There was a time when the world’s leading central bankers could set off market alarms by unexpectedly shifting policy gears. Their typically guarded, opaque comments turned veteran analysts into the Street’s version of Bletchley Park code-breakers, parsing sentence fragments for possible clues about slight changes in direction.
Soon after taking the helm of the Federal Reserve in 1987, Alan Greenspan made a rare appearance on a popular Sunday morning TV news program. There were no signs of inflation, he declared, but that could change. What about interest rates? The Fed might have to hike. But then again, it might not. Asked later how he thought he had fared, he responded: “I’m not allowed to say.”
But then along came a new wave of media-savvy central bankers like Canada’s (and now Britain’s) Mark Carney, the Fed’s Ben Bernanke and others who promised and sought to deliver greater transparency and fewer surprises. Mr. Carney’s trademark policy of providing clear forward guidance, linking future rate moves to specific targets, caught on. The goal was to make it clear that monetary policy, for example, would remain loose for a long time and that market players, borrowers and lenders should behave accordingly.
But as Mr. Bernanke and other Fed policy-makers discovered last week, it’s still possible to confound expectations and catch markets by surprise, even when following the right script and doing nothing.
The communications breakdown that triggered last week’s uproar began earlier this year when Mr. Bernanke set out the essential conditions – sturdier economic data, improved job numbers – for the eventual reduction of the Fed’s unprecedented bond purchases. But the message that reached the markets – aided and abetted by critics of the biggest monetary stimulus in history, including some Fed regional bank chiefs – was that tapering was imminent. The great quantitative easing experiment would soon be over. In response, long-term U.S. bond yields shot up and money poured out of riskier assets around the world.
Then came the September surprise. The Fed would not be trimming its monthly purchases of $85-billion (U.S.) worth of assets a month, and any future tapering would depend on “what’s needed for the economy.”
The upshot was a flood of capital back into bonds, equities, foreign currencies and gold. By the end of the week, markets showed signs of cooling again, at least partly because what Mr. Bernanke and the Fed were trying to say last Wednesday had begun to sink in: The U.S. economy isn’t in good enough shape yet to remove even a few strands of the monetary safety net.
Not everyone was surprised by this development.
The market reaction “once again reveals the degree to which mainstream analysts have overestimated the strength of our current economy,” famously bearish U.S. investor Peter Schiff wrote in a commentary. “The Fed understands, as the market seems not to, that the current ‘recovery’ could not survive without continuation of massive monetary stimulus.”
To say Mr. Schiff and other harsh critics are no fan of Mr. Bernanke’s performance would be putting it mildly.
“I knew that when they first started doing QE that they would never stop. Because I knew it wouldn’t work,” Mr. Schiff, CEO of Connecticut-based Euro Pacific Capital, told me during a recent Toronto visit. “Which is why they’re not going to taper. They can’t come out and admit that, so they pretend that they’re going to. Just like they used to pretend they had an exit strategy. Now they don’t pretend any more. They’re never going to sell those bonds.”
He likens the Fed’s monetary policy to a jetliner, with Mr. Bernanke in the pilot’s seat. “He knows how to take off and he knows how to fly. … But he never learned how to land. He can’t tell the passengers, because they’ll panic. So he has to make excuses. Meanwhile, he’s trying to look through manuals. The problem is there’s a limited amount of fuel, so he can’t procrastinate forever.”
Mr. Schiff has been singing from this gloomy songbook for years. Like several other prominent doomsters, he traces the Fed’s policy dilemma back to Mr. Greenspan and his aggressive monetary easing in the wake of the 1987 market crash, which eventually led to a series of dangerous asset bubbles.
He was early in predicting the 2008 financial crash. But he went further than most, warning that the debt-ridden U.S. economy would become mired in recession, the currency would collapse, interest rates would shoot up and hyper-inflation would cast a dark shadow over the land.
Mr. Schiff acknowledges that certain segments of the U.S. economy are doing well, citing the oil industry and a handful of tech players. And the perpetual gold bug remains as high as ever on the yellow metal, citing the drop in price as a buying opportunity.
“The problem is that the bright spots [in the U.S. economy] are outnumbered by the dark spots. The economy needs to be allowed to restructure. It’s going to be painful for a lot of individuals and it’s certainly going to be painful for politicians. They may not survive that, because during those tough years, there are going to be elections.” So Washington’s survival instincts dictate postponing the inevitable reckoning, “even if it means that the [eventual] pain is worse.”
So far, Mr. Schiff has been wrong. But it’s good to know that his sunny pessimism hasn’t changed.