Ben Bernanke’s decision to cut interest rates in September will probably be used as the leading example in the “what not to do” classes for central bankers in decades to come.
Besides focusing too much on a single piece of data – the August headline payroll decline of 4,000, he was also accused of paying too much attention to the wishes of Wall Street moguls. As it turns out, even as stock markets jumped significantly in September, the original headline for August jobs was actually erroneous. Announcement of the September payrolls last Friday saw an upward revision of the August number to a positive 89,000 jobs, along with a substantial rise of 110,000 in September. That sent bond yields higher around the world, and probably caused billions of dollars of losses across Asia, where central banks hold a bulk of their countries’ reserves in US Treasury bonds.
Investors rejoicing about the rise in global stock markets though must stop and think about their gains in the context of other asset prices, such as gold. When used as the benchmark, ie, index prices as a function of gold prices, America’s stock markets are actually down around 9% this year, rather than being up 10% as people report. For much the same reason, the Hong Kong stock market is up “only” 20% this year, rather than the 45% gain that newspapers report using simplistic index calculations.
In effect, the rise in nominal stock market values shows a lack of confidence in monetary policy by investors who are looking to re-leverage their portfolios in order to avoid inflation. This is an important point that is not always appreciated by central bankers – investors behave in relation to expected price changes, rather than observed variables. Thus, even in places where interest rates are being kept steady, when investors expect a rise in inflation, their view of the real cost of borrowing changes, ie, it becomes lower. Reduced cost of borrowing, in their minds, would then equate with higher borrowing.
Look at this from the perspective of savers, and the view is much the same. When Bernanke cuts interest rates as he did last month, he reduces the amount paid to savers each month. Even as their incomes are reduced, they may find that expenses remain the same or actually increase. Under this scenario, keeping money with a bank is not an option, so investors have to go out and buy assets with greater chances of appreciation. Now that no one in the US believes in buying houses, they have gone back to chasing stocks.
This is of course a wonderful cycle. Confronting the dotcom bubble in 2000, former Federal Reserve chairman Alan Greenspan cut interest rates aggressively, in effect encouraging speculation on home ownership. Now that house prices are falling after the boom went just a bit too far, his successor has attempted the same medicine but this time to favor stock markets. Many companies are now trading at multiples that are similar to those observed in 1999, just before the dotcom bubble broke.
Inflation springs eternal
Across various non-G7 countries, often referred to by the dubious label of “emerging markets”, the increase in observed inflation has been strong. Financial websites estimate average inflation in these countries at over 5%, from under 4% just last year. What is more important though is the figures that are not published – namely food price inflation, which now runs at over 10% in major emerging countries. Breaking down the components of price increases shows that meat and poultry are the main contributors of food inflation across Asian countries such as China, Taiwan, Korea, Indonesia, the Philippines and Malaysia.
One of the greatest frauds perpetuated on modern monetary policy was pulled by the US Federal Reserve about 30 years ago, when the oil crisis of the 1970s led to the abandoning of fuel prices as an input for the calculation of inflation, along with other volatile components that were removed over the period, such as food and house rents. The new measure, called “core” inflation, in effect is useful for people who don’t eat, drive or live in houses. Other than Dick Cheney, I cannot think of any American who fits this description.
But I digress. The rule of thumb for central banks is that they can control only two out of the following three: money supply, interest rates and currency values. In Asia, most banks are wedded to controlling currency values due to politically-inspired pegs, and also have a habit of setting interest rates due to their need to corral bank profitability that is driven by the gap between borrowing and lending rates. For more on the subject of how banks make money, and where Asian currency policies fit into the picture, I refer readers to a recent article (1).
As a result of frequent intervention in the currency and interest rate markets, Asian central banks lost control of their money supply a while ago, with the most extreme failure being observed in China. The resulting storms of liquidity going through their financial systems have caused massive asset bubbles to build up – whether it is stock markets in Shanghai, houses in Chengdu or office blocks in Beijing, the effects of China’s central bank, the Peoples Bank of China, losing control of its money flows are there everywhere. In addition, skyrocketing prices have also caused a seismic shift in Chinese consumption – which extends from luxury items such as mobile phones to mundane daily items such as pork.
