One flew over the cuckoo's nest

Why monetary policy has become a madhouse

https://www.pricevaluepartners.com/one-flew-over-the-cuckoos-nest/

“Three geese in a flock,

One flew East, one flew West,

One flew over the cuckoo’s nest

O-U-T spells OUT

Goose swoops down and

Plucks you out.”

• Children’s nursery rhyme.

“The Japanese are both aggressive and unaggressive, both militaristic and aesthetic, both insolent and polite, rigid and adaptable, submissive and resentful of being pushed around, loyal and treacherous, brave and timid, conservative and hospitable to new ways..”

• Ruth Benedict, ‘The Chrysanthemum and the Sword’.

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Ruth Benedict, an anthropologist, wrote ‘The Chrysanthemum and the Sword’ in 1946 to help Americans understand the Japanese culture during their occupation of the country. It is widely considered to have popularised the distinction between guilt cultures (primarily, those of the West) and shame cultures (primarily, those of the East).

Around the time this correspondent started his first job in the City – working, incidentally, for the Japanese – he came across another description of the differences between East and West. The advocate of this theory, whose name now eludes us, suggested that the economies of the East (and also Germany and Switzerland) had characteristics in common as “Alpine economies”, as opposed to those of the West, which were described as “Anglo-Saxon economies” (the most notable being those of the US and the UK).

Whereas the Alpine economies were more like social market economies which acknowledged a benign role for the State, the Anglo-Saxon economies were more ruggedly individualistic and libertarian, promoting an enhanced role for the individual over the community at large.

Whether these somewhat crude identifiers are really much help to investors is something of a moot point. We remember, however, growing increasingly sceptical about the Japanese model while we worked within one of its banking groups.

This correspondent was the sole hire for the Mitsui Taiyo Kobe Bank as a bond salesman in London in 1991, and nevertheless our appointment as a graduate trainee had to be approved by the Tokyo office. All inter-office memoranda had to be “stamped” by senior managers (all Japanese, naturally) with personalised hand stamps.

Something of a glutton for punishment, we elected to work for the Japanese again, two years later, at a company called Daiwa Bank Capital Management, which was conveniently located right next door in Broadgate Circle. There, the British staff had successfully managed to westernise the Japanese staff’s names. So he might have been Kamamoto-San in Tokyo, but he was going to be called “Kevin” as far as the London employees were concerned. Bet the Japanese staff loved that.

We distinctly remember one day asking “Kevin” whether “Harry” was in the office that day. “Not really,” came the reply. Now we appreciate that the Japanese prefer not to give direct “yes” or “no” answers for fear of giving offence (more evidence of a “shame culture”?), but the idea that we couldn’t get a direct answer to a completely innocuous question led us to suspect that the Japanese staff – at least at their banks in London – might not be the pioneers of thrusting, dynamic, fast-response capitalism, red in tooth and claw. That the Japanese economy at the time was then entering what would become a two-decade period of deflationary depression pretty much confirmed these suspicions.

We mention these sweeping anthropological generalisations because the profound economic and cultural fissures between East and West seem to be opening up again. One example – in an interview for our State of the Markets podcast, investor Chris MacIntosh – at the time based in New Zealand – cites a friend of his working for a large US investment bank (named in the show but which shall remain anonymous here) where weekly meetings begin with everyone explaining precisely what they self-identify as, and how they would like to be addressed.

This is all well and good, but a tremendous waste of time and resources for people who are already generously well paid, by any standard. Meanwhile, as Chris points out, the workers of Asia are simply “getting on with it” – and they don’t have the tolerance for the sort of woke nonsense that has taken pernicious hold in the West (albeit Trump 2.0 has done his level best to demolish it within the US).

Our co-host on the podcast, Paul Rodriguez, has an intriguing take on the woke culture: namely that it is, to all intents and purposes, comparable to the so-called “hemline index” – i.e., a reflection of a society’s looseness and effeteness that has tracked markets as they have risen ever higher on a tide of easy money.

Paul’s suggestion, in other words, is that our increasingly woke culture may not fully survive the next brutal bear market. Given the damage that the likes of Extinction Rebellion are already inflicting on the social fabric and public tolerance of our increasingly woke police, we hope Paul is right. While investment bank employees debate their preferred personal pronouns, the workers of Asia, in the words of fund manager James Hay, manager of the Pangolin Fund, amount to 670 million just for ASEAN (the Association of Southeast Asian nations) alone, “and they all want a house, two cars and high cholesterol just like the rest of us”.

So while not all Asian nations are created equal, the region as a whole feels overlooked, not just because of its potential, but because so many of its regional valuations seem to be at giveaway levels. We have flirted with the likes of Japan and Vietnam in the past, and it is likely we will do so again.

