Central banks make an historic turn
The historic significance of this month's central bank decisions should now be clear. The Fed has promised to keep printing money until full employment is restored - and it has committed itself to even bolder measures if those announced last week prove inadequate. The ECB has undertaken to "do whatever it takes" to preserve the euro and specifically to buy Spanish and Italian government bonds with newly created euros in unlimited amounts.
In making these announcements, the Fed and the ECB were not just demoting their previously inviolable inflation targets to near-irrelevance. They were breaking intellectual and political taboos that had dominated central banking for four decades. This iconoclasm has prompted an extreme reaction from the one remaining bastion of traditional monetarism in central banking, Germany's Bundesbank. On Tuesday the Bundesbank's president, Jens Weidmann, described the new central banking quite literally as the work of the devil; Mephistopheles, he recalled, had used just such policies to create chaos and hyperinflation in Goethe's Faust.
And indeed, the attempts to use monetary policy to restore full employment will need to overcome the two main objections presented by monetarist theory and repeated his week by the Bundesbank. Will printing more money produce intolerable inflation? And what happens if businesses fail to respond to monetary expansion by creating more jobs - won't that lead to ever more desperate and risky efforts to artificially stimulate employment?
Most of the admonitions against using monetary policies to achieve full employment focus on the risk of unleashing inflation. On this score, the Fed and the ECB have a very credible response, offered most recently from Ben Bernanke and Mario Draghi last week: As long as unemployment and industrial excess capacity remain anywhere near present levels, generalized inflation is very unlikely. Even if some commodities, such as oil or food, experience inflation, this will be offset by others goods and services whose prices fall.
The more insidious danger is that the Fed will simply fail in its efforts to stimulate job creation and accelerate economic growth. Disappointment was, after all, the outcome of the last two rounds of QE. So why should this one be any different, even if the Fed keeps increasing the amount of new money printed? This is the troubling question that Bernanke has so far failed to answer or even seriously confront.
David Fuller's view I will always have a soft spot for a central banker who knows his opera. Regarding the future inflation risk created by QE, I do not agree that "the Fed and ECB have a very credible response…" The inflation which most people are experiencing is occurring in the cost of their daily, weekly and monthly living expenses. This is not offset by technology-related declines in prices for manufactured consumer goods which only need replacing once every few years. Also, as purchasing power continues to decline as a consequence of excessive money printing, the inevitable result will be more upward pressure on prices of goods and services. Lastly, I struggle to think of services which have fallen in value relative to those where the cost has increased in recent years.
I certainly do not fault Mr Bernanke for following the full employment side of his mandate, but I do not think it will work, for two reasons: 1) globalisation will continue to ensure that many jobs flow to countries where labour is less expensive, less unionised, and where government costs from healthcare to regulation are less onerous; 2) manufacturing assembly, distribution and even clerical jobs will increasingly be undertaken by robots.
The US and other governments could address their unemployment problems with the productive rebuilding of deteriorating or inefficient infrastructure. Education could certainly be improved, not least regarding skills which businesses require but for which they cannot find sufficiently qualified workers locally. Governments could also provide funding for more cutting-edge research projects with demonstrable commercial potential.
I believe Milton Friedman was right: "Inflation is first and foremost a monetary phenomenon." The current fashion for neo-Keynesian stimulus has not altered the logic behind Friedman's truism. Any investor who understands this will most likely hold some gold.
So far and logically, QE also remains a tailwind for equities when indices are broadly in an overall upward trend and it should help to cushion downside risk when they are generally weaker.