- New Science in old markets -

FED time on Thursday

What will the Fed do next?

We live in strange times. Social attitudes change, sometimes fast and what comes along is often completely at odds with what came before. The old bedrock assumption that free market economies renew themselves through periodic destruction is changing and it’s worth having a look at why.

Political correctness began as a self-mocking term used by leftist intellectuals to make fun of their own pomposity, but it (now called PC by everyone) has taken on a life of its own and it has spread throughout much of the Western world. Its origins lie deep in Marxist theory and it’s now hard to remember now just how dominant Marxism was until its high-water mark at the 1968 student riots in Europe. After that people turned from redistributing wealth via socialism to prosperity through competition in free markets - baking a bigger cake instead of cutting equal slices. This was a complete victory for competition and a defeat for collectivist economics, from Thatcher’s free-market Tories in the UK via Ronnie’s Reaganomics in the US to Deng Xiaoping’s brave adventure to overthrow Mao’s legacy in China.

But political Left vs Right is as much to do with emotion as it is reason and Leftists didn’t disappear just because they had lost the economic argument. For them this was just a battle lost, not the entire war and there was still much to do in the social arena. The starting point was ‘critical theory’ developed at the University of Frankfurt in the 1930s which explained that workers were compliant in their oppression by capitalists because they had been fed a diet of lies which they had swallowed: ‘work hard and you will prosper’ for example. If these ‘false narratives’ could be exposed, the oppressed would realise their aggrieved state and the revolution would soon be back on track.

The best way to do this was for agitators (or ‘activists’ as they prefer) to encourage a sense of resentment and grievance among the workers. So began a period in which constant repetitive shouting about oppression gradually reinforced the point that society was wrongly ordered and that almost everyone could find something to resent. This still didn’t get much traction in the economic sphere but by the early 1980s all kinds of groups in society were thinking that they too had other grievances for which someone else was to blame. Even anti-Marxist America fell in line, where the inconvenient origins of this new thinking were ignored and it took vigorous root, especially in the politics of race and a virulent version of radical feminism. What Americans call the Culture Wars had begun; PC stopped being a humorous idea and came of age.

The grievance industry developed, especially in the universities that are the usual source of Marxist ideas and it has since taken many forms. In the self-censorship that replaces free speech in political correctness it is not permitted to insult others because of their race or other innate characteristics. This was always just plain good manners since ancient times but it became rigorously policed and extended to cover matters of personal choice. Good old-fashioned rough-and-tumble political insult has been replaced by bland assertions of what is or is not ‘acceptable’.

Homosexual equality is often held up as an example of the benefits of PC, even though the actual legal reform (in the UK at least) came under a Tory government, not as a result of leftist agitation. In a fit of self-righteous indignation the leftists of the day included legalising paedophilia in their list of correct causes until even they realised that this was a step too far.

There are now ‘hate crimes’ in which the opinion of the victim whether it was motivated by hatred is an important element in defining the offense. Even normally sensible observers don’t seem to mind this irrational inclusion in the world’s foremost and fairest legal system (the Common Law) which is strong evidence as to how far PC has penetrated public discourse and seeped into the collective unconscious.

An important separate strand has developed – the avoidance of risk and harm. This seems merely sensible until its extent is examined. Health and Safety rules are burdensome and often miss the point, risk evaluations based on procedure rules and process have taken the place of basic principles and perhaps worst of all there is the ‘precautionary principle’ which avoids activities that just might create risk. If a risk assessment had been done at the court of Ferdinand and Isabella in 1492 then Columbus could never have sailed.

Harm includes emotional damage, so it is improper to make others feel bad. This proved a slippery slope. If you start with the idea that insult should be criminalised it is a short step to include disapproval of hurting someone’s feelings by firmly rebutting their arguments. It is then an even smaller step to forbid direct reprimands for poor behaviour, substituting the excuse that people only do bad things because they are victims of a cruel system. We passed that stage some while ago, leading a senior British police officer to remark of delinquent youth that ‘many of these kids have never been told off when they are doing wrong’. Apart from the terrible effect this has had on child-raising, adults also now fear to remonstrate with the young for fear of an aggressive response. The result is a generation of indulged and largely undisciplined children who are wrapped in a protective bubble to protect them from all kinds of perceived harm. We can already see what kind of infantilised adults they are becoming.

