The Rime of the Central Banker

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IN THIS EDITION

Central bankers continue to pour monetary petrol on the raging fires of insolvency. As a result, central bank balance sheets across the developed world continue to expand in size and deteriorate in quality. The US Fed claims that its policies will support asset prices, yet without contributing to rising consumer prices. As such, they are claiming that they can create a set of conditions similar to, say, 1996-99 or 2003-06, when stock markets rose strongly yet consumer price inflation was relatively subdued. Unfortunately, each of those episodes was followed by a stock market crash and economic recession. Are central bank policies invariably so hubristic, short-termist and reckless? In this regard, it is instructive to consider the lessons of one of the greatest of all English poems, Samuel Taylor Cooleridge’s Rime of the Ancient Mariner. Also instructive is to look at the greatest low-inflation boom-to-bust period of modern times: 1927-1933.

At Length Did Cross An Albatross

Samuel Taylor Cooleridge was known for employing vivid imagery and complex allegory. In his famous ballad, Rime of the Ancient Mariner, he uses an Albatross to symbolise the natural, mystical power of the wind and sea, the disrespect of which can lead to disaster for ship and crew.

Near the beginning of the poem’s narrative, the Ancient Mariner speaks thus:

At length did cross an Albatross:
Thorough the fog it came;
As if it had been a Christian soul,
We hailed it in God's name.

As a creature of nature and one thought to bring good fortune, it was only natural that the sailors would welcome its presence. Thus they found themselves in disbelief and fear when, inexplicably, the Ancient Mariner shot the bird out of the sky:

And I had done an hellish thing,
And it would work 'em woe:
For all averred, I had killed the bird
That made the breeze to blow.

The Ancient Mariner was quick to seek exculpation for his dastardly deed. While nautical wisdom held that the Albatross brought with it the wind, without which no ship could sail, he focused on present evidence only, blaming the Albatross for the fog that had been hindering their passage:

Then all averred, I had killed the bird
That brought the fog and mist.
'Twas right, said they, such birds to slay,
That bring the fog and mist.

While surprisingly easy for the Mariner to convince his fellow sailors he had behaved sensibly, sure enough, a short time later, the severe consequences of his reckless act did follow:

Down dropt the breeze, the sails dropt down,
'Twas sad as sad could be;
And we did speak only to break
The silence of the sea!

In the subsequent stanzas the full horror of the Mariner’s contempt for nature would be revealed, eventually claiming many sailors’ lives. But poetry being poetry, he survives to tell the tale of misguided human hubris over the ultimate power of nature.

Poems and legends of pride and downfall abound in literature and cut across nearly all cultures and religions. The Greek legend of Daedelus and Icarus comes to mind, as does the Babylonian legend of Babel. In all cases, the lessons are much the same: Just because it appears that one has achieved the knowledge or power of God does not make it so. And because pride knows no bounds, the prideful tend to push far beyond all reasonable limits before realising their folly, much too late to avert disaster.

Liquidity, Liquidity Everywhere, Nor Any Drop to Drink

One would be hard-pressed to find a better way in which to understand the hubris of the current set of global central bankers. Prior to the arrival of Lord Keynes and others like him on the scene, who believed that artificial, short-term fixes for immediate economic conditions should win out over longer-term-oriented, generally laissez-faire policies, the traditional response to sharp economic downturns was, in the famous words of US Treasury Secretary Andrew Mellon, “Liquidate! Liquidate! Liquidate!” He did not advocate throwing liquidity at the financial markets but, rather, standing by and allowing the swift liquidation of overleveraged and/or inefficient enterprises to take place, thereby enabling a swift return to economic growth. In the recession of 1920-21, for example, this is precisely what occurred.

Yet during the 1930s, this tradition of respecting the markets was thrown out in favour of artificial, arbitrary ways of trying to deal with the immediate problems at hand. Many believe that this process began when FDR assumed the presidency in early 1934. In fact, it began in 1930 under president Hoover, just months after the downturn had begun.

