Sailboat racing is very much like Central Banking’. It is always about choices: starboard or port, right or left, higher or lower (prioritize angle or speed). A sailboat racer must be ambivalent; good reasons impel us to do one thing, but other reasons may compel us to do the other.
Just like Central Bankers, when racing, sometimes you have all the choices available, and some you don’t. In order to have complete freedom of choice, you have to be in a good position. Unfortunately it is the nature of the game that all sailboat racers have spent more time in the middle of the fleet, than they would care to admit. It could have happened because we were not the fastest boat in our group (one of the problems with handicap racing). Alternatively it could have been a bad choice of the side to sail in the first beat. Or it could well be inadequate sail trim, generating below polar boatspeed. Maybe it was just a bad start or, worse yet, a full OCS (translated: an early start makes you go around the start line again). When various factors accumulate, your choices become limited. When you hit the layline, you have run out of them. Most of the CB’s are sailing their starboard laylines right now.
In the economy, the same situations apply. An economic system is much like a sailboat racing environment. It has to deal with structures of essential complexity whose characteristic properties can be exhibited only by DSGE models with large numbers of variables. It is also a system, as Hayek once said, of “organized complexity”. Events are not only determined by the properties of the individual elements that concur, but also on the manner in which the individual elements are connected with each other. Our tactics when racing condition the tactics of the rest. It is not all about the pure physical interaction of boat speed, wind, and currents. Every economic decision has not only objective direct implications on other variables (lagged or not), but game theory implications on the conduct of the other participants as well.
Central Banks are a substantial part of the economic system. They have climbed the ladder of economic relevance all the way up to a regrettable point -they are the only game in town. Their actions condition the reactions of the rest of the economic agents. Furthermore, they also condition the actions of the other Central Banks.
Sail tactics when you are first.-
On occasions you round the the weather leg mark first. Most frequently, the first portion of the inmediate run will look like a long line of boats. Everyone rounds the windward mark on starboard tack, sets the spinnaker, and then points their bow right at the transom of the boat ahead of them.
Alan Greenspan inherited this wonderful situation at the Fed. Paul Volcker passed the baton when inflation had been definitely beaten, and debt, both public and private, was growing, but still near levels that had been acceptable over the last century. He got off to a rough start (the October 87 crash), but was clearly in charge and leading the pack downwind. You can see his position in the previous chart. Take a close look at the initial stages of outstanding credit, relative to GDP.
The head boat is in an enviable position—everyone wants to be in front—but it also means making a difficult decision: how and when to jibe, and head back toward the center of the course.
The old saxophonist was late to realize he was overstaying the starboard tack of “easy money”. Only in 1996, nearly ten years later, he seemed to consider the option of jibing. He then pronounced those in-famous words: “irrational exuberance”. It was, in retrospect, the obvious moment to jibe, and head for the center of the course (if not the other side). It was the moment to realize that easy money not only generates inflation but also entices speculation and grows malinvestment (ask China or Spain). To admit that it bloats the financial sector, and generates bubbly markets. It was the moment to find out that inflation was a concept that could very well show in prices of consumer goods … or in the prices of listed investment products. It was a time to consider the disadvantages of propelling the Nasdaq to the aberrant 5000 level.
We all know how the story ended only four years later. From then on, he was no longer the first boat downwind, and had begun a new weather leg in the course. We all make bad choices, but that was a terrible misjudgment indeed.
In China, towards the end of the century, Deng Xiaoping was getting nearly everything right. In his quest to emulate Singapore’s economic success, he engineered a difficult exit from communism, and made China progress substantially in all fronts. Initial growth, generated from the animal spirits induced by the new capitalistic opportunities, needed a round of infrastructure spending to reduce evident structural growth constraints. And thus he began what Michael Pettis labels as the “Gershenkron” period.
They were the first boat downwind. It was time to consider a jibe. It was time to prevent the overheating of an economy driven, from then on, by the twin engines of exports and infraestructure credit financed spending. He controlled the PBOC and the banking system as as well. It was easy to decide to counteract evident fiscal expansion with some monetary tightening and credit growth control.
