Baffled in Jackson Hole

Every year in late summer the secretive priestly caste that is the world’s central bankers meets in conclave at the Wyoming mountain resort of Jackson Hole. It’s an inconsequential place really – just an upscale mountain cum fishing resort set in a verdant valley between the jagged peaks of the Teton Mountains and the Ventre Range. A place where fine minds can re-boot on pure mountain air in sympathetic company.

Technically, the Annual Economic Policy Symposium has been hosted since 1982 by the Federal Reserve Bank of Kansas City (one of the USA’s 12 Federal Reserve Banks); but in practice the Chairman (sorry, Chairperson) of the US Federal Reserve, currently Janet Yellen, is the focus of attention. Why Jackson Hole? Apparently, former Chairman of the Fed Paul Volcker (1979-87) was keen on fly-fishing.

Central bankers, who are un-elected and who conduct their dark arts with much less scrutiny than mere politicians, manage the media carefully. The real business of Jackson Hole, as indeed that of Davos and of the Bilderberg Club, takes place sotto voce over good brandy late at night. The speeches and press releases are assiduously massaged to avoid controversy or anything that might phase the markets. Of course, as a freemasonry, any vestige of dissent is suppressed – the general impression left after all the textual analysis is done, is one of the unanimity of the wise.

Last Friday – 26 August – Ms Yellen climbed to the podium to share her pearls of wisdom with the cognoscenti. She spoke of the improving outlook for the American economy citing expanding output and falling unemployment. Gradual increases in interest rates would be needed in due course, she said. Of course, the question we were all gagging to ask was: When? Some Wall Street analysts, based on the futures market, pencilled in a rate hike for December. But that would be just after the US Presidential elections and before the President-elect is inaugurated – in other words at a moment when the direction of fiscal policy will be most unclear. Stanley Fischer, Ms Yellen’s deputy, intimated the next day that the Fed could move as early as the next meeting of the FOMC[i] on 21 September if the jobs data was sufficiently robust. Overall, said The Guardian, the markets were “baffled”[ii], with the dollar rising then falling and then rising again in the two hours after Ms Yellen sat down, and the Dow Jones doing an Irish jig.

And if the good economic news flow turns sour, don’t worry said Ms Yellen, she’s got tons of really amazing “policy tools” in her handbag. She is aware of course that while the US labour market is strong with unemployment falling by 190,000 per month, GDP growth is actually behind expectations. In the three months to the end of June the US economy grew at an annualised rate of 1.1 percent – up from 0.8% at the end of Q1 2016 – but less than the anticipated rate of 1.2 percent.

Under the lugubrious title of Designing Resilient Monetary Policy Frameworks for the Future, attendees discussed the challenges ahead. This, at a time of historically unprecedented negative interest rates. Haruhiko Kuroda, Governor of the Bank of Japan, has said, post-bean feast, that he has “no hesitation” about further QE and a deeper Negative Interest Rate Policy (NIRP) in his own country[iii]. The ECB of course, under the helm of Mario Draghi, has taken the Eurozone into NIRP territory, and in its wake, Switzerland, Sweden and Denmark too. This is one bunch of negative central bankers.

Negative interest rates mean that commercial banks must pay to keep their funds on deposit with their central bank. The policy is supposed to stimulate commercial banks to lend out available funds to borrowers or to invest them in riskier assets. Even here in the UK where the interest rate is at a stratospheric (by comparison with Japan and the Eurozone) 0.25 percent, Royal Bank of Scotland (LON:RBS) advised corporate customers that it will charge them 0.4 percent for depositing cash (in other words impose negative interest rates on deposits) from 22 August[iv]. So we are already in a world where successful corporations are not just taxed for making profits, but charged for accumulating cash. And this is supposed to be a free enterprise system.

Meanwhile, while the baffled central bankers of the world’s largest economies were fly-fishing, a red light started flashing on one of my World Bank fire alarms. You see, countries which run heavy current account (trade) deficits should raise interest rates to attract foreign capital. That does not apply to America because of the “Dollar effect”. The world is so desperate for Dollars, which is the currency in which most commodities are traded (especially gold and oil) that America is exempted from this law of economics. But it does apply to the Mercedes-hungry states of Southern Europe (is it still polite to call them PIGS?). Though, being in currency union (I call it currency paralysis), they just can’t raise rates.

