Commodity spike queers the pitch for Bernanke’s QE2
by Ambrose Evans-Pritchard
Originally published 08 August 2010
DON’T BE FOOLED: A FOOD AND OIL PRICE SPIKE IS NOT AND CANNOT BE inflationary in those advanced industrial economies where the credit system remains broken, the broad money supply is contracting, and fiscal policy is tightening by design or default.
It is deflationary, acting as a transfer tax to petro-powers and the agro-bloc. It saps demand from the rest of the economy. If recovery is already losing steam in the US, Japan, Italy, and France as the OECD’s leading indicators suggest – or stalling altogether as some fear – the Eurasian wheat crisis will merely give them an extra shove over the edge.
Agflation may indeed be a headache for China and India, where economies have over-heated and food is a big part of the inflation index. But the West is another story.
Yields on two-year US Treasury debt fell last week to 0.50pc, the lowest in history. Core US inflation is the lowest since the mid-1960s. US business inflation (pricing power) is at zero. Bank lending is flat and securitised consumer credit has collapsed from $900bn to $240bn in the last year. Hence the latest shock thriller – “Seven Faces of Peril” by James Bullard, ex-hawk from the St Louis Fed – who fears US is now just one accident away from a Japanese liquidity trap.
In Japan itself core CPI deflation has reached -1.5pc, the lowest since the great fiasco began 20 years ago. 10-year yields fell briefly below 1pc last week. Premier Naoto Kan has begun to talk of yet another stimulus package. “The time has come to examine whether it is necessary for us take some kind of action,” he said.
In a normal recovery, the US labour market would be firing on all cylinders at this stage. Yet the latest household jobs survey showed a net loss of 35,000 jobs in May, 301,000 in June, 159,000 in July. The ratio of the working age population with jobs has fallen to 58.4, back where it was in the depths of recession. Over 1.2m people have dropped out the work force over the last three months, which is the only reason why the unemployment rate has not vaulted back into double digits. A record 41m Americans are on food stamps. This is unlike anything since the Second World War. It screams Japan, our L-shaped destiny.
“Unprecedented monetary and fiscal stimulus has produced unprecedentedly weak recovery”, said Albert Edwards from Societe Generale in his latest “Ice Age” missive. That stimulus is now fading fast before the private economy has clasped the baton.
After digesting Friday’s jobs report, Goldman Sachs’ chief economist, Jan Hatzius, thinks the Fed will abandon its exit strategy and relaunch QE this week, taking the first “baby step” of rolling over mortgage securities. Future asset purchases may be “at least $1 trillion”. He is not alone. Every bank seems to be gearing up for QE2, even the inflation bulls at Barclays. The unthinkable is becoming consensus.
Into this deflationary maelstrom, we now have the extra curve ball of Russia’s export ban on grains. There is a risk that this mini-crisis will escalate if Kazakhstan, Belarus, and Ukraine follow suit, and if the scorching drought lasts long enough to hit seeding for winter wheat next month. But remember, there was a global wheat glut until six weeks ago. Stocks are at a 23-year high. Prices are barely more than half the peak in 2008. The US grain harvest is bountiful; Australia, India, Argentina look healthy.
The Reuters CRB commodity index is no higher now than in April. Last week’s commodity scare looks like an anaemic version of the blow-off seen in the summer of 2008. The chief risk is that central banks will panic yet again, seeing ghosts of a 1970s wage-price spiral that does not exist.
In July 2008, Jean-Claude Trichet told Die Zeit that there was “a risk of inflation exploding”. As we now know – and many predicted – eurozone inflation was about to fall off a cliff. But acting on this apercu, the European Central Bank raised rates. No matter that half Europe was already tipping into recession.
The Western banking system went into melt-down within weeks. The Fed was not much better. It issued an “inflation alarm” in August 2008. Dr Robert Hetzel of the Richmond Fed has written a candid post-mortem in “Monetary Policy In The 2008-2009 Recession”, rebuking the Fed and ECB for over-reacting to inflacionista hysteria. They tightened into the crunch.
For those wonkishly inclined, Dr Hetzel said their error was to view the enveloping crisis through a “credit” prism, missing the tectonic issue that the “natural rate of interest” had fallen below the Fed funds rate. Failure to diagnose the problem properly meant that Fed policy may have made matters worse. This is perhaps the best analysis I have ever read on what went wrong, yet it has received scant attention.
Do we have any assurance that central banks have learnt their lesson? Clearly not the ECB, judging from Mr Trichet’s ill-judged article for the Financial Times two weeks ago: “Now it is Time for all to Tighten”. Much of what he wrote is correct in as far as it goes. Public debt is out of control. Budget stimulus may start to backfire. We are at risk of a “non-linear” rupture should confidence suddenly snap in sovereign states.
Yet he also suggested that half the world can copy the fiscal purges of Canada and Scandinavia in the 1990s, all at the same time, without setting off a collective downward spiral. He offered no glimmer of recognition that the fiscal squeeze must be offset by ultra-loose money. True to form, the ECB is now draining liquidity. Three-month Euribor has risen to the highest in over a year.
John Makin from the American Enterprise Institute described the Trichet argument that collective removal of fiscal thrust can be expansionary as “preposterous and dangerous”. Mr Edwards called it “risible”.
Berkeley’s arch-Keynesian Brad DeLong could only weep, saddened that everything learned over 70 years had been tossed aside in a total victory for 1931 liquidationism. “How did we lose the argument,” he asked? Unfortunately, such obscurantism is taking hold in the US as well. Alabama Senator Richard Shelby has blocked the appointment of MIT professor Peter Diamond to the Fed Board, ostensibly because he is a labour expert rather than a monetary economist but in reality because he is a dove in the ever-more bitter and polarised dispute over QE.
The Senate has delayed confirmation of all three appointees for the board, who all happen to be doves and allies of Fed chairman Ben Bernanke. The Fed is in limbo until mid-September. So the regional hawks who so much misjudged matters in 2008 have unusual voting weight, and now they have a commodity spike as well to rationalise their Calvinist preferences.
Whatever Dr Bernanke wants to do this week – and I suspect he is eyeing the $5 trillion button lovingly – he cannot risk dissent from three Fed chiefs: one yes, two maybe, but not three. He faces a populist revolt from the Tea Party movement, with its adherents in Congress and the commentariat. And China simply hates QE, which may or may not be rational but cannot be ignored.
Global markets have already priced in the next QE bail-out, banking the “Bernanke Put” as if it were a done deal. We will find out on Tuesday if life is really that simple.