Central bankers without a Clue but with Criminal Intent

Monthly Market Commentary: July 1, 2022

“If all currencies are moving up or down together, the question is: relative to what? Gold is the canary in the coal mine. It signals problems with respect to currency markets. Central banks should pay attention to it.”
Alan Greenspan

“Bernanke Is Fighting the Last War” – “Everything works much better when wrong decisions are punished and good decisions make you rich,” was the title of an article by the Wall Street Journal about the views of Anna Schwartz regarding the monetary interventions by Fed Chairman Ben Bernanke in 2008. Ms. Schwartz who co-wrote with Milton Friedman The Monetary History of the United States, 1963, argued that by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury had actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."

Year ago, Milton Friedman observed that, “The only cure for inflation is to reduce the rate at which total spending is growing….. There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked….I don’t think monetary policy has to be backed up by fiscal policy at all. I think monetary policy can curb inflation…. A budget deficit is inflationary if, and only if, it is financed in considerable part by printing money.”

Milton Friedman thought that a computer would do a better job than the Fed’s employees and stated that, “Central bankers always try to avoid their last big mistake. So, every time there’s the threat of a contraction in the economy, they’ll over stimulate the economy, by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one.”

Obviously, Ms. Yellen had forgotten these words when she confidentially asserted that I don’t believe the next financial crisis will be “in our lifetime.” Instead, she created the highest inflation rate since the seventies.

When I look at the decline in the quality of central bankers and also of western governments over the last 20 years or so, I am reminded of the words of Arthur Koestler “If one looks with a cold eye at the mess man has made of history, it is difficult to avoid the conclusion that he has been afflicted by some built-in mental disorder which drives him towards self-destruction.”

An unusual feature of the current environment is that S&P 500 Index Earnings-per-Share Estimates have continued to expand although the heavy-handed interventions by the US administration into industrial sectors will likely have a negative impact on corporate earnings in future. Along with a recession, which is already in place, and a multitude of international ill-conceived sanctions these factors will in my opinion depress corporate earnings. Furthermore, given the fact that rising costs, rising interest rates, and an economic decline will impact corporate earnings negatively, I find it remarkable how analysts and strategists still expect US corporate earnings to expand over the next three years. Serious disappointments are likely.

Finally, I always remember the wise words of the late Leon Levy, who said: “For most people, the most dangerous self-delusion is that even a falling market will not affect their stocks, which they bought out of a canny understanding of value.” Applied to the current financial environment, during which, over the last two years, just about every asset class passed through a bubble phase, I propose to rephrase this sentence: For most investors it is a self-delusion that, in a monetary global tightening phase, the decline in one asset class would not affect the prices in another asset class, which was bought because of an understanding of relative value.

With kind regards
Yours sincerely
Marc Faber

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