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: How Markets Fail?

 

Yearning for the Miracle Man

Pervez Hoodbhoy in The Dawn


After rough weather and stormy seas battered the country for three quarters of a century, a nation adrift saw two miracle men arise. Separated by 50 years and endowed with magical personalities, Zulfikar Ali Bhutto and Imran Khan set the public imagination on fire by challenging the established order.

After Bhutto was sent to the gallows, many PPP jiyalas self-flagellated, with several immolating themselves in despair. Till their fiery end, they believed in a feudal lord’s promise of socialist utopia. Similar horrific scenes occurred after the assassination of his charismatic daughter. That the father was instrumental in the break-up of Pakistan, and that during the daughter’s years Pakistan fell yet deeper into a pit of corruption, left jiyalas unfazed. Today’s Sindh remains firmly in the grip of a quasi-feudal dynasty and the Bhutto cult.

But still worse might lie ahead as Imran Khan’s cult goes from strength to strength. Writing in Dawn, Adrian Husain worries that a matinee idol with a freshly acquired messianic status is skillfully exploiting widespread anger at corruption to sow hate and division among Pakistanis. Fahd Husain evinces alarm that PTI’s flag-waving ‘youthias’ can see no wrong in whatever Khan says or does. He wonders why even those with Ivy League degrees put their rational faculties into deep sleep. Conversing with PTI supporters, says Ayesha Khan, has become close to impossible.

What enabled these two men to command the senseless devotion of so many millions? Can science explain it? Forget political science. The dark secret is that this isn’t really a science. So, could neuroscience give the answer? Although this area has seen spectacular progress, it is nowhere close to cracking the brain’s inner code.

Instead one must turn to the animal kingdom. Gregariousness and suppression of individuality helps protect members of a species because leaders give direction in a difficult environment. But there is a downside. Herds of sheep are known to follow their leader over a cliff and self-destruct. Human groupies have done similarly.

Specific social attitudes — groupthink and its diametrical opposite, scepticism — explain why some societies crave messiahs while others don’t. At one level, everyone is a sceptic. When it comes to everyday life — where to invest one’s life’s savings, what food to eat, or which doctor to see for a serious health problem — we don’t simply believe all that’s told to us. Instead, we look around for evidence and are willing to let go of ideas when contrary evidence piles up. But in political and religious matters, open-mindedness often turns into absolutism.

Absolutism has made Pakistani politics less and less issue-oriented and more and more tribal. It is hard to tell apart PML-N or PPP from PTI on substantive matters such as the economy, foreign debt, or relations with neighbouring countries. The only certainty is that the government in power will blame the previous government for everything.

This absolutism makes most party supporters purely partisan — you are with us or against us. Zealots willingly believe accusations aimed at the other side but dismiss those aimed at their own. A rational PTI supporter, on the other hand, will entertain the Toshakhana as possible evidence of wrongdoing just as much as Surrey Palace or Avenfield Apartments. He is also willing to admit that all Pakistani political leaders — including Khan — have lifestyles at odds with their declared assets and income. Rational supporters who can say ‘yeh sub chor hain’ exist but are few.

Instead, a culture of intellectual laziness feeds upon wild conspiracy theories coupled with unshakeable belief that political destinies are controlled by some overarching, external power. The ancient Greeks believed that the world was run by the whims and desires of the great god Zeus. For the PTI zealot, the centre of the universe has shifted from Mount Olympus to Washington.

In the zealot’s imagination, an omnipotent American god sits in the White House. With just the flick of his wrist, he ordered Imran Khan’s (former) military sponsors to dump him and then stitched together his fractured political opposition into organising a no-confidence vote. Of course, everyone dutifully obeyed orders. And this supposedly happened inside one of the world’s most anti-American countries! But we know that pigs can fly, don’t we? (Incidentally, America’s severest critic for over 60 years, Noam Chomsky, has reportedly trashed Khan’s claim of a regime change conspiracy.)

Fortunately, not all who stand with a political party, PTI included, are zealots. They do recognise that the country’s entire political class is crass, corrupt, self-seeking, and puts personal interest above that of the electorate. Knowing this they choose a party that, in their estimation, is a lesser evil over a greater one. Democracy depends on this vital principle.

To see this, compare the mass hysteria generated by Khan after being voted out of office with the calmness that followed France’s recent elections. Though despised by the majority of those who voted for him, Macron won handsomely over Marie Le Pen, his far-right, Islamophobic opponent. To her credit, Le Pen did not attribute the defeat either to Washington or to a global Islamic conspiracy. That’s civilised politics.

Why democracy works for France but has had such a rough time in Pakistan is easy to see. It’s not just the military and its constant meddling in political affairs. More important is a culture where emotion and dogma shove truth into the margins. What else explains the enormous popularity of motivational speakers who lecture engineering students on methods to deal with jinns and other supernatural creatures?

Pakistan’s education system stresses faith-unity-discipline at the cost of reason-diversity-liberty. This has seriously impaired the ordinary Pakistani’s capacity to judge. Even in private English-medium schools for the elite, teachers and students remain shackled to a madressah mindset. Why be surprised that so many ‘youthias’ are burger bachas? Unless we allow children to think, the yearning for Miracle Man will continue. It will long outlast Imran Khan — whenever and however he finally exits the scene.

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