pivot smoothly, but it is the risk of taking their insurance at face value.
Since it is inexpensive to hedge market risk today, entrusting the Three Little Birds with your financial well-being entirely may not be the best idea. And a good read on economics and scientific decision-making might also be recommended for policymakers and investors.