The Fed Chair must acknowledge that free money has made asset prices unsustainably high

Gillian Tett in The FT 

This week financiers’ eyes have been firmly fixed on the Federal Reserve. No wonder. On Wednesday the US central bank raised rates at the most aggressive pace for 22 years, as Jay Powell, Fed chair, finally acknowledged the obvious: inflation is “much too high”. 

But as investors parse Powell’s words, they should spare a thought for a central bank on the other side of the world: the Reserve Bank of New Zealand. 

In recent years, this tiddler has often been an unlikely harbinger of bigger global trends. In the late 20th century, for instance, the RBNZ pioneered inflation targeting. More recently, it embraced climate reporting ahead of most peers. 

Last year, it started tightening policy before most counterparts. And this week it went further: its latest financial stability report warns of a “plausible” chance of a “disorderly” decline in house prices, as the era of free money ends. 

Unsurprisingly, the RBNZ also said it hopes to avoid a destabilising crash. But the key point is this: the Kiwi central bankers know they have an asset bubble on their hands, since property prices have jumped 45 per cent higher in the last two years and “are still estimated to be above sustainable levels”. This reflects both ultra-low rates and dismally bad domestic housing policies. 

And it is now telling the public and politicians that this bubble needs to deflate, hopefully smoothly. There is no longer a Kiwi “put” — or a central bank safety net to avoid price falls. 

If only the Fed would be as honest and direct. On Wednesday Powell tried to engage in some plain speaking, by telling the American people that inflation was creating “significant hardship” and that rates would need to rise “expeditiously” to crush this. He also declared “tremendous admiration” for his predecessor Paul Volcker, who hiked rates to tackle inflation five decades ago, even at the cost of a recession. 

However, what Powell did not do was discuss asset prices — let alone admit that these have recently been so inflated by cheap money that they are likely to fall as policy shifts. 

A central bank purist might argue that this omission simply reflects the nature of Powell’s mandate, which is to “promote maximum employment and stable prices for the American people”, as he said on Wednesday. In any case, evidence about the short-term risk of asset price falls is mixed. 

Yes, the S&P 500 has dipped into correction territory twice this year, with notable declines in tech stocks. However, the American stock indices actually rallied 3 per cent on Wednesday, after Powell struck a more dovish tone than expected by ruling out a 75 basis point rise at the next meeting. 

And there is no sign of any fall in American property prices right now. On the contrary, the Case-Shiller index of home prices is 34 per cent higher than it was two years ago, according to the most recent (February) data. 

However, it beggars belief that Powell could crush consumer price inflation while leaving asset prices intact. After all, one key factor that has raised these prices to elevated levels is that the Federal Reserve’s $9tn balance sheet almost doubled during the COVID-19 pandemic (and has expanded it nine-fold since 2008.) 

And, arguably, the most significant aspect of the Fed’s decision on Wednesday is not that 50bp rise in rates, but the fact that it pledged to start trimming its holdings of mortgages and treasuries by $47.5bn each month, starting in June — and accelerate this to a $90bn monthly reduction from September. 

According to calculations by Bank of America, this implies a $3tn balance sheet shrinkage (quantitative tightening, in other words) over the next three years. And it is highly unlikely that the impact of this is priced in. 

After all, QT on this scale has never occurred before, which means that neither Fed officials nor market analysts really know what to expect in advance. Or as Matt King, an analyst at Citibank, observes: “The reality is that tightening hasn’t really started yet.” 

Of course, some economists might argue that there is no point in the Fed spelling out this risk to asset prices now, given how this might hurt confidence. That would not make Powell popular with a White House that is facing a difficult election, Nor would it help him achieve his stated goal of a “soft” (or “softish”) economic landing, given that consumer sentiment has wobbled in recent months. 

But the reason why plain speaking is needed is that a dozen years of ultra-loose policy has left many investors (and households) addicted to free money, and acting as if this is permanent. Moreover, since the Fed has repeatedly rescued investors from a rapid asset price correction in recent years — most recently in 2020 — many investors have an innate assumption that there is a Fed “put”. 

