Which mistake will central bankers choose to make next?
The heads of the Bank of England and the US Federal Reserve have choices – but none of them are good choices, says Merryn Somerset Webb.
I used to think the worst job in the world would be chancellor of the exchequer. I’ve changed my mind. At least as chancellor you pretty much always have the opportunity to do things you know will improve the nation’s financial security, or even make people’s lives better. That chancellors often don’t use those opportunities very well doesn’t mean they aren’t available. That is not the case if you are a modern central banker.
The heads of the Bank of England and the Federal Reserve do get choices. It is just that none of them are good choices. Such leeway as they have consists entirely of choosing which mistake to make when it comes to monetary policy. They are already so far behind the inflation curve that there is no easy way out (I am generously leaving aside that they are lying in beds of their own making). They can either raise interest rates very sharply to control inflation, and thus create a recession – or they can keep rates below inflation and give in to prices rising at rates way above their 2% inflation targets (we talk in this week's magazine about how we all need to learn to live with inflation, and why there’ll be more of it for longer than anyone thinks).
Which will it be? For the full details of the many varieties of mistake to come, do listen to this week’s podcast with the wonderful Mohamed El-Erian. But my best guess (after 25 years of watching central banks) is that they will have a stab at both. First they’ll put rates up too fast – inflation is too high to ignore. Then, as inflation stays high (there isn’t much central banks can do about the inflationary impact of China’s idiotic zero-Covid lockdowns), markets tank and consumers slam their wallets shut, they’ll reverse too fast. A bit of start, a bit of stop and then perhaps a bit more start. The result will be slow growth, or even recession and inflation too. Lovely.
Losses wherever you turn
It isn’t just central banks who get to choose which mistake to make this year: investors do too. You can move more money into cash. You can stay in equities, or you can buy bonds. Cash will lock in a real loss of whatever inflation turns out to be (anywhere from 7%-10% this year). Stick with equities and you are unlikely to end the year up in real terms – the S&P 500 is down 12% in the year to date. To get you to purchasing power evens with inflation at 8.5% it would have to end the year up 24% from here. That might happen; it probably won’t.
The UK isn’t doing so badly – the FTSE 100 is flat on the year and high dividend payouts compensate for inflation to a degree. But you get the picture. Almost no one is making money. Your aim is just to choose the mistake that loses you least. I’d go central bank on this, and make both. Have cash (25% says our guru in this week's magazine) and equities too – choose the latter with a view to minimising misery. Max King reckons you can do that in HgCapital Trust, for example.
There is also merit in the idea that if you are going to lose money you should not pay too much to do so – we have details of AJ Bell’s super-cheap new app-based investment platform. Finally, don’t forget to hold some gold. And if you want to talk about any of this and you happen to be in Edinburgh this weekend, come and hear John and me talking at the new Library of Mistakes this weekend (see Eventbrite for tickets).