The myth of independent central banks

Trying to invest well in this pandemic world requires careful consideration of the policies of major central banks. The US Federal Reserve led the rescue after the virus crash in March 2020. The Bank of Japan and the European Central Bank have been important sources of support for financial markets and economies.

The Bank of China has pursued a harsher policy than the others, while avoiding recession. Chinese stocks, as we expected, were undermined by monetary tightening and attacks on excesses in sectors such as real estate.

Buying bonds and low rates drove fixed income up and people into higher yielding stocks, which looked cheap compared to low current bond yields.

Today’s high stock values ​​owe a lot to decisions by central banks to cut interest rates in an attempt to keep asset markets inundated with liquidity and keep long-term lending rates low. It was the Fed’s decision to create at least $ 3 billion to offset the foreclosure black hole that persuaded me to invest from the summer of 2020 in anticipation of a strong stock market rally thanks to to all that money.

As this year draws to a close, the question is whether they will withdraw the stimulus too quickly for the markets, as they seek to contain the inflation genius they have nurtured. So far we’ve had good returns for investors as the US has continued to heat up.

The markets have come to believe that the big central banks are independent and that is a good thing. The ECB was modeled – in part on the Bundesbank – on the idea of ​​independent experts setting short interest rates in order to contain inflation. The Bank of Japan and the Fed also have inflation targets of 2%.

The high noon of the idea of ​​independent central banks ensuring discipline came during the first two decades of this century. The theory says they will be led by wise and impartial people, who understand economies and markets so well that they know when to increase money and credit and when to contract them by changing interest rates, to keep the money going. inflation at around 2%.

It’s hard to know why people believe this. After all, economies have been hit hard by the banking boom and recession, where central banks allowed commercial banks to increase credit and inflate asset values, only to halt them too abruptly in 2008 and cause the collapse. banks, as well as triggering a sharp fall in the markets and a great recession. Central banks have succeeded in blaming commercial banks for the excesses, without properly accepting their part in the boom and the slowdown.

It has turned out to be very difficult to find those particularly insightful people who can call him well and avoid major swerves. They are usually appointed by presidents or prime ministers with the help of finance ministers who have a political interest in the policies they follow. This year, several major central banks predict that inflation will be much lower than it turned out to be.

It is difficult to identify a fully independent central bank, even in this era of legendary independence. Today we can see a tendency for governments to have more explicit influence.

Turkey’s President Recep Tayyip Erdogan has flexed his power to appoint the central bank governor, seeking someone who will keep rates low or cut them, regardless of the rate of inflation or tensions on the currency. The People’s Bank of China does not hide in all its statements that it considers its task to be to implement the ideas and policies of President Xi Jinping and the Communist Party.

The Fed itself has long had a dual mandate: to keep inflation low and to ensure decent growth. Where there is some tension between the two goals, the Fed must make a judgment and would generally listen to the views of the administration.

Some central banks have been associated with extravagant fiscal policies. In some Latin American countries, they were unable or unwilling to compensate for government excesses and ended up supporting or supporting very high inflation rates. Argentina and Venezuela are not big advertisements for the work of their central banks.

Joe Biden, the US president, began to reshape the Fed, using his powers to make board appointments. He appears to have negotiated a political platform for the new Fed between Jay Powell, its outgoing chairman, and Lael Brainard, its newly appointed vice chairman, who wants to bring it closer to the Democrats’ full agenda.

The new Fed will take its net carbon emissions and social inclusion obligations more seriously and may take a tougher course against banking as a regulator. The Republican-oriented president and the Democratic vice-president both want to run the economy as hotly as the markets allow, looking for a stronger and longer recovery. Both are worried about inflation, while Biden comes under heavy political criticism for presiding over 6% inflation.

There are more worries about how quickly the Fed will have to withdraw its stimulus measures and how long inflation will stay high

Markets must adapt to more political central banks. Mexico has a new central bank manager in the government ranks. The ECB is the guardian of the EU project and will always take into account what is needed to strengthen and advance economic, monetary and political union. What it takes to reassure the markets is that a given central bank works well with its government and that among them, they adopt a responsible but pro-market view.

The FT fund once again benefited from American exceptionalism, where the combination of large technology companies and a very accommodating monetary policy enabled substantial gains.

As we move into the end of 2021, concerns are mounting over how quickly the Fed will have to withdraw its stimulus measures and how long inflation will stay high. It appears, however, that the global economy will continue to be supported by zero interest rates and a lot of extra money from the Bank of Japan and the ECB. The People’s Bank of China doesn’t want to trigger a recession, but it is helping the government cut the big poppies out of the corporate world, especially in real estate.

It’s time to be safe, not to panic. The Fed will try to reduce high inflation and Biden will seek solutions to address the many supply bottlenecks. The Fed has a new political deal to find to allow Democrats to advance their vision of recovery and social justice.

Sir John Redwood is Charles Stanley’s chief world strategist. The FT fund is a fictitious portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while reducing investment costs. john.redwood@ft.com