So if Powell truly wants to emulate his hero Volcker, and take tough measures for long-term economic health, he should take a leaf from the Kiwi book, and tell the American public and politicians that many asset prices have been pumped unsustainably high by free money. 

That might not win him fans in Congress. But nobody ever thought it would be easy to deflate a multitrillion dollar asset price bubble. And the Fed has a better chance of doing this smoothly if it starts gently and early. Wednesday’s rally shows the consequences of staying silent.

Inflation falls to 0%: what does it mean for the UK economy?

With average earnings growing by just under 2%, living standards should rise and interest rates should remain low but it’s not all good news

Larry Elliott in The Guardian

Britain is within a month of a period of deflation. When the figures for March come out next month lower energy bills mean that the cost of living will be lower than it was a year earlier.

These are uncharted waters for the UK, at least in the modern era. There have been times when inflation has turned negative but they have been few and far between since the second world war, and there have been none since the move to the consumer prices index as the preferred yardstick.

The general assumption is that this is good news, for two reasons. The first is that the fall in inflation boosts living standards, because wages are rising faster than prices. Wages have risen extremely slowly since the recession of 2008-09 and even against a backdrop of falling unemployment are currently only going up by 1.6% a year.

But the sharp drop in oil prices in the second half of 2014 has pushed inflation lower and meant those modest wage increases now stretch further. This is clearly welcome news for the government, eager to fend off Labour’s accusation that the coalition has presided over a cost-of-living crisis. The opposition will say that the recent increase in living standards does not make up for the earlier falls.

The second boost to consumers comes from the outlook for interest rates. It will come as no surprise to the Bank of England that inflation now stands at zero, and the Bank’s governor, Mark Carney, has said it would be “foolish” to cut the cost of borrowing in response to what is thought to be a temporary fall in commodity prices.

That said, the Bank is not going to be in a hurry to raise rates either. All nine members of the Bank’s monetary policy committee are in favour of official interest rates remaining at 0.5%, which is where they have been since early 2009. They look like remaining there for the rest of this year, and one MPC member – Andy Haldane, the Bank’s chief economist – says he can contemplate voting to cut borrowing costs.

That’s because there’s a potential dark side to the fall in inflation, namely the risk that it becomes a permanent feature of the economic landscape. The reason the majority of economists view February’s zero inflation as benign is because they think lower unemployment will put upward pressure on wage settlements. Higher pay deals will start to push up inflation at a time when last year’s drop in oil prices starts to unwind. There is, on this view, little prospect of deflation becoming embedded, as it did in Japan.

This, though, assumes that wage settlements are not dragged lower by the drop in inflation. The fact that average earnings are growing at an annual rate of below 2% even after two years of a relatively robust period of growth is indicative of a labour market where employers are able to secure workers cheaply. They may be tempted to be even less generous once inflation goes negative.

Food banks in the UK: cowardly coalition can't face the truth about them

Conservatives cannot admit a real fear of hunger afflicts thousands

• 
• • Nick Cohen
  • The Observer, Saturday 28 December 2013 18.29 GMT

Donated food at a a food bank. Photograph: Christopher Thomond for the Guardian

I went to the Trussell Trust food bank round the corner from the Observer's offices just before Christmas. If I hadn't been reading the papers, I would have assumed it represented everything Conservatives admire. As at every other food bank, volunteers who are overwhelmingly churchgoers ran it and organised charitable donations from the public.

What could be closer to Edmund Burke's vision of the best of England that David Cameron says inspired his "big society"? You will remember that in his philippic against the French revolution, Burke said his contemporaries should reject its dangerously grandiose ambitions , and learn that "to love the little platoons we belong to in society, is the first principle (the germ, as it were) of public affections". Yet when confronted with displays of public affection – not in 1790 but in 2013 – the coalition turns its big guns on the little platoons.

It would have been easy for the government to say that it was concerned that so many had become so desperate. This was Britain, minsters might have argued, not some sun-beaten African kleptocracy. Regardless of politics, it was a matter of common decency and national pride that Britain should not be a land where hundreds of thousands cannot afford to eat. The coalition might not have meant every word or indeed any word. But it would have been in its self-interest to emit a few soothing expressions of concern, and offer a few tweaks to an inhumanely inefficient benefits system, if only to allay public concern about the rotten state of the nation.