The consequences are many and serious, especially when a firm hand is required to steer the economy. Monetary policy was always the province of central bankers and treasury/finance politicians who set the conditions of the day based on their reading of circumstances. Their mandate was often quite vague and sometimes contained contradictory elements such as ‘aim for full employment’ while also perhaps ‘guard against inflation’ – it’s hard to do both let alone include yet more aims. Central banking, including managing the supply of money and the rate of interest was more of an art than an exact practice and it required the will to get tough if needed. Raising interest rates to cool inflation bankrupts some businesses and individuals, so was unpopular but sometimes had to be done. All of this has been written in the past tense because it is no longer true. The desire to avoid harm has conditioned the activities of central bankers just as it has the upbringing of children and the conduct of business.

The first years of the new century brought a huge financial bubble and a large drop in asset prices as it deflated but there were few of the other consequences of a boom-and-bust. The bubble inflated through the Greenspan years at the Federal Reserve (America’s central bank) as the surge in economic activity seemed to gather speed without the usual accompanying increase in inflation. As a result, the Fed saw no reason to ‘cool it’ by raising rates (and thereby inflict pain) so the boom continued. This was a mistake as there was indeed inflation - not the monetary kind but the asset price kind. The crunch was massively worsened by the desire to avoid discomfort when it would have been the proper thing to do.

The subsequent implosion crunch was so bad that extraordinary measures were deployed to try and lessen its worst effects. The US Federal reserve and the UK’s Bank of England both created massive amounts of new money and bought various bits of financial paper with it. This injected money into the system (like a giant repo) but this cash creation continued even as the immediate danger passed into history. So terrified were the central bankers (and their political masters) of any resumption of the downturn that money printing became the new normal and the total quantities involved since are staggering. This process eventually stopped in both the US and the UK but not before the whole world experienced another giant boom in asset prices, fuelled by this new money. The central banks of China, Europe and Japan did the same thing and the open nature of most of the world’s financial system meant that leakage occurred across borders whenever money was being created at this precautionary high rate. Assets continued to bubble and the danger of another crash is ever-present. It has already started in China.

So why not abandon this suicidal course? To quote Jean-Claude Juncker, President of the European Commission in a slightly different context: ‘We all know what to do, but we don’t know how to get re-elected once we have done it’. Some central bankers appreciate that holding the tiger by the tail will end badly but they cannot let go for fear of the mauling when they do. The majority of central bankers actually don’t see a problem with all this money creation and perpetual zero interest rates and there are ranks of academic economists lined up to support this view. A serious problem seems to be that central bankers are no longer remote figures who discharge their serious obligations with dispassionate calm. Instead they are now media figures and the Bank of England’s current governor is even described as ‘the thinking woman’s George Clooney’ (sorry, Amal).

The central banker’s job description always included a contrarian propensity to ‘lean against’ the prevailing economic direction so as to moderate both excessive enthusiasm and pessimism. Now they have become affected by the prevailing mood of the culture, and instead join everyone else in trying to protect against corrective forces: Pain? Not if we can help it!

Indeed, short-term pain is endlessly postponed. The business cycle has longer and longer intervals between routine downswings and outdated companies stagger along as zombies, keeping out the new competitors that should be taking their place. The eventual unwinding of this tottering structure will bring agony far worse than the sharp scratch of medicinal pain that should have been sought much earlier.

But Hawks have evolved into Doves and the thought of that pain is too much to bear. So we slide toward the edge. What will the Fed do on Thursday? This is not the right question, which should be: ‘Will sanity prevail before we all go to hell?’ If there is any reason to hold back on a rate rise – even a stock market dip in anticipation of a rate rise – then the Doves who are in the ascendant will probably hold back. It is not what they should be doing.