Yes, Hoover. FDR’s court historians and economists may have chosen to portray things somewhat differently for obvious, political reasons, but Hoover was a highly interventionist president in comparison to his generally laissez-faire predecessors Calvin Coolidge and Warren Harding.1

While beyond the scope of this report, there is an extensive, revisionist literature on the Great Depression which focuses on Hoover’s interventionism in 1930-32, including his collusion with major industrialists at the time to artificially support workers’ wages. It was believed that this would support demand, which it of course did for those employed. The impact on the unemployed, who were priced out of the labour market as a result, was somewhat less fortunate. For the industrialists, who were concerned primarily about profit, not employment, it was rather convenient that their smaller competitors, not so deep-of-pocket, were driven out of business by their inability to remain profitable amid federally mandated, artificially high wages. Industry consolidation into anticompetitive oligopoly and in some cases monopoly was the natural result.

Eminent historian Paul Johnson summarises Hoover’s influence on US economic policy thus:

Hoover’s was the only department of the U.S. federal government which had expanded steadily in numbers and power during the 1920s, and he had constantly urged Presidents Harding and Coolidge to take a more active role in managing the economy. Coolidge, a genuine minimalist in government, had complained: “For six years that man has given me unsolicited advice—all of it bad.” When Hoover finally took over the White House, he followed his own advice, and made it an engine of interference, first pumping more credit into an already overheated economy and, then, when the bubble burst, doing everything in his power to organize government rescue operations.2

But let’s not take Mr Johnson’s word for it. Let’s take the man, president Hoover, at his. While campaigning for re-election in 1932, he made the following reference to his heretofore unprecedented economic interventionism:

[W]e might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times. For the first time in the history of depression, dividends, profits, and the cost of living, have been reduced before wages have suffered. They were maintained until the cost of living had decreased and the profits had practically vanished. They are now the highest real wages in the world.3

The highest real wages in the world? Well isn’t that precisely what wasn’t needed when all of Europe had already sunk into Depression and resorted to currency devaluation and trade barriers in a beggar-thy-neighbour approach to restore competitiveness by reducing real wages and restricting imports! By deliberately holding US wages artificially high, Hoover was ensuring that, alongside a global investment bust, US unemployment wouldn’t just rise, but soar to unprecedented heights!

This is not to say that FDR was not himself an interventionist. Quite clearly he was, and not just at home, but all over the world. The US entered WWII not only to ‘make the world safe for democracy’, as Wilson had done some 25 years earlier, but to ensure that portions of Britain’s and France’s empires would be ‘liberated’ from the occupying Germans and Japanese not by Britain and France, but by the United States, with obvious implications for the post-war balance of power and associated US economic advantages.

Although there was a continuation of government interventionism from Hoover to FDR, a dramatic shift in US monetary policy took place. Initially on the sidelines, the Fed began to provide liquidity aggressively in 1933 by expanding the monetary base. While this had little if any direct impact on the economy at large, when combined with a large dollar devaluation in 1934—the convertibility price of gold was raised from $20.67 to $35.00, or some 60%‑the consumer price deflation of the Hoover years reversed sharply into moderate inflation. Yet amid still uncompetitive, artificially high wages and various other interventionist economic impediments, the Depression dragged on. A brief light shone in 1936, when unemployment began to decline somewhat alongside what appeared to be a nascent recovery. But in the event this recovery was feeble. It resulted in little growth in fixed business investment and, notwithstanding a positive rate of consumer price inflation, petered out already in 1938.

In any case, in a supreme economic historical irony, it was precisely a plunge in US wages and a soaring private savings rate (the opposite of borrowing/stimulus) which finally got the US out of the Great Depression. And how did that come about? Well, once the US declared war on Japan and Germany, increased industrial productivity became a matter of national security. As such, wages were now forced sharply lower and, with a huge portion of the young male population summarily conscripted into the military, women were strongly encouraged to enter the private work-force in their stead. With two incomes instead of one, households found it easy to save more, even if each working parent was on lower, more competitive wages!

So did WWII end the Depression? Only indirectly. The real solutions to the Great Depression were, as shown above, entirely consistent with the causes: Lower instead of higher wages; higher savings instead of increased borrowing. Can there possibly be a clearer historical lesson of what NOT to do when an investment bubble bursts, financial markets crash and firms and households seek to de-leverage their balance sheets? Hoover and FDR made huge, prolonged economic policy mistakes in peacetime, subsequently reversed years later in wartime, and historians and today’s reigning mainstream economists make the classic analytical error of assuming that association equals causation.

Ben Bernanke and his economic mainstream colleagues at the US Fed and central banks around the world should not only spend a bit more time investigating the true causes and cures of the Great Depression, they should read Cooleridge’s Rime of the Ancient Mariner. If they did, they would cease their superstitious shooting at albatrosses and focus on the real economic issues at hand. In so doing, they would recognise that the deckhands of government and interventionist central banking are just making a bad situation worse. It is the invisible hand of the marketplace that should be employed instead. The government and central banks should just get out of the way; allow interest rates and wages to adjust; allow firms to reorganise and restructure as necessary, via bankruptcy if so expedient; allow labour and capital to migrate to where they can be most efficiently used, instead of to where they are misdirected into some influential politician’s pet programme. There would still be pain involved, but at least this would be incurred as part of a real healing and renewal process, rather than as part of a history-repeating, failing experiment in how to ‘manage’ an overleveraged, unbalanced economy.

What Is the Ocean Doing?

Economies are complex systems. They have so many moving parts it is simply impossible for any observer both to acquire a full set of information as to the goings-on, process it in some way, determine a course of action that would somehow improve on what the voluntary actions of individuals in a free-market can achieve, and implement it properly, and quickly enough, before conditions have already changed such that the policymaker reaction is no longer optimal, appropriate or even relevant. Most probably, the course of action, even with the best of intentions (don’t politicians and bureaucrats have those?) ends up being sub-optimal, inappropriate, irrelevant and, as such, economically harmful.

But tell me, tell me! speak again,
Thy soft response renewing--
What makes that ship drive on so fast?
What is the OCEAN doing?

What is the OCEAN doing, indeed? Can any sailor possibly anticipate each gust of wind, each wave, fog, iceberg or gathering storm, each challenge that presents itself on a voyage? No, sailors must follow the tried-and-tested rules of seamanship, taking the uncertainties of OCEAN as is, not somehow anticipating the wind and waves and micro-managing the ship and her sails as hubris might have it or, worse, raising three sheets to the wind and hoping for the best.

Sadly, this is exactly what the broad set of current global central bank policies entails. When in doubt, print. Or accept downgraded, questionable, perhaps even impossible-to-value collateral in return for your own, impeccable credit. But such credit is only impeccable in that central banks, possessing the exorbitant privilege of printing the very paper with which to service their obligations, can’t technically default. Of course, they can devalue their currencies, either through an incremental increase in relative supply and gentle price inflation or, by hook or crook, through a qualitative loss of confidence, precipitous devaluation and possible hyperinflation.

While we doubt any major central bank would purposely hyperinflate, just what do you expect might happen once you start sailing dangerously close to the wind? Whose fault is it in the event that the rail slips under, increases drag, and throws the ship over, passengers and crew be damned?

All Things Both Great and Small

Perhaps I have already stretched Cooleridge’s rich nautical allegory too far. In any case, it remains to say something of how investors should respond to activist central bankers who know not what harm they might cause in their futile quest to do something, anything, other than sit by and let the world economy sort itself out of its excessively indebted, overleveraged mess.

In brief, there is nothing better than diversification, in particular into assets, the values of which are not so easily distorted by artificial monetary or other stimulus. While basic commodities and associated infrastructure and businesses naturally come to mind, care must be taken to understand that, even the most basic of the basic is still likely to be volatile in an environment in which economic outcomes are unusually binary in nature. Now severely hooked on various forms of stimulus, as these are periodically, incrementally withdrawn or adjusted in some way, so all asset prices may suddenly, with little or no warning, adjust. We live not in a world of robust financial analysis, in which we can thoughtfully apply sensible models, research companies and draw confident investment conclusions. No, we must accept that we just don’t know, can’t know, what policymakers are apt to do next.

