East of Eden with the ECB

“In the sweat of thy face shalt thou eat bread, till thou return unto the ground; for out of it wast thou taken: for dust thou art, and unto dust shalt thou return.”

Or so a rather angry Jehovah was said to have thundered at Adam when he cast him out of the Garden for committing the cardinal sin of developing self-awareness. Ever since, the story goes, mortal man’s lot has been a sorry one of incessant toil, the inevitability of his demise and – for his beloved partner – the anguish and deadly peril of childbirth.

So, if we could persuade a forgiving God finally to relent and to repeal our sentence, giving us safe passage back out of the Land of Nod to the primaeval, care-free paradise of our creation, do you think His mercy would be well-received by those who presume to rule over us here and now in the earthly realm?

Not a bit of it! They’d all start moaning about the ‘deflationary’ consequences of the alleviation of our suffering and instantly start threatening to perpetrate yet more violence upon our property and our preferences by forcing upon us an even greater swathe of their costless, irredeemable, legally non-refusable liabilities in exchange for any and every financial title arising from our private, voluntary contracts and even to our very physical goods, either by directly stockpiling them or through financing their sequestration via government deficits.

Do you think this sounds extreme? But what else are we to make of the rumblings emanating from the Bank of Japan that the fall in crude oil prices is a curse upon the archipelago’s citizens, rather than being an unbounded benefit to everyone not too heavily invested in the expectation that they can only remain more elevated in real terms than at any time in modern history (i.e., that they cost more ‘sweat of thy face’ per barrel than ever before).

What do we make of the ramblings of the ECB’s chief economist, Peter Praet, when he argues that the long-held tenet of central bankers that one-off changes in the price of certain components in their favoured basket of goods and service – most notably food and energy – should be overlooked when making policy as not being amenable to short-term monetary manipulation?

Of course, this argument is all too convenient when such goods are becoming more expensive, since it provides a ready excuse for the Bank to procrastinate in facing up to the unpleasant (and usually politically contentious) task of reining in its levels of accommodation. All too often, of course, this ends up enabling a kind of interpersonal ‘deficit without tears’ to develop as the CB’s inaction essentially lessens the budget constraints which would otherwise be imposed by the need for increased outlays on those items, like food and fuel, whose consumption can only be partially foregone and for which immediate substitutes are hard to find.

Absent such a move, those on a fixed income (other than the oil and food providers themselves) would perforce have less to spend on all other offerings. Assuming that the bracketed grouping do not immediately parlay their windfall into an exactly offsetting (and, strictly, an exactly corresponding) expansion of demand, this would tend to exert a downward pressure on all other prices. In this way, the shift would do its job of signalling to entrepreneurs, investors, and those seeking work that the declining sectors should no longer command so much of their time and effort, but that they could more profitably and usefully divert their endeavours towards meeting the increased scarcity being felt elsewhere and so restoring a new balance to the system.

Instead, what this business of only responding to ‘core’ indices of price tends to provoke in the upswing is a more expansive provision of money aimed at forestalling any such decline but also serving to frustrate the required adjustments in the real economy. Simultaneously, this will heighten the risk of igniting a blaze of ever higher prices for all things, once that extra money flows, as it must, into the very sectors left out of the policy makers’ calculation, the need for which is still perceived as more urgent than for the others, just as it would have been had the Bank failed to act.
Conversely, if the price of crude falls, this should naturally allow more money to be spent (other than by the now disappointed energy providers) on whatever else is on offer in the shops. Additionally, it may lead to the creation of an investible surplus with which to expand the range of possibilities for tomorrow and so, incidentally, to help replace the capital being lost in the energy industry with a new endowment devoted to bringing other things to market in its place.

What is not needed is for the monetary authorities to act to offset the fall in energy simply because they are in thrall to the prevailing fiction that they are in the business of ‘expectations management’ with regard to what they call ‘inflation’. Under this perverse imagining, what our overlords seem to envisage is that if people find they have more left in their wallets when they next fill up the family car, they will not rejoice at being better off but will instantly indulge in a fearful hoarding of their cash amid the suspension of all enjoyment of life’s pleasurable non-essentials, and that, as this paralysis takes hold, they may even sit starving outside the groaning display window of the baker’s shop, simply because a CPI index of which they have probably never heard and which, in all likelihood, has very little relevance to their individual mix of preferences and possibilities in any case is doomed to show a nought-point-something decrease when next it is published.

Praet may of course simply be indulging in a degree of special pleading. He knows his boss is envious of the power wielded by a Bernanke or a Kuroda and that his dreams of glory are being frustrated by those annoying northern European curmudgeons who would prefer it if he stuck both to the charter of their institution as well as to its more intangible, though no less weighty, traditions. If that is the case we could overlook the poor logic of his recent appeal, though only at the cost of questioning his intellectual integrity in its place.

As the man himself put it: ‘…well-anchored inflation expectations are indispensable for medium-term price stability. They provide a nominal anchor for the economy [just how exactly?]. And even more so in the current environment: given the potency of the current oil price shock, the risk is that inflation may temporarily fall into negative territory in coming months… Normally, any central bank would prefer to look through a positive supply shock… But we may not have that luxury at present. The reason is that shocks can change: in certain circumstances supply shocks can morph into demand shocks via second-round effects [again, how, pray tell us?]. In these conditions monetary policy needs to react to what initially appeared to be a supply shock, so as to prevent a destabilisation of inflation expectations.’

Stripped of its jargon, what he is saying is that the lower oil prices go, the more he wants the price of all other goods in the shops to go up: that he wishes to pass a law insisting that you when you stand before the girl on the supermarket till to pay for your groceries, you have to fork over the tenner you thought you had just saved out on the store’s garage forecourt.

Better yet, why not reverse-subsidize the price of oil: let us keep its price fixed and remit the difference between what Mme Renoir or Herr Pfister will continue to pay at the pump and the actual lowered market level straight to those poor, anxious souls fretting at their lost racehorse acquisitions and foregone casino jaunts in their five star hotels in Dubai, or Moscow, or Houston. If not, you should be aware, Mr. Praet seems to be admonishing us, that economic activity in Europe will contract further since this is predicated solely upon the dominant economic shamanism of ‘well-anchored inflation expectations’ – and also watch out for the region’s towering debts to appear even more unserviceable than they are today, into the bargain!

Have we really reached such a stage where decisions relating to trillions of dollars and euros of centralised, indiscriminate, and utterly inequitable asset buying hinge upon such an insubstantial construct as this chimera of ‘expectations’?

It seems, alas, we have. Truly, we have nothing to fear but the fear of fear itself!

Mind you, if might not hurt to take this expectations/animal spirits lark a bit more seriously in the context of what European policy says to the entrepreneur about what his chances are of both successfully launching a new, or expanding an existing, venture and of actually getting to enjoy some of the fruits of his achievement without suffering either arbitrary confiscation or enduring populist outrage should he manage it. We shall return to deal with this matter in a forthcoming posting.

NB The foregoing is for educative and entertainment purposes only. Nothing herein should be construed as constituting investment advice. All rights reserved. ©True Sinews