Investors fear Fed’s outdated theories have hit sell-by date

Financial Events


Index Jun16These are difficult times for companies and investors.  It is becoming more and more apparent that central bank stimulus policies have failed to counter today’s demand deficit, caused by ageing populations.  It is also clear that central bankers themselves have little idea of what is happening in the real economy.

They have based their programmes on outdated and unreliable theories from former gurus such as Milton Friedman and Franco Modigliani:

  • Friedman didn’t realise that a BabyBoom was taking place when he developed his theory that “inflation is always and everywhere a monetary phenomenon”.  He therefore confused cause and effect, as hindsight tells us it was clearly excess demand from the young Boomers – when supply was literally “bombed-out” after World War 2 – that caused the inflationary problems of the 1960s/1970s
  • Modigliani’s lifecycle consumption theory was similarly flawed.  His view that people would even out their consumption in the best possible manner over their lifetimes appeared to make sense in the 1950s, when most people died before or close to pension age.  But it makes no sense at all when 65-year old Western pensioners now have 20 years of unexpected life expectancy ahead of them

Both Friedman and Modigliani can be forgiven their mistakes, as there was no reliable data at the time they were working, to explain the errors in their thinking.  But today’s central bankers have no such excuse.  Western fertility rates have been below the replacement level of 2.1 babies/woman since 1970 – making it obvious that spending and hence economic growth would slow, and then probably decline, as the Boomers moved into retirement.  And slowing demand would automatically reduce inflation, no matter what they did to the monetary supply.

Investors have chosen to ignore these factors until recently.  Instead they have taken advantage of the free cash available from central banks to boost the prices of financial assets – whether these were commodities such as oil and copper, or houses or stocks and shares.  But all good things come to an end.  And they are becoming unpleasantly aware that if central banks really don’t know what is happening in the real economy, then populist solutions provided by Donald Trump or Brexit leaders may end up causing chaos in their markets.

We saw these first signs of doubts on Friday, when the major decline in US jobs growth – which fell back to 2010 levels – clearly shocked the US Federal Reserve.  But far from celebrating the potential for new stimulus programmes, investors pushed US share prices down for the day.

This new caution is also reflected in this month’s Boom/Gloom Index above.  It has fallen back again after the euphoria that followed the Fed’s decision to back off the promised interest rate rise in March. Now, I suspect, many investors would prefer an increase to come quickly, to reassure them that recovery was still possible.

It could be a long and difficult summer, particularly if the Leave campaign maintains its current opinion poll lead into the vote itself – now less than 3 weeks away.  Attention is also shifting to the potential implications of a narrow Remain vote for the ruling Conservative Party.  Many believe the Party could split if this occurred, such has been the bad feeling during the campaign.  This could end up handing the keys for 10 Downing Street to the opposition Labour Party.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 52%
Naphtha Europe, down 52%. “The loss of naphtha supply from French refineries has been offset by loss of naphtha demand from French crackers”
Benzene Europe, down 57%. “a steady flow of imports into Europe since the start of 2016 have kept the market well supplied.”
PTA China, down 41%. “Demand from spot buyers in the market was also lower, as the peak seasonal demand has started dipping”
HDPE US export, down 29%. “China’s market outlook is cautiously negative due to expectation of increased supply”
¥:$, down 4%
S&P 500 stock market index, up 7%


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