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Why Central Bankers Rule The World

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What's been amazing of late hasn't been the market swings but the extent to which central bankers have contributed to them. Every press conference, statement and newspaper leak of central banks has been pre-empted, interpreted and re-interpreted - all in real time and often within seconds. Investor dependence on the thoughts and actions of central banks isn't new, but it seems to have reached unparalleled and absurd heights.

The big question is: why? The obvious answer is that the trend has been driven by greater central bank intervention in markets via quantitative easing (QE) and zero interest rate policies. But Asia Confidential suspects there's more to it than that and the field of psychology may offer some clues. For instance, it's well documented that people have a tendency to defer to authority, particularly in times of crisis. Could this explain at least some of the investor behaviour towards central banks? It's worth exploring given the apparent reliance of stock and bond markets on the world's central bankers. At a minimum, being aware of possible investor biases, including your own, could put you one step ahead of others.

Reading Fed tea leaves

Will the U.S. Federal Reserve slow stimulus or not? That's been one of the big questions on the minds of investors over the past month. We first had rumours of a Wall Street Journal article suggesting the Fed had mapped out a strategy for the winding down of QE. Then the article came out a day later, confirming the rumour. Since that time, various Fed members have come out publicly, some pushing for an end to QE, others for its continuation. The release of Fed Open Market Committee (FOMC) minutes on Wednesday gave us some more clues. Or did it?

Let's first take a look at some of the key passages from the minutes:

"A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting ... Most participants emphasized that it was important for the Committee to be prepared to adjust the pace of its purchases up or down as needed."

And this:

"... participants generally continued to expect that inflation would move closer to the 2% objective over the medium run. Nonetheless, a number of participants expressed the concern that inflation was below the Committee's target and stressed that future price developments bore careful watching ... A couple of participants expressed the view that an additional monetary policy response might be warranted should inflation fall further. It was also pointed out that, even absent further disinflation, continued low inflation might pose a threat to the economic recovery by, for example, raising debt burdens."

Confused? You should be, as the markets certainly were. The S&P 500 initially rose on the comments and later fell on those same comments.

It became clear to many investors that the statements contained little fresh information. In essence, the Fed will play it by ear. If the economy improves, it'll scale back stimulus. If the economy doesn't improve, the current stimulus will remain.

But that didn't stop the commentariat from using the minutes to support their points of view. The bulls emphasised that the U.S. economy was improving and though QE tapering may take place, it wouldn't have a negative economic impact. The bears suggested that the U.S. economy was showing signs of deceleration and there's no way that the Fed would reduce stimulus. In other words, the minutes suited everyone, and no-one, because they were open to many interpretations.

There are two things to note about the reaction to the minutes. First, it shows the extraordinary power that the Fed has over markets now. It's amazing to think that Bernanke's predecessor, Alan Greenspan, has been utterly discredited for his part in creating the credit bubble. And even though Bernanke was at the helm when the Fed had no clue about the pending bubble, his reputation, and that of the Fed, has not only stayed intact but grown.

Second, does the obsessive focus of investors on the Fed distract them from more important issues? For instance, let's look at the potential impact of a normalisation in U.S. interest rates. Currently, the interest paid on U.S. government debt is about 1.5% of GDP. In a US$15.7 trillion economy, that's about US$235 billion in interest paid.

If you saw 10-year bond yields rise from close to the current 2% to the long-term average of 6.6%, the interest on government debt could multiply. The U.S. could possibly be paying US$500 billion or more in interest, on top of that already being paid. That's a lot and would more than offset GDP growth of 2%, perhaps rising to 3% if the economy improves.

To put the possible increased amount of interest paid into context, it could dwarf the recent so-called sequestration cuts of US$85 billion. More interest paid on debt would mean less money elsewhere and likely more serious government cutbacks. And that's assuming that bond yields don't spike above long-term averages.

Would Bernanke really allow that happen? Probably not. Particularly when the less painful way to reduce debt and the interest paid on that debt is through inflation via QE.

Japan's bizarro world 

If investors are stalking the Fed's every move, they're doing the same thing with the Bank of Japan (BoJ), and to a degree that's becoming comical.

The background is that the new government installed a new BoJ chief, Haruhiko Kuroda, in March. Kuroda's mandate was to print a bucket load of money to buy bonds and stocks in order to reinvigorate the economy and end 15 years of deflation.

