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Central Banks Now In "Dangerous Situation": "You've Thrown The Kitchen Sink At It, What's Next?"

When both Europe and Japan slipped back into deflation despite trillions in central bank stimulus, it served notice that what developed market central planners are doing simply isn’t working. 

That is, the idea that ZIRP, NIRP, and endless asset monetization can stimulate aggregate demand and boost inflation expectations is a myth, and the longer the Janet Yellens, Mario Draghis, and Haruhiko Kurodas of the world attempt to perpetuate it, the more the market loses faith.

In fact (and this is something we’ve detailed exhaustively over the past nine or so months), promoting the misallocation of capital actually serves to create deflation, as it allows otherwise insolvent producers to keep pumping, drilling, and digging, contributing to the global deflationary supply glut that’s wreaked havoc on emerging markets. 

Now, in the wake of the Fed's policy "error" that paradoxically triggered a flight to safety even as the FOMC leaned dovish, the market is signalling that investors are beginning to lose faith. Here's Bloomberg:

More and more, bond traders are drawing the same conclusion: central bankers globally are coming up short in their attempts to combat the world’s economic woes.

 

Even after hundreds of interest-rate cuts and trillions of dollars in quantitative easing, the bond market’s outlook for inflation worldwide is approaching lows last seen during the financial crisis. In the U.S., Europe, U.K., and Japan, those expectations are now weaker than they were before their respective central banks began their last rounds of bond buying.

 

That’s leading investors to write off the Federal Reserve’s chances of raising interest rates this year and increase their bets that it will tighten less than policy makers forecast in the years to come. Speculation has also increased that the European Central Bank and Bank of Japan will need to step up their quantitative easing in the face of deflationary pressures, despite statements to the contrary from their own officials.

 

“There’s a lack of faith in monetary policy -- you’ve thrown the kitchen sink at it, you’ve cut rates to zero, you’re printing money -- and still inflation is lower,” said Lee Ferridge, the head of macro strategy for North America at State Street Corp. “It leads to a risk-off environment.”

 

Recent economic reports have renewed calls for major central banks to do more. Consumer prices in the euro region unexpectedly fell, deflation re-emerged in Japan, while wages in the U.S. stagnated yet again.

 

International Monetary Fund Managing Director Christine Lagarde also signaled the organization is preparing to lower its outlook for the world economy.

And here's more from The New York Times, who reports that in fact, central bankers may be quietly losing faith in their own abilities as it becomes ever more apparent that the adoption of counter-cyclical policies is simply serving to create larger and larger booms and subsequent busts:

The 2008 financial crisis convinced most people in the world of central banking that it would be a good idea to try to prevent that kind of thing from happening again.


But policy makers have made little progress in figuring out how they might actually do so, a troubling reality highlighted at a conference that ended over the weekend at the Federal Reserve Bank of Boston.


The Fed has publicly committed itself to a strategy of so-called macroprudential regulation, meaning it is now focused on maintaining the stability of the financial system as well as the health of individual firms. But senior Fed officials at the Boston conference described that as more of a goal than an achievement.


Crises remain hard to anticipate and prevent, and the available tools could cause significant economic damage.


“My own view is that while the use of macroprudential tools holds promise, we are a long way from being able to successfully use such tools in the United States,” William C. Dudley, president of the Federal Reserve Bank of New York, told the conference.


Donald Kohn, a former Fed vice chairman, said he was troubled by the gap between perception and reality. “If you ask people who is responsible for financial stability they would say, ‘The Fed,’ ” said Mr. Kohn, a senior fellow in economic studies at the Brookings Institution. “But the Fed doesn’t really have the instruments. It doesn’t really have the tools.


“And I think this is a dangerous situation if people perceive that it has the responsibility and it doesn’t have the tools.”


Eric S. Rosengren, the Boston Fed president, argued in a paper that opened the conference that financial stability should join inflation and employment as explicit objectives of monetary policy. Moreover, Mr. Rosengren and his co-authors presented evidence that the Fed already treats financial stability as a goal. They showed that the movement of the Fed’s benchmark rate tracks discussions of financial stability at Fed policy-making sessions.


Others, however, said it was not clear that raising rates was a more effective means of addressing risks to the financial system than sensible regulation.


 

“I’m a skeptic,” Mr. Kohn, of Brookings, said. “I think that monetary policy, changes in interest rates, are likely to be not very effective in damping a lot of these cycles.

Indeed.

And as we showed last week, excessive central planner micromanagement only serves to widen out the financial cycle which translates directly into ever larger speculative execesses. 

Of course one shouldn't expect that to matter in the minds of the world's monetary authorities. The simple fact here is that the notion that cycles can be smoothed out with Keynesian tinkering is accepted as gospel in developed market economic circles and so the tendency is to simply double- and triple-down on policies that aren't working. 

But here's the real danger: the degree to which unconventional monetary policy is effective is in no small part dependent on perception. That is, the fiat regime is in large part a giant confidence game. If that confidence starts to evaporate in the minds of very "serious" people, this will all come to an end, and that's not simply the latest rant from a "fringe blog", that's just the way confidence games work. Ironically, the best thing developed market central bankers could do right now is simply stop the madness and allow capital markets to crash and reset. There may still be some hope of preserving the notion of central bank omnipotence here if everyone suddenly comes to their senses, steps back from the money printing, and lets creative destruction purge the system. That would allow the world's foremost monetary authorities to start from scratch and perhaps reclaim some credibility on the way to rebuilding things. 

Of course that won't happen because no one is going to completely admit that they have failed which is why the cycle depicted in the graphic below will simply play out over and over until the entire house of cards collapses on itself: