The same economists that gave us inflation are going to save us all... with Stagflation.
When Frederick Hayek accepted his Nobel Prize for Economics back in 1974 he noted that at the time, “Economists were being called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted had been brought about by policies which the majority of economists recommended and even urged governments to pursue.” Fifty years on and this is only one of the many similarities with what we see today.
Hayek went on to criticise the ‘Pretence of Knowledge’ in those claiming to be able to predict things and thus drive policy and it is certainly true that there is little more dangerous than a bureaucrat on a mission, especially when they are backed up by an overly complicated computer model that in truth does no more than produce an implausibly precise conclusion that simply reflects the imprecise (and usually biased) assumption plugged into it.
We saw this most recently with Covid modelling and predictions that were wildly pessimistic (and hugely wrong) but were used to justify policies of Zero Covid – thankfully now passed except for China. Prior to that we had years of similar ‘policy based evidence making’ with apocalyptic Climate predictions being generated by extreme assumptions plugged into models in order to justify Zero Carbon policies. Despite some welcome recognition of the need for nuclear, these, sadly, remain too close to mainstream policy for comfort. Before either of these, however, came the, equally damaging in its own way, policy of Zero Interest Rates and the obsession with Quantitative easing, which have not only failed to solve the original problem, but have also created more inequality and more economic instability by driving asset price inflation. Zero Covid, Zero Carbon, Zero Interest rates, the deadly Trinity, whose baleful effects are only now starting to appear in a form of perfect storm of bad ideas.
And so, with retail price inflation soaring – thanks to a large degree to supply chain chaos and energy shortages caused by Zero Covid and Zero Carbon policies respectively - the Central Bankers are moving in more or less lockstep, not to unwind this disastrous policy of Zero Interest Rates but to make things even worse by imposing an equal and opposite disaster through direct targeting of financial assets with no regard to collateral damage! The RBA’s latest move is part of this new financial puritanism and countries like Australia, the UK, Ireland and parts of Europe face the prospect of an additional blow to their economies on account of the extreme interest rate sensitivity of their consumer sector, reflecting not only the size of the mortgage book, but more importantly the fact that it is almost entirely floating rate. This is in contrast to the US (ironically the economy on which many if not most of the models are based) which is insulated from rising short rates on account of having more than 90% of its mortgage book fixed rate and refinance-able. In effect, the US household is interest rate hedged, Australia, the UK and others are not. Not that the policy makers are paying any attention.
Interest rates will thus serve to act as a (further) tax on consumer disposable income – already hit by sharply higher prices for essentials like heating and eating – especially in Europe thanks to supply chain disruption and poor policy making in recent years. The war in Ukraine has added to these problems, but was not the root cause – that lies with policies of Zero Covid, Zero Carbon and a failure to have either a coherent energy policy or any storage capacity in supply chains. With actual taxes rising (to pay for Zero Covid), essential goods prices soaring (to pay for Zero Carbon and general policy failure) and now mortgage rates rising to ‘pay for’ Zero Interest Rate policy, the cash flow squeeze is going to be tremendous.
Australia is starting to wake up to this emerging crisis and talk of falling house prices is becoming more widespread as the realities of higher funding costs are likely to be far worse than any of the models likely ‘predict’. We would expect it to start in areas popular for second homes, where the reality of what is effectively going to be a margin call on assets is going to produce an imbalance of sellers to buyers of underlying assets. Good news if you want to buy a beachfront home/speedboat/white range rover or a jetski. Not so good if you want to or need to sell any of the above. Or if you lent the money in the first place. Nor is it good news if you work in industries grown up to support that leveraged consumer spending. As we saw in 2008, many of these people were heavily leveraged themselves and their job losses only fuel the situation as they trigger defaults and further asset sales. Wonder how many job losses there will be among the economists?
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Mark Tinker is Chief Investment Officer and Managing Director of Toscafund HK Limited, part of Toscafund Asset Management LLP, a London based specialist Asset Management and Investment firm with around USD 5bn in assets. He is also the Founder of...