So why not just sit in cash? Or government bonds? The latter had a banner year in 2011. No, bonds represent the greatest trap of all. Think of it this way: What, exactly, would cash-strapped, overindebted governments have you buy? In a growing number of countries, various groups of investors are being coerced, one way or another, into purchasing more government debt, at lower prices, than they otherwise would. They call this ‘financial repression’, and it is. Why buy voluntarily today what you are highly likely to be forced to buy anyway tomorrow? No, better to look elsewhere.

Even where financial repression might appear absent at first glance, it lurks in the regulatory shadows. This is particularly true of pension funds and insurance companies. In many cases major institutional investors have regulatory guidelines which, in effect, force them to purchase a certain portion of long-dated government bonds. It doesn’t matter whether or not such bonds offer an attractive yield, in nominal or real (inflation-adjusted) terms. No, if you’re required to hold them, you buy at any price.

For those who do have flexibility, there is no reason to buy what others are forced to hold. This is not a prediction as to when yields begin to rise again, and prices fall. In real terms (ie inflation/devaluation-adjusted) if not nominal, excessive debt and leverage imply that a major bond bear market is inevitable. As with many things, the timing is far from certain. Those who are confident that they can exit the theatre at the first whiff of smoke, escaping the conflagration, be my guest and buy government bonds. But don’t fool yourselves: You are speculating, not investing.

Cash may still provide liquidity, but please note that this is now ALL it provides. Cash is no longer a store of value, not when central bankers dilute it on demand as required to make bank or sovereign bondholders whole and to create a general inflation to devalue the total economic debt burden (as if printing paper can possibly improve our general welfare. They are long past caring about that, no?).

So the focus must remain on that which cannot be printed, or so easily distorted. Basic commodities, their production, processing, refining, storage, transport and distribution, is the farthest one can get away from the complex financing operations of a modern economy and the corporations and other investible entities that comprise it. So while I have nothing against other sectors—by all means there are well-run companies out there in every conceivable line of non-financial business—I am acutely aware that they are simply unusually difficult to value at present.

As such, were I to invest in a broad array of basic-value companies, I would prefer a long-term, private equity approach. Don’t even pretend that you can cash out of such investments on a shorter-term horizon. Acquire your value portfolio, place it in the drawer, close it, lock it up. Someday, yes, many of these companies are going to be worth a pretty penny, notwithstanding the interim volatility associated with what could be a disorderly de-leveraging of the economy. But that penny will have morphed, in the long meanwhile, into the coin of a hard currency. For there is just no way that soft currencies can survive indefinitely. Eventually, a tipping point is reached, confidence is lost and the central banker, staring no doubt into the abyss of crisis, must make the fateful decision: Do I raise interest rates to a level that defends the currency but forces a sharp, deflationary restructuring of the economy, or do I go all-in, hyperinflate, and hope that history will somehow treat me kinder than it has treated my hyper-printing predecessors?

He went like one that hath been stunned,
And is of sense forlorn:
A sadder and a wiser man,
He rose the morrow morn.

Let us hope that our central bankers make the right choice.

Resources

[1] To this day, Harding and Coolidge are often derided as extreme in their laissez-faire views on the economy. To be sure, they resisted the Progressive movement, with which Presidents Theodore Roosevelt and Woodrow Wilson were associated. Progressives believed that the role of the federal government should extend well beyond the explicit, enumerated powers of the US Constitution, the ostensible reason being to use the power of government to improve society at home and, when necessary, to intervene militarily abroad. Indeed, some historians consider T. Roosevelt and Wilson to be most responsible among US presidents in inaugurating the ‘globalist’ or ‘world-policeman’ foreign policy which has more or less been the norm ever since and, most recently, is behind the current US military involvement in a number of countries and, perhaps in the coming weeks, in Iran.

[2] As quoted in the Introduction to Murray N. Rothbard, America’s Great Depression, fifth edition (Auburn, Alabama: The Mises Institute, 2000), p. xvi.

[3] IBID, p. 187.

AMPHORA: A lateral-handled, ceramic vase used for the storage and intermodal transport of various liquid and dry commodities in the ancient Mediterranean.

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