Wow. People really didn’t like the Bank of Japan’s laid-back attitude yesterday.
As we discussed yesterday, the BoJ didn’t do anything much yesterday. About the only thing that pointed to further action was Haruhiko Kuroda’s promise to do “whatever it takes”, Mario Draghi-style, to achieve Japan’s inflation objectives.
The BoJ was right to put a halt on doing anything else for now, as I’ll discuss below.
But the reality is that no one is as good at this as the Federal Reserve. What’s the secret of the Fed’s success? And what does it mean for investors?
It’s tough being a central banker in Japan or Europe
One key plank of our belief here at MoneyWeek, that inflation is likely to make a comeback, is that central banks – if they’re determined – can always get what they want.
However, some central banks are more determined and effective than others. If you look around the world, there’s only one central bank that clearly gets what it wants almost all of the time. The Federal Reserve.
The Fed is winning for a few reasons. Obviously, it has the benefit of being the central bank behind the most powerful economy in the world. It is also the custodian and printer of the global reserve currency. Those are both major benefits.
But the Fed also has another key advantage. The truth is that the Fed is the only central bank that markets truly believe can and will do “whatever it takes”.
“Don’t fight the Fed” is a long-running market adage for a reason – because historical experience (in living memory at least) suggests that what the Fed wants, the Fed gets.
You think it through for a minute. The European Central Bank (ECB) – we all know what Mario Draghi wants, and he’s played a bad hand incredibly well. But we also know that he’s constrained by the fact that Germany wants one thing, Greece wants another, and all the other countries in the region want something in between.
And this isn’t about blame-throwing, by the way. There’s nothing unreasonable about the Germans having qualms about current ECB monetary policy. I saw some clever person on Twitter do a “Taylor Rule” calculation on what German interest rates should currently be, given their growth, inflation etc. The answer came out at 6%.
(The Taylor Rule is one way to calculate how interest rates, employment, and inflation all interact. It’s not perfect by any means and seems to be increasingly out of fashion, but then next to nothing in economic theory works anyway so you might as well use the tools to hand.)
Obviously, this is all a perfectly predictable (and widely predicted) side effect of adopting the euro. But the point is, it makes Draghi’s job damn difficult, and markets can’t easily predict who’s going to win and what the outcome will be.
The Bank of Japan also has a huge credibility problem – much worse than Draghi’s. At least everyone knows roughly what Draghi wants – the question is just how cunning he can be in getting it. Over in Japan, there’s no real certainty. They have tried so much, and failed for so long, and seem to have a habit of chopping and changing strategies, that no one is sure what the real goal of the central bank is from one day to the next.
That’s why it made perfect sense for the Bank of Japan to avoid acting yesterday. The market didn’t like it, but the Bank has to be careful. Whatever it does next has to work for more than five minutes. Otherwise a lot of its power will be lost.
Why the Fed has the easiest job in central banking
So what about the Fed? The Fed has none of these problems. Unlike the ECB, it doesn’t have a whole group of conflicting national governments to keep happy. Just one. And unlike the Bank of Japan, it hasn’t spent decades flailing around trying to recover from one of the most epic asset bubbles in history.
Ever since Alan Greenspan took over, it’s been pretty clear what the Fed’s real priority is. It’s not employment, or inflation, or any other “fundamental”. It’s been about keeping the stockmarket going up.
It’s the “Greenspan put”. If you’ve put your faith in the assumption that the Fed will always act to put a floor under US stocks and to drive them higher where possible, then you’d have been well rewarded in recent decades.
That same tight focus on the value of a stock index as a measure of overall economic health simply doesn’t exist elsewhere.
It sounds simplistic, but it does explain a lot. Why are US stocks persistently so expensive on a cyclically-adjusted basis? Why does the CAPE average seem to have shifted higher in recent decades?
It could well be a result of the Greenspan put. Why not? Who wouldn’t want to invest in a market where the central bank (and therefore the government) has essentially made it a policy to ensure ever-higher highs?
(The same theory would explain a lot about the UK housing market.)
Anyway – that’s just a bit of theorising. I’m still not keen to invest in US stocks at these levels. But I do think that it continues to make sense to expect a weak dollar policy from the US this year, and don’t be surprised if there aren’t any interest rate hikes before the election.
I’m popping along to see a member of the Federal Reserve make a speech in the City later on this morning. I’m curious to see how or if he addresses issues like the strength of the US employment market, the Fed’s apparent insouciance about inflation, and the whole question of negative rates and quantitative easing and the “Shanghai Accord”. I’ll let you know how it goes.