But the coalition is not even prepared to play the hypocrite. Iain Duncan Smith showed why he never won the VC when he was in the Scots Guards when he refused to face the Labour benches as the Commons debated food banks on 18 December. He pushed forward his deputy, one Esther McVey, a former "TV personality". All she could say was that hunger was Labour's fault for wrecking the economy. She gave no hint that her government had been in power for three years during which the number attending food banks had risen from 41,000 in 2010 to more than 500,000. Her remedy was for the coalition to help more people into work.

If she had bothered talking to the Trussell Trust, it would have told her that low-paid work is no answer. Its 1,000 or so distribution points serve working families, who have no money left for food once they have paid exorbitant rent and fuel bills.

But then no one in power wants to talk to the trust. As the Observer revealed, Chris Mould, its director, wrote to Duncan Smith asking if they could discuss cheap ways of reducing hunger: speeding up appeals against benefit cuts; or stopping the endemic little Hitlerism in job centres, which results in unjust punishments for trivial transgressions. In other words, a Christian charity, which was turning the "big society" from waffle into a practical reality, was making a civil request. Duncan Smith responded with abuse. The charity's claims to be "non-partisan" were a sham, he said. The Trussell Trust was filled with "scaremongering" media whores, desperate to keep their names in the papers. But he had their measure.

Oh, yes. "I understand that a feature of your business model must require you to continuously achieve publicity, but I'm concerned that you are now seeking to do this by making your political opposition to welfare reform overtly clear."

Ministers will not confess to making a mistake for fear of damaging their careers. But it is not only their reputations but an entire world view that is at stake. Put bluntly, the Conservatives hope to scrape the 2015 election by convincing a large enough minority that welfare scroungers are stealing their money. They cannot admit that a real fear of hunger afflicts hundreds of thousands. Hence, Lord Freud, the government's adviser on welfare reform, had to explain away food banks by saying: "There is an almost infinite demand for a free good."

My visit to the food bank showed that our leaders' ignorance has become a deliberate refusal to face a social crisis. Of course, the volunteers help working families and students as well as the unemployed and pensioners. Everyone apart from ministers knows about in-work poverty. As preposterous is the Tory notion that the banks are filled with freeloaders.

You cannot just swan in. You get nothing unless a charity or public agency has assessed your need and given you a voucher. The trust is at pains to make sure that the beggars – for hundreds of thousands of beggars is what Britain now has – receive a balanced diet. To feed a couple for five days, it gives: one medium pack of cereal, 80 teabags, a carton of milk, two cans apiece of soup, beans, tomatoes and vegetables, two portions of meat and fish, fruit, rice pudding, sugar, pasta and juice. That this is hardly a feast is confirmed by the short list of "treats", which, "when available", consist of "one bar of chocolate and one jar of jam".

Sharon Cumberbatch, who runs the centre, tells me that she is so worried that shame will deter her potential clients that she packages food in supermarket bags so no one need know its source. The clients, when I met them, reinforced her point that they were not the brazen freeloaders of Tory nightmare. They trembled when they told me how they did not know how they would make it into the new year.

Most of all, it was the volunteers who were a living reproof to a coalition that can cannot correct its errors. They not only distribute food but collect it. They stand outside supermarkets all day asking strangers to buy the tinned food they need or hand out leaflets in the streets or plead with businesses to help. Sharon Cumberbatch is unemployed but she works to help others for nothing. Her colleagues said they manned the bank because hunger in modern Britain was a sign of a country that was falling apart. Or as one volunteer, Richard Moorhead, put it to me: "I am gobsmacked that people are going hungry. I'm ashamed."

The coalition can call such attitudes political if it wants – in the broadest sense they are. But they are also patriotic, neighbourly, charitable and kind. They come from people who represent a Britain the Conservative party once claimed a kinship with, and now cannot bring itself to talk to.