Anyway, there is a clearing system which settles interbank payments between Eurozone states. (That is probably the most boring sentence I have ever written – but I had to do it.) It is called TARGET. Well, actually, since 2007 it’s been called TARGET2; but never mind. Since 1999 it has facilitated payments between the various Eurozone internal settlement platforms. So, in essence, when an Italian importer buys machine equipment from a German exporter, a claim is generated by the Bundesbank on the Banca d’ Italia. So far so good.

In 2010, as you will no doubt recall, the global interbank market had a cardiac arrest – banks simply refused to lend to their counterparties. TARGET2 stepped in to supply sufficient liquidity to facilitate intra-Eurozone trade deals. It worked; but on the down side, imbalances within the TARGET2 system exploded to levels that it was not designed to withstand.

The situation calmed somewhat in 2012 after the partial resolution of the European Sovereign Debt Crisis (bailouts for Greece, Portugal and Ireland and so forth). But the system was impacted from spring 2014 onwards by the ECB’s programme of asset purchases – QE et al, including the Long-Term Refinancing Operation (LTRO) – a programme whereby the ECB lent to Eurozone banks at preferential rates.

The LTRO succeeded in narrowing spreads between Bunds and southern European government bonds. Yet, according to Deutsche Bank Research[v], there was a capital flight from the deficit countries to the surplus countries (principally Germany and the Netherlands). This capital flight has been exacerbated by debt service flows from the debtor Eurozone nations to creditor nations. The TARGET2 balances (or rather imbalances) are rising to unsustainable levels. According to Deutsche Bank this is being taken as a crisis indicator within the Eurozone control room (Germany).

Presumably, these flashing lights were observed by the economic Illuminati arraigned in Jackson Hole. But they were certainly not discussed before servants and children. Though I think I may have found one piece of evidence of what these central bankers really think.

The European Central Bank’s Benoit Cœuré, speaking at Jackson Hole, said policymakers were determined to meet central banks’ inflation targets. But he called on “other actors” – presumably governments who run fiscal policy – to do what they can to ensure the Eurozone’s recovery. Should governments “not take the necessary measures in their policy domains, we may need to dive deeper into our operational framework and strategy to do so”, the French banker opined[vi].

So it’s not all the central bankers’ fault, then. Monetary policy is reaching the limits of what it can do. Beyond that there is fiscal policy too: the domain of the politicians. The central bankers would probably much prefer to retreat to the quiet life that they enjoyed in days gone by and let the politicians take the flack.

Is it just me, or are the central bankers, as a breed, losing credibility? I really can’t remember the last time that calls abounded for the resignation of the Governor of the Bank of England (a True Believer in NIRP). In last week’s Spectator, James Delingpole demanded that Mr Carney be sacked – and yesterday it was Jim Mellon’s turn in these very pages.

Mr Carney has been to Jackson Hole many times, not least when he was Governor of the Bank of Canada. I wonder if he caught any trout this time. We know that Mark was a REMAIN-iac and we suspect that Janet is of a similar HILLARIAN persuasion. They might both have a lot more fly-fishing time very soon.

[i] Federal Open Market Committee – the equivalent to the Bank of England’s Monetary Policy Committee which sets interest rates.

[ii] See Fed chair hints at early rise in US rates, by Jana Kasperkevic, The Guardian, Saturday, 27 August 2016.

[iii] See: http://www.cnbc.com/2016/08/28/bojs-kuroda-vows-no-hesitation-on-more-qe-lower-negative-rates.html

[iv] http://www.dailymail.co.uk/news/article-3749817/RBS-bank-set-negative-rates-s-charging-large-firms-hold-cash-families-next.html

[v] See: https://deutscheam.com/en-gb/thought-leadership/cio-view/article/increasing-tension-in-the-system-2016-08?kid=int.CIOView201608.fb_ic_finance_ppla.linkad.target2.

[vi] See: http://www.ft.com/fastft/2016/08/30/first-trickle-of-german-inflation-points-to-steady-prices/?siteedition=uk