Food prices have gone up due to America’s poor handling of environmental issues (2), which has helped to push up the cost of corn and with it, the prices of meat-related products. Chinese people have always associated the consumption of meat with prosperity and true to form the current bout of rising markets has contributed to sharp increases in the prices of staples. I wrote about this a few months back (3), arguing that China will have to loosen its currency peg in order to reduce politically sensitive inflation, but clearly the export lobbies continue to have greater success than people’s deputies within the Communist Party. Then again, recent events in Burma (or Myanmar as the world’s communists and this publication call it), where the normally stable populace erupted after a long-term economic decline that resulted in their purchasing power plummeting to near zero, would probably help change this equation for China.
For an example of a country that keeps the voice of the public above that of business lobbies, Asia doesn’t have to look further than India. By allowing its currency to appreciate – the rupee is now below the important 40 level against the US dollar – the country has reduced the cost of food imports, thereby keeping its populace happy. Indeed, inflation in India is now at its lowest (3.8%) in recent history even though food prices are rising at over 7%. In India though, the rise in food is led by fruits and vegetables rather than meat-related products, and is a result of farmers allocating more land to staples such as wheat whose prices have been going up steadily. The reasons for wheat prices rising have been explained in “A quick aside” below.
Not having adequate control on monetary policy might be okay for the Americans and Europeans, but it is distinctly not alright for Asians who still have a century of economic growth ahead. The choices are therefore to allow currencies to increase against the US dollar, or look for alternatives that help to constrain the demand side of the equation. Asian central bankers do not have enough political strength to put in effect the first alternative, in effect leaving the second idea as the only real path available.
A quick aside
Perhaps a quick view of the economics of meat would help here. Cattle, pigs (livestock) and poultry raised for their meat consume more food grains than people do directly. Global livestock numbers exceed the human population, which effectively implies that the main consumption of food grains is for raising meat. Rising demand for meat thus has an exponential impact on the demand for food grains, in turn causing inflation in food prices across the chain.
Raising livestock causes efficiency gaps in the food chain, due to the need for sustaining life. Put simply, a calorie from meat is produced at the expense of more than 4 calories from food grains. This clearly positions the consumption of meat as a luxury good which guarantees that the price of meat would be higher due to associated costs. However, governments across G7 have consistently provided financial subsidies to farmers that are aimed at keeping input costs low enough for them to make a living from selling meat products, which is why Europe has an interesting position of mountains of food along with rising subsidies.
The environmental impact of livestock is also negative – for example, more than 60% of methane emissions globally come from cattle. As I wrote in a previous article (5), allowing a negative economic good to be priced at zero causes the obvious reaction of mispricing, which is observed in this case as well as farmers around the world increase their livestock due to rising demand for meat.
Alternative way out
The way out of this self-created mess is for the major G7 economies as well as emerging markets to turn the clock back on meat consumption, in effect reducing the demand for both dairy and meat products. Fortunately for anyone grappling with the sheer difficulties associated with propagating this diet, there is a centuries-old religion that stands ready to do just that.
Buddhism is forever associated with the principles of non-violence and kindness of human beings to each other, as well as to other animals. Whilst not prescribed as a basic principle of life in the holy texts, Buddhists generally abjure meat. Their pacifist principles are broadly applicable to solving the most intractable crises in the world, including those of the Middle East. The centuries of debate between Buddhists and other religions, including Hinduism, have produced more than adequate philosophical sophistication in dealing with intellectual challenges from the well-to-do. Then again, people don’t have to convert to Buddhism to follow the principles laid out.
Accepting the religion or at least its principles therefore carries with it a steady decline in the demand for meat and related products, which will help the US Federal Reserve, the Peoples Bank of China and other central banks to cut inflation expectations at home. In turn, this helps to engender greater efficacy for monetary policy. Given that markets love to listen to the Fed chairman, perhaps it makes sense for him to be the first to recommend the Buddhist way of life, in some suitably informal chat – perhaps a quiet word to Maria Bartiromo (5) would do the trick.
Notes 1. Asia and the vicious cycle of bank bailouts
2. Pork barrel politics
3. Deja-wu: Why China must revalue
4. Food and Agricultural Organization, www.fao.org 5. News anchor for CNBC, an informal conversation between the two earlier this year was misrepresented as the Fed’s official position and led to significant market volatility in its aftermath.