Investors have warmed to the story, sending stocks up nearly 40% and the yen down 18% this year. That's despite stimulus only recently being initiated and the evidence of success or otherwise still not yet known.

The story's positive glow has taken a darker turn over the past week though. On May 22, commenting on the sharp spike in Japanese government bond (JGB) yields, Kuroda said that gains in yields should be expected as the economy improves. The problem was that he'd previously said that the central bank aimed to lower interest rates. It sent the Topix index down 6.9% on the day, the largest decline in two years. And bond yields swung 17.5 basis points intraday, briefly reaching a one-year high of 1%.

A three year chart of 10-year JGBs is shown below, courtesy of Bloomberg.

Then the next day, after a further spike in bond yields, Kuroda said the stimulus already announced by the government was sufficient but conceded he needed to communicate better with markets. The stock market swung wildly as Kuroda spoke, and after, moving 6% intraday, but finishing slightly up.

The problem, of course, is that investors had put total faith in Kuroda's ability to turn the economy around and that faith's now being questioned. The question is why investors had such faith in the first place.

Also, the focus on the BoJ's every move may mean investors are ignoring more pertinent issues. For example, if the BoJ succeeds with its aim to raise inflation to a targeted 2%, that means interest rates will rise. With interest paid on government debt equivalent to 25% of Japanese revenue, any rise in rates could prove diabolical. If the BoJ doesn't succeed, the enormous government debt load will compound and bond markets may eventually revolt. It seems like a lose-lose situation, and if that's right, the BoJ's every move takes on less importance.

Cognitive biases at work

What's behind this investor obsession with central banks then? It's obvious that central bank invention in bond and stock markets (direct and indirect) is greater than at any time in recent history. Undoubtedly, investors are struggling with this. Normal market operations are no longer normal. Investors have had to turn into part-time political scientists in order to anticipate market movements.

But is there more to it? I'd suggest that there might be and investors could be turning to time-old psychological biases to try to cope with the new environment.

Of course, the application of psychology to finance, known as behavioural finance, isn't new. It's a growing area of study though given the recognition that most investors are far from rational actors when it comes to markets.

Anyhow, here are five psychological biases that may explain some of the recent obsession with the actions of central banks.

  • Deference to authority. Studies have shown that people defer to authority, particularly during extreme crises. Stanley Milgram conducted the most famous experiment into this in 1963. The context for the experiment was that after World War Two, many wondered how ordinary people could commit unspeakable crimes. Milgram sought to test this in a laboratory to see how far people would go when an authority figure ordered them to hurt another human being. The shocking answer was: very far. While an extreme example, the lesson for investors is that many people will often do what an authority figures tells them to do, either overtly or otherwise.
  • Conformity, or the herd principle. The best-known study on this was done by Solomon Asch in the 1950s showing that people will deny evidence from their own eyes to fit in with others. This suggests that groups exert a tremendous influence over individual decision making.
  • Group conformity. A corollary of the above is that people conform more strongly with others that are in the same group as them. If your an economist, you're more likely to conform with the thinking and actions of other economists.
  • Cultural conformity. Collectivist cultures, particularly in Asia, are more conformist in their behaviour. This is because non-conformity is seen as deviance. Average conformity rates range from 25-58% in collectivist cultures compared with 14-39% in so-called individualist cultures. This explains much about Japan...
  • Adherence to social norms. Other people affect us even when they're not there. Studies by Robert Cialdini suggest that most people are strongly influenced by thinking about how others would behave in the same situation, particularly if they're unsure how to act. For instance, a decision about whether we buy into the stock market is often influenced by society's view of such a purchase. That makes for bad investing!

These are just some of the biases that may have contributed to the heavy reliance of financial markets on the words and deeds of central bankers.

Bias awareness means better investing

An understanding of these psychological biases is critical if you accept that they may be behind at least some of the investor behaviour of late. An awareness of the biases means that you can work to minimise them if they're impacting your own decision making. Minimising psychological biases can make for more rational, objective investment decisions. And a tidy edge over others.

This post was originally published at Asia Confidential  (http://asiaconf.com).

 

 

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Tue, 05/28/2013 - 12:34 | 3603913 MeelionDollerBogus
MeelionDollerBogus's picture

The background is that the new government installed a new BoJ chief, Haruhiko Kuroda, in March. Kuroda's mandate was to print a bucket load of money to buy bonds and stocks in order to reinvigorate the economy and end 15 years of deflation.

Ponzu? IMPOSSIBRU!

Sun, 05/26/2013 - 01:24 | 3599283 torak
torak's picture
Why Central Bankers Rule The World

Because they have all the money, including your money that really isn't your money anymore, but it's their money because it's in their banks?

Sun, 05/26/2013 - 01:15 | 3599275 Lordflin
Lordflin's picture

Central bank activity has gained such notoriety for the simple reason that after the real economy disappeared from view it was the only game in town... Moreover, there is little left trading other than algo's... and they could care less about real value... Not that they care about anything necessarily... care in the euphemistic sense...

As to Ben... Amongst those with any kind of brain he is one of the most despised of public figures... kept alive only by a lap dog press...

Sun, 05/26/2013 - 00:34 | 3599251 TNTARG
TNTARG's picture

It's amazing how people keeps circling the point. It has been written centuries ago.  At this point, I would advise to go back to Philosophy, Backwards to Locke versus Hobbes, minimum.

Sat, 05/25/2013 - 22:48 | 3599134 IamtheREALmario
IamtheREALmario's picture

With Great Power Goes Great Responsibility?

Apparently the banks think that their responsibility stops at their own pocketbooks and crony cabal power circle. Admittedly they are probably too incompetent to run the full world, so they have to select the portions that they ignore ... such as the 99% that suffer under their rule.

Sat, 05/25/2013 - 13:58 | 3598533 Sean7k
Sean7k's picture

Well written discussion of why people allow the CB's to control economic policy, completely devoid of any discussion on why they rule the world.

The reasons they rule the world have a number of areas of study, separate, but interlinked- including history, politics, economics, criminal behavior and zionism. 

Once you start with the zionist's beliefs regarding all other races, add in the brilliant insights of the Rothschilds on banking, money and government control; you can begin to color in the other disciplines as means and record of their motivations and ultimate plans.

Well developed propaganda is incredibly difficult to identify and reason against under the pressure of social norms, the manipulation of information and State threats. 

Tue, 05/28/2013 - 12:39 | 3603931 MeelionDollerBogus
MeelionDollerBogus's picture

Bu... bu... but... thats rayciss!!

Sat, 05/25/2013 - 23:38 | 3599199 DeadFred
DeadFred's picture

I speculate that this is based in biochemistry and ultimately genetics. A (hypothetical) gene that allows one to disconnect from reality and believe whatever the others around believe would have enormous adaptive value. Call it the Obama gene, symbol Bs, and from familly inheritance patterns it seems to be dominant. Bs/Bs and Bs/bs individualal are able to see the evidence of reality and then filter it to fit with what they are told thus avoiding the deleterious consequence that come from fighting those with power it the community. They can see the fact that Obama has never done a single thing to hurt a bank and Bernanke is destroying the economy and then somehow filter that into thinking that Obama is anti-bank and the Fed is our friend. Individuals with the bs/bs genotype are unable to do this, leading them to fight city hall, to get on DHS watch lists and to read Zero Hedge. We would all be happier if we could do this filtering, the happiness of the docile sheep being led to the sheering pen. Sadly I am of the mutant genotype and will have no choice but to resist and scream as they lead me down the chute.

Sat, 05/25/2013 - 13:49 | 3598505 0b1knob
0b1knob's picture

One of the most tiresome aspects of zerohedge and similar sites is the paranoid tendency to blame EVERYTHING on the bankers.   The evil banksters took all the money!  Bad banksters!   In times of stress (like Germany after the Weimar inflation and the depression) there is always a tendency to scapegoat some group.   In the 1930's it was the Jews.   You don't have to look far thru the posting on zerohedge to see the same sort of twisted reasoning.

 

Well I hate to break this to you but the banks don't have any money of their own.   The loan out OPM (other people's money).   The losses aren't being transfered from the banks to others.    The losses will be borne by everybody.    Bank capital of all US banks was wiped out years ago.    Its not a conspiracy, its just the way fractional reserve banking works.     See Cyprus for a prevue of the very near future for the US.   I spent some time in a hospice once and it always amazed me how people who were very close to death somehow could see how sick they were.   It was only after I left (my doctor described me as a miracle to some interns at one point) that I realized that I was in denial the whole time myself.

Thats the state of the world right now.   Terminal but in denial.   Some sort of great reset is going on and nothing, not even the stacks of gold so beloved by zerohedge posters will save you.   I fear we will see war, famine and suffering on a scale beyond imagining before it is over.   Perhaps the world will go all the way back to the stone age.   When it is over human civilization will be very different and the population will be reduced to a sustainable level.   Perhaps the Mayans were right all along.   The world as we knew it ended, we just haven't realized it yet.

Tue, 05/28/2013 - 12:42 | 3603941 MeelionDollerBogus
MeelionDollerBogus's picture

Then how did we get the fractional reserve banking?

The sheeple and the overlords (bankers).

When we are our own banks there is no such problem.

Sat, 05/25/2013 - 14:12 | 3598523 Widowmaker
Widowmaker's picture

More "nobody saw it coming" horse shit.

Banks are the alpha and omega of incorporated corruption, oppression and systemic breakdown of the rule of law.

Unfortunately for you, history, including the persecution of Joos, agrees with Widowmaker.

End the Fuckup Fed and see the power of money restored to the people, instead of in your face racketeering supported by the likes of you.

The Huffagton post misses your ignorance and misinformation.

Sat, 05/25/2013 - 21:00 | 3599005 0b1knob
0b1knob's picture

My point is not that "nobody saw it coming" but that EVERYBODY saw it coming.    And we all went on flipping houses, living beyond our means, worrying about nonsense like global warming, and insider trading the stock market (you all know who I'm talking about with that one don't you?)    And then when TSHTF we elected choom boy president and even more unbelievably RE elected him in some sort of magical thinking mass delusion I can't pretend to understand.

 

We are truly screwed and its not the bankers.   We did it to ourselves.

Tue, 05/28/2013 - 12:45 | 3603957 MeelionDollerBogus
MeelionDollerBogus's picture

no, it was the will of the bankers to do this and only the bankers had financial benefit from it.

It's like injecting people with meth against their will and ordering them into traffic.

Just because some come out alive doesn't mean it was their fault for running high in traffic.

The injections are FORCED and the contents OF them are lied about at all times.

The overlords in charge tell you it's vitamins, it's good for you and by the way, we'll jail you if you refuse to play with our "vitamins" (methamphetamines).

Sun, 05/26/2013 - 05:26 | 3599380 Unique Snowflake
Unique Snowflake's picture

If you were to lead a bunch of retards to a cliff and suggest eternal bliss if they hurled themselves off, are you really suggesting they would be the only ones to blame?

Remember: look at how stupid the average citizen is, then realise half of them are more stupid than that.

Bankers and their exorbitant privilege (of outright fraud) promised the world wealth without toil, and the world's retards were only too willing to start hurling.

Sat, 05/25/2013 - 12:59 | 3598446 Hohum
Hohum's picture

Long term interest rate of 6.6%?  Trend is not destiny.  UST 10 year will not go above 3% for 10 years or longer, maybe forever.  Why?  Because growth, defined as GDP/total credit market debt + fed liabilities, is over.

Sat, 05/25/2013 - 23:43 | 3599204 DeadFred
DeadFred's picture

Bookmark your comment and come back to it in a year. A diet with a little crow in it is a healthy diet. Growth is not the only way yields can rise.

Sat, 05/25/2013 - 13:51 | 3598527 Crisismode
Crisismode's picture

 

 

If the value of the USD starts to plummet, would you still be willing to pay only 3% for a Ten-Year at that point?

And how many other people would?

 

Sat, 05/25/2013 - 14:09 | 3598548 Hohum
Hohum's picture

Crisismode,

 

Your comment makes sense, but why are investors snapping them up at 2% now (the Fed)?  I think an oil price that the economy cannot afford will force the Fed's hand, although it could be a couple of years away.  Because we cannot grow, deflation will eventually overtake inflation.  Cash will be king.

 

You're right, though, that if inflation is the winner, then nominal rates will rise.  I don't see it happening.

Tue, 05/28/2013 - 12:49 | 3603973 MeelionDollerBogus
MeelionDollerBogus's picture

That makes no sense. Cash can't be king unless credit & base money contract. They aren't.

Investors aren't "snapping up" anything.

It's the Fed and that's not "investors" that's central control.

Growth of real tangible goods in today's markets can not push inflation up or down - the control of the printers (ECB, Japan, USA, China, various others attached) are too strong.

Cash will not be king - tangible goods will.

Sat, 05/25/2013 - 12:57 | 3598442 Kayman
Kayman's picture

Real economic growth comes from increasing value in goods and services- it is the value-added from production and/or labor. Bernanke is still strapped to his hobby-horse playing "giddy-up" with the "wealth effect". It's time Bernanke's Mommy told him its bedtime.

Those closest to politicians and central banks will continue to increase their share of a diminishing economic pie, while producers, individually or collectively, are robbed of their assets.

Sat, 05/25/2013 - 12:21 | 3598362 robnume
robnume's picture

These observations; while right on the money, are sociological rather than psychological in basis. While I personally believe all disciplines - psychology, sociology, poli sci, et al. - are inextricably intertwined, the fact is that studying the group matrix is sociological. Studying individual behavior is psychological. Yes, I'm an anal twit, but I am always pleased to see an article such as the one above - because the truth is that people do seem to "group think" when it comes to economics when they would be better served to think as individuals. If this country wasn't so damned propagandized and distracted by any number of things they might learn that central banking, fractional reserve banking and so on, are what is killing this country. But, the real problem is that NO ONE is intellectually curious anymore. (As if they ever were). I still call Bush II "Incurious George".

Sat, 05/25/2013 - 12:47 | 3598430 decentralizedsc...
decentralizedscutinizer's picture

 

I think the biggest problem we face today is our lack of appreciation for the innate power and danger of incorporated entities of any sort, including government. Such collectives, like wild chimpanzees, are prone to a degree of aggressiveness unthinkable in an individual. Yet our society permits such incorporation to occur, without restraint, by the worst elements of our population, the sociopaths, by the simple process of registration with the State.  We'll never have a democratic republic nor a capitalist economy until society defines the legal limits to which incorporated entities must conform. I think this amendment would restore personal responsibility to both. It should at least be the subject of current debate.

28th Amendment (The Constitutional Emergency Amendment)

    Corporations are not persons and shall be granted only those rights and privileges that Congress deems necessary for the well-being of the People. Congress shall provide legislation defining the terms and conditions of corporate charters according to their purpose; which shall include, but are not limited to:
    1, prohibitions against any corporation;
    a, owning another corporation,
    b, becoming economically indispensable or monopolistic, or
    c, otherwise distorting the general economy;
    2, prohibitions against any form of intervention in the affairs of government by means of;
    a, congressional lobbying
    b, electoral sponsorship or advocacy
    c, educational sponsorship or publication
    d, media news reporting
    3, provisions for;
    a, the auditing of standardized, current, and transparent account books
    b, closing the FRB and the establishment of state-owned banks
    c, civil and criminal penalties to be suffered by corporate executives et al for violation of the terms of a corporate charter.

Optional: (or possible 29th amendment)

    The 16th Amendment to the United States Constitution is hereby repealed and Congress shall re-write the U.S. Code to reflect the changes embodied herein.

     

Tue, 05/28/2013 - 12:53 | 3604006 MeelionDollerBogus
MeelionDollerBogus's picture

A proper capitalist society permits any organization of individuals based on individual rights, consent, and gives no special favour to collectivist groups. Investors, workers, business partners sharing ownership, whatever, already get economies of scale if they join to larger groups and know what they’re doing – they don’t need additional legal or financial protection from anyone else or they shouldn’t be working together and the market will make their folly apparent over time.

Sun, 05/26/2013 - 07:51 | 3599450 Mitzibitzi
Mitzibitzi's picture

When I was in the service, a few of my co-workers took part in a fairly exhaustive investigation to see at what size operational units worked most effectively and how many of the basic unit could be effectively managed by the next link up the chain of command, and so on. IIRC, the study concluded that 10-15 people was the largest base unit size that worked well. Only 5 of these could be effectively controlled by the next higher command authority. Only 3 of those could be commanded effectively. And no larger organisation was possible, without a marked decline in task performance.

Bear in mind this is a military formation, where each member is (in theory, at least) aware of his role and responsibilities, is adequately trained to carry them out and is part of a very clear chain of command - a level of organisation that is vanishingly unlikely in a corporate structure, with it's inbuilt echelons of chair warmers and pointless report, chart and graph producers. Given those organisational advantages, it was concluded that ~150 people is the largest organisation that can work at anything close to it's maximum theoretical efficiency. Beyond that number you started to see a rapid rise in confusion, scheming and back-biting