Meanwhile, the drumbeats signifying the risk of approaching Modern Monetary Theory (MMT) get louder. Russell Napier warns of its doleful implications in a recent edition of The Solid Ground essay, entitled “Takahashi’s Lament: Europe’s rush for the helicopter”.

Who is (was) Takahashi?

We’ll let Russell explain his relevance to the modern monetary world. First thing to remember – there is nothing really new about MMT (emphasis ours):

“It has been tried many times before. It was tried by seventy-seven year old Viscount Takahashi Korekiyo who, in December 1931, was appointed to his fifth stint as finance minister of Japan. Takahashi, a policy maker with many decades of experience, may have been steeped in the orthodoxy of the gold standard but he was an old man prepared to take the risk of implementing bold new ideas. Appointed to relieve the deflationary contraction Japan faced in the Great Depression, he took the risk of launching the monetary helicopter and the central bank began to credit government accounts with newly-created money. The government spent it. In the face of a seemingly existential threat in the form of the Great Depression, it seemed like such a small step to take.

“Within a year the yen had fallen 44% against sterling, a currency itself newly floating, and 60% against the US dollar, which was still linked to gold. That depreciation occurred despite the enactment of the Capital Flight Protection Act of July 1932 and the further capital controls that followed. The new lower exchange rate pushed inflation higher but it did stimulate exports and industrial activity.

‘Japanese cloth allegedly was sold in Germany at little more than half of local prices, in Norway for little more than the cost to Norwegian producers of imported yarn, in the Congo at prices 30 to 50 percent below those of Belgian competitors. For the first time Japanese electric light bulbs, machinery, rayon products and processed foodstuffs appeared in foreign markets. Industrial production recovered strongly, led by the growth of exports.’

(Golden Fetters: The Gold Standard and The Great Depression 1919-1939.)

“On February 26th 1936 Takahashi was assassinated. Modern readers might think that he was murdered by savers aggrieved at their losses through a pernicious combination of the decline in the exchange rate, rising inflation and enforced lower yields. However, Takahashi was not murdered by savers suffering from the introduction of helicopter money. He was murdered because he stopped helicopter money. Those recipients of the continually expanding ‘public purpose’, most noticeably but not exclusively the military, wanted Takahashi dead because he had landed the monetary helicopter. A policy initially disastrous for just savers, proved impossible to stop and soon it had taken flight again to finance the ‘public purpose’ of the subjugation of the peoples of Asia to Japanese rule.”

As we see things, there is no way on earth that MMT, if unleashed, can possibly end well. That doesn’t mean, of course, that it won’t be allowed to happen.

Here is a plausible narrative of how it is unveiled.

Our overarching macro thesis, dating back to the dawn of the global financial crisis (GFC) in 2007, is that there is now too much debt in the world – both governmental, corporate and household – and just in terms of the government debt load alone, it can never possibly be paid back.

There are three, and only three, possible ways out of the debt predicament (which has only worsened as the world’s central banks opened the monetary floodgates in the form of policies like quantitative easing (QE) and zero interest rate policy (ZIRP)):

Option 1: governments manage to engineer enough economic growth to service the debt. In the first instance, governments can’t really create wealth so much as simply redistribute it. In the second, we would argue that for some regions, and the European Union is among them, the prospect of meaningful economic growth is a fantasy.

Option 2: governments default on their debt. Since we live in a credit-based global economy, the prospect of widespread governmental debt default can fairly be described as apocalyptic. Just think what impact it would have on pension funds, for example – the primary “investors” in government bonds. So let’s park Option 2 in the very long grass.

Option 3. What is the Option to which all heavily indebted governments have ultimately resorted since the beginning of recorded history? Hint: it’s inflation.

QE, one presumes, was expected to do the heavy lifting in this regard, and it failed. It did not manage to inflate away the debt. It did not even manage to stimulate consumer price inflation or wage inflation.

What it did manage to do was inflate financial asset prices, and in the process make the gap between the wealthy and the poor even greater than before the GFC. So perversely, at a cultural level, QE ushered in precisely the sort of social tensions, social grievances and wealth disparities that may make MMT almost inevitable, for fear otherwise of some form of social revolution (not least among the jobless youth of Europe).

The president of the European Central Bank (ECB), Christine Lagarde, has already spoken, odiously, of her apparent priorities. In a now notorious statement prior to assuming her role, she commented:

“We should be happier to have a job than to have our savings protected… I think that it is in this spirit that monetary policy has been decided by my predecessors and I think they made quite a beneficial choice.”

This is some statement, coming from an unelected monetary technocrat within a putative democracy. You would think that the primary role of the ECB would be to protect the purchasing power of Europe’s currency, rather than to destroy it. But then, we should perhaps ask the young unemployed across the eurozone what they think of Madame Lagarde’s success at protecting the jobs they don’t have, and perhaps never will..

John Maynard Keynes called such a policy “the euthanasia of the rentier”. Lest you be in any doubt, when he said “rentier”, he meant: you. And me. Investors who largely despair of the government’s ability to protect our savings so have taken it upon ourselves to do so instead. The English language does not possess words to describe just how disgusting and morally repellent this form of monetarily murderous, self-interested bureaucracy really is.

In his book ‘Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems’, L. Randall Wray outlines the essential workings of MMT. To put it mildly, implementing its recommendations comes at a price:

“These principles also do not deny that too much spending by government would be inflationary. Further, there can be exchange rate implications..

“What if markets react against budget deficits, so the bond market “vigilantes” demand higher rates?.. As discussed, the central bank can set the overnight rate, plus the rate on any other financial assets it stands ready to buy and sell. It can peg the 10-year government bond rate, or the 30-year bond rate.. In the United States, policy used to set saving and demand deposit rates. (This was called Regulation Q, which imposed a zero interest rate on demand deposits…)

“We conclude that shifting portfolio preferences of foreign holders can indeed lead to a currency depreciation. But so long as the currency is floating, the government does not have to take further action if this happens.

“OK, if that happened there could be depreciation pressure on the dollar, in which case China loses since its dollar assets decline in value relative to the RMB. Fortunately, China does not want the dollar to crash.

“Capital controls offer an alternative method of protecting an exchange rate while pursuing domestic policy independence.

“Yes, Congress could have decided not to raise the debt limit. Default on commitments appeared to be quite close. There was no good economic reason to do it – but politics can lead to some crazy results.

“One solution for a troubled country is to leave the EMU and return to a sovereign currency issued by the government.. Default on euro-denominated debt would be necessary.”

Wray seems confused as to whether he is talking about MMT in the US or the EU. Given its political, economic and demographic problems, the EU seems a far likelier and earlier candidate to be “treated” to the policy. But if it comes, it will come at the potential cost of outcomes including: currency depreciation, financial repression, exchange controls and sovereign debt defaults.

Russell Napier, again:

“In the world of MMT, helicopter money drops while savers remain immobile or perhaps deliberately immobilised. Proponents of MMT gaze heavenwards at the beauty of the descending snow of money, seemingly unaware of the rumbling noise behind them as the accumulated years of chilled precipitation rushes upon them in an avalanche. The focus on the flow of the falling monetary snow simply ignores the scale of shift in savings’ balances that this policy change has always brought. Savers will move their savings when helicopter money is dropping from the sky and the impact of such a shift in stock will almost certainly swamp the impact of the increase in the money flow.

“Savers will seek to exit government securities as helicopter money seeks to destroy real returns from such investments. Savers will seek to exit local currency assets, for foreign currency assets, as they realise that the purchasing power of the local currency is being undermined as a matter of policy. As L. Randall Wray makes clear, any such shifts will ultimately have to be stopped, with savers penned into the killing zone of local currency assets and, in particular, in fixed-interest securities.

“In a new system where ‘public purpose will continually expand’, what room is there for the private enterprise that generates the corporate profits that drive higher dividends and higher share prices? Given the scale of the likely decline in the euro exchange rate that follows helicopter money, what are the consequences for global policy and economic growth when the Eurozone embarks upon its new, but really rather old, monetary experiment?”

If, like us, you nurse serious concerns about the imminence of this policy, let alone the introduction of CBDC (central bank digital currency), then the pragmatic response is to reduce or eliminate your exposure to (highly vulnerable) fiat currency and fixed income instruments denominated in that currency, and replace such instruments with tangible, non-financial real assets such as precious metals and other commodities, especially where the prices of those assets remain some way below their historic highs. If, like us, you prefer to own a process rather than a product, sensibly priced mining businesses may be ideal; in many instances, they remain remarkably cheap. You can see the sort of investments we are making in this space here.

The central banking world was already on the verge of turning into a madhouse. The bewildering monetary response to a confected pandemic and latterly to the conflict in Ukraine has only accelerated the likely deployment of helicopter money, MMT, CBDC – and complete and total insanity.

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As you may know, we also manage bespoke investment portfolios for private clients internationally. We would be delighted to help you too. Because of the current heightened market volatility we are offering a completely free financial review, with no strings attached, to see if our value-oriented approach might benefit your portfolio – with no obligation at all:

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Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: info@pricevaluepartners.com.

Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and also in systematic trend-following funds.