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What changed this week? Our dependence on central banks.


The article references an interview between Danielle DiMartino Booth of Quill Intelligence and Peter Boockvar, CIO of Bleakley Advisory Group, where they discuss systemic risks to the global financial system. The interview was published on Real Vision on 4 December 2019.


Gone are the days of the free market. As Peter points out, there is an increase in participation by central banks across global markets. This is akin to playing soccer in a minefield, where the mines are controlled by the central bank - it could work in your favour if the victim was from the opposing team, but over the course of time, you are left with fewer players than what you started with. But why so? Isn’t it good that the central bank exerts more control? Yes, if they were able to predict accurately how the economy would react to their every move. Unfortunately, they are biased in their interpretations and we are biased in bestowing a large responsibility to them.


As Peter elaborates, central bankers operate with a simple rule - lower rates are better for the economy - but they don’t see the second or third order ramifications of the same. You want more goals this season, so you bring in younger players, but do they have the skills? A lot of this comes from witnessed history. For instance, as Peter points out, Bernanke witnessed the depression and what happened in Japan and felt that central banks did not act fast enough and big enough to course-correct. But what if his underlying assumptions were in itself wrong? Central banks often lay importance to inflation as being the core metric. Japan was deflating, and the banks needed to reduce rates to stimulate the economy. Peter argues that deflation in Japan was more a symptom of the changes in the underlying demographic - more older people and more savers than spenders. No bout of monetary policy would have eased this. More structural changes were needed. Even today, we witness inflation targeting as core to central bank action. This isn’t a bad thing, but what is the ideal target?


Bernanke, in one of his talks, spoke about 0% inflation as the target, but we seldom practice this. The US runs a 2% inflation target, while India runs a target even higher. Peter sides with a 0% long-term inflation target - he alludes to how tech is a leading industry now. Every year, technology is depreciated in value and this forces incumbents to rethink and configure better products with higher value. There is an inherent necessity to add more value when you know your product is going to lose value next year, and so, we witness tech majors outperforming other sectors. Your players are going to age, you need them with better skills next year. Depreciating value is not bad, and a 0% inflation target makes sense - some industries will do well and some will not, but there will be long term price stability, he argues. So, why do we still do a 2% target? With a 2% target, central banks have enough ammunition to drop rates in adverse situations. A cushion at the behest of the entire market.


We did not cut rates this week - 5.15% is our current repo rate. We don’t have a long history of interventions like the US, but we need to study them and be aware of potential pitfalls. Populist measures often trounce prudence - jobs lost in the auto sector could add pressure for rate cuts, but will it increase underlying demand? Or instead, increase jobs in the near term for the government to win another election. A history of lowered rates, is like detonating mines in the opposition for a long time. It could make you complacent and you could take things for granted, akin to allocating money to stocks and bonds because they are seemingly less risky given central bank action. Every rate cut meaningfully pushes up the stock market, as companies can refinance and take on more debt and increase earnings per share, but will their bigger balance sheets support this? What happens, if now, central banks increase rates and blow out your captain in one shot?