Submitted by Eric Peters, CIO of One River Asset Management
“I was a maths major,” said the CEO. “And at one point in my studies, we delved into the realm of relativity. Like the idea that a five-inch ruler is not really five inches if you are traveling close to the speed of light,” he said. “And I remember thinking, well hold on, let’s get back to math. I always like the idea of having a singular correct answer.” Our sushi arrived. Arranged perfectly. Symmetry. “I always thought money had one answer too. But I find myself unsure. If Japan has debt/GDP of 225% but the BOJ owns half of that, what does it mean?”
“What would happen if the BOJ announced they burned the bonds they own?” asked the same CEO. “I know they need never do that, but suppose they did.” Would it matter? “What would happen if we simply extinguished America’s $1.5trln student debt?” No one quite knows. “I’ve come to see money as more philosophical than mathematical.” I smiled, always interested to explore the meaning of money. “And the most interesting thing happening in the world now is this debate about MMT. It is the thing that would truly shift market paradigms, correlations.”
“There’s a think tank in the UK,” the CEO continued. They surveyed a leading political party, asking each member whether they considered themselves to be reasonably likely to lead the party. “In my firm, perhaps 10 people would think they have a realistic shot at taking my job someday. But 95% of our politicians think they’re reasonably likely to lead their party.” They’re a totally different breed. “Modern Monetary Theory plays into the type of person who becomes a politician. And it’s probably too alluring for them to resist it in some capacity.”
“But one thing is clear,” said outgoing ECB Chief Economist Praet. And across the world, skeptical ears perked right up. Because of course, if there’s one thing we’ve learned from this monetary experiment, it’s that nothing is clear. “The ECB’s Governing Council will always find ways and means of acting if it needs to,” declared Praet, making his point. But is that really the point? It is one thing to act, and another thing to do. And while there is little doubt that the ECB or any central bank can act, might we be approaching the limits of what they can do? “If the euro-area economy were to slow more sharply, we could adapt our forward guidance on interest rates and this could be complemented by other measures,” explained Praet, assuredly, without explaining why 3yrs of -0.40% overnight deposit rates has left the central bank still talking about new ways to boost growth rather than novel ways to elicit a soft landing.
“Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year,” read the January Fed Minutes, “Participants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook … maintaining the current target range for the federal funds rate for a time posed few risks at this point.” Having hiked rates from 0.00%-0.25% to 2.25%-2.50%, the Fed abruptly stopped. A $1.5trln tax stimulus, expanded budget deficits, and deregulation provided the cover for the US central bank to attempt to normalize policy. No other major nation has been able to come close. And now they’ve all turned dovish, bumping along the bottom, with rates still at crisis settings.
“Economies operate with a lag, and the tightening that has already occurred virtually assures a more dramatic slowdown, or recession later this year or 2020,” said the CIO. The Fed hiked 225bps starting in Dec 2015. “Even if the Fed ends its balance sheet reduction later this year, that tightening will also take time to work its way through the system.” The Fed balance sheet grew from $870bln in 2007 to $4.5trln in May 2015. QT started shrinking it in Oct 2017. It’s roughly $4trln now. “The bear market in equities started with the October sell-off.”