Thursday, 20 June 2013

I'm forever blowing bubbles

The soccer fans of West Ham United have sung the song ‘I’m forever blowing bubbles’ since God was a boy (or least since the mid 1920s) and whatever relevance it may have to inspiring sportsman has been lost in the mists of time.  The chorus of this American ballad goes;

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high,
Nearly reach the sky,
Then like my dreams,
They fade and die.
Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.
As with sports so with finance, the economic cycle is an endless treadmill of  precarious bubbles that ‘fade and die’.  The simple truth is that markets (people) are lazy, we are programmed to take the easy option, that’s evolution for you.  And this rubs off in the world of finance, we almost always lurch from one soft option to the next; in the last 15 years we have had the dotcom boom, the alchemy of algorithmic trading, the credit bubble and the addictive pleasures of QE.   In the good old days we had central bankers who would from time to time burst the bubble and insist that we get back to the serious business of controlling inflation and nurturing sustainable growth.  With deflationary pressure all around the Fed have been busy blowing bubbles not bursting them, but this is about to change.  
 In the last week the markets for both bonds and equities have been in full scale retreat, frightened by the smoke signals coming out of the Fed, which is pouring $85bn of new money into the US economy every month.  QE has had the effect of lowering interest rates and presumably nurturing some growth and new jobs.  All this has been achieved without stoking the fires of inflation but this can’t go on forever; in the short run negative real interest rates have a positive impact in the longer run (just ask the Japanese) worthless money kills ambition and productivity. It is therefore somewhat worrying that our Central bankers are now so cautious on the need to wind back QE and return to real money.  Probably more worrying is the fact that these self-same central bankers now believe that they should have a remit for ensuring high levels of employment and positive rates of growth rather than just managing the money supply and inflation.  News that the Fed will use QE until employment rates rise to 92.5% and to be in a world where employment should be the sole arbiter of interest rates and money supply is a madness of schizophrenic proportions.  Have we have forgotten all the important lessons of the of the 80s and 90s when we had raging inflation, high interest rates and low employment?  The world’s central bankers need to get back to their day jobs of managing inflation, otherwise more pretty bubbles will fade and die!

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