He held all the choice spectrum. But he shouted to his crew: “We’ll hold this jibe!” ¡Growth was so sweet! The wrong decision. Too much of a good thing is never a good thing after all. From then on, he grew the country, but it was the last, end of the year, solid balance sheet for them. And his future choices were severely diminished. Dear Mr. Xiaoping, at that point it was not about prioritizing speed (growth) any more, it was about jibing to the other side of the course. Even great men make substantial mistakes.
The BOJ has been playing conditioned racing tactics ever since the 1990 stock, and sequential real estate, crash. They also got their chance to jibe in their high times, the low eighties, when the Japanese bubble was just beginning. They squandered their jibe choice, when they had them all available. They also overstayed the downwind starboard course of “easy money”.
There has to be something to that downwind starboard side that attracts everybody. Casino players never know when to go home. Central Bankers never find the right moment to take the punch bowl away. Nobody likes to spoil the party.
In Europe, the decision to implement the euro, and the simultaneous birth of the ECB, was the crucial moment in which to plan for the sailing race, with all options available. We Europeans could opt for a pin or committee start, and protect whichever side of the beat we thought best. But our politicians messed it up. It was an OCS call.
I am of the view that a shared common currency, with individual separate economies, is viable. But you must control credit growth and credit levels, beggar thy neighbor policies, and subsequent cross border credit. Most importantly, the ECB would have to minimize the use of monetary policy as a tool to stimulate the economy, because different countries would have different needs at different times. With the benefit of hindsight, it was a great chance to get a Central Bank doing the right thing; running a stable currency with few, if any, monetary amphetamines. And that’s what the ECB tried to do. It has clearly been the most orthodox central bank in the race (until today).
But the ECB never got off to a clean start. The European problems were not their fault; they found themselves in the middle of the fleet.
They might have made the same mistake as the rest of the Central Banks. But European politicians messed it all up beforehand.
Sail tactics when you find yourself in the middle of the fleet.-
For the US, it was all “middle of the pack” racing tactics after Alan decided to remain oblivious to irrational exuberance. Available choices decreased daily from then on. After the year 2000 crack, they realized that the consequences of their mistake would be severe. It was a clear cycle end, and the moment to pay for the wrong decision in 1996. They decided not to do so. It was the second big mistake, but certainly conditioned by the previous one.
When markets blew it all up, in 2008, they FED was up against an even poorer prognosis. This last time, the banking system had been affected both by credit growth, and credit quality degradation, to the point that the whole financial system’s stability was at stake. Trillions in unsettled and unknown OTC derivatives made matters worse. When they decided QE1, they really had no other option. They had overstayed the starboard jibe with no windshift to be seen. They had hit the starboard layline (extreme end of the course) and lost all viable alternative options. Q2 and Q3 were to follow suit.
In China, by 2008, all of Xiaoping’s cards had been played. When the GFC hit, he decided again to go for growth at all costs (validating Einsteins definition of insanity), doubling up on infrastructure spending, and feeding the real estate boom, providing trillions of dollars of fake additional money vía credit expansion.
It was the wrong decision, at least from a local point of view, but if we see this from a global perspective, we all owe him a favour. With his massive credit expansion, he enabled the global desperate bid for banking stability. He bought us all some extra time. China will pay a hefty price for that.
In Europe the ECB was only the bartender, they weren’t really in control of what was going on. Some silly Spanish municipalities decided to build airports and sport centers on credit, and some equally silly German banks and enterprises decided to finance them -in order to support the activity of their export markets (subordinated, captive aggregate demand). Many Spaniards decided to lease BMW´s, and Deutsche and Dresdner Bank decided to fund those sales. More of the same everywhere else. The French took the opportunity to further bloat their “super welfare no toil” state. From then on the relation between the north and the periphery was that of a marriage with four children and a huge mortgage monthly payment. They needed sex twice a week to keep going when they lost the groove. We are all caught in a creditor debtor high stakes game, and unable break up in an orderly fashion.
After the GFC hit in 2008, the ECB continued to play a secondary role in the race. They had not joined the long starboard side jibe of the rest of the fleet, and stuck to the mid-course area. They combined some easy money when needed, with and orthodox approach to central banking. Initially they even thought that the GFC was a USA local issue, that had nothing to do with Europe (when people want to be blind, they can manage to see nothing at all. Ask residents in Sicily).
When they saw things deteriorate rapidly, they tried everything they could, but never really stood a chance. Other Central Banks played the limits of the course, printing and abusing currency markets. They chickened out and were unable to temper credit growth, because they really did not control the different banking systems in the different countries. They should have tightened rates, but the price to pay for that -both politically and for the weighted exchange rate of the euro- was too high. They did not generate a bubble, but they were unable to fight disequilibriums. Their political environment, and the economic situation of their shareholders, created an impossible task for them.
In Japan, the BOJ continued with its middle of the fleet sailing tactics, and was surprised by the appreciation of the yen -induced by the risk-on environment after 2008. The yen went all the way from 110 to 75 yen per dollar ( a 30%+ appreciation of their currency in less than three years). That was the proverbial nail in the coffin for them. Brainless investors bid the JPY as a safe haven (a country with a 250%+ debt/GDP, massive public deficits, and stagflation for nearly 20 years). The BOJ chugged along, sailing near the layline for nearly four years. They had limited options available by then. They tried to talk down the JPY, but it didn’t work.
Sailing tactics when you are last or sailing the layline.- (aka desperate survival techniques)
In China today, they cannot possibly grow credit much more, they cannot improve exports (the developed world is stagnant), the yen devaluation is hurting their competitiveness, their malinvestments are coming to haunt them, and the real estate sector is imploding. The PBOC is the last tool left to keep things running smoothly, in spite of the malinvestment and real estate disaster that is now evident if you visit the country. They are well past the layline. Printing, lowering rates, or expanding credit is the last resort. Last week they lowered interest rates. It was not substantial, but they are playing with fire. Bankruptcies are just around the corner. The consequences of a hard landing will be very severe. They will do their best to postpone/avoid it. They are in a chronic economic DEFCON 2 situation.
The Japanese are desperate as well. After Fukushima, they further deteriorated their position. Abenomics is, similar to Syriza or Le Pen, but in a civilized bundle with three arrows painted in the cover.
The BOJ board are now permanently sitting on top of the panic button. Some symptoms of panic begin to emerge. Decisions are far from consensual, and ex BOJ officials suggest in private that there is no way out. They will never get away with what they are doing. They will default on their debt, but will try to survive for as long as possible.
I would not like to sit in Dragui’s chair. He is better off than Japan but ¡he has to try and convince both the north and the south! The PR department should be boosted to the thousand job mark. Trying to keep everybody together, in a desperate all in-er QE strategy, must be somewhere close to hell. Europe needs nominal GDP growth in order to keep debt sustainability expectations above the water mark. Politically the pressure is all too evident; Podemos, Syriza, Le Pen, UKIP, AfD, and others are profiting from the nightmarish scenario. With NIRP already working, he has to jawbone the currency down, print as fast as possible, and hope for the best. Some sincere praying would help.
The US is the cleanest dirty shirt. They hit the layline with QE3, but they are now finished, and US markets are stable. They have still got some options left. Bullard uses them conceptually on a weekly basis, applying in all merit for the title of “the most inconsistent central banker of the world”. They are the only wild card left. The rest will print to death.
Janet told the republicans printing would stop. ¿Would she restart it again, given the case? I do not think so, Winston Churchill famously said you can always count on the Americans to do the right thing, but only after they have exhausted all the alternative options. I am not totally sure though. The long tentacles of Princeton economics are still there.
CB’s are in panic mode, but they are powerful. They cannot consent a system break down, and are unable (the market does not allow them to do so) to take a glide path to monetary “uncommon sense”. We have to wait. Sooner or later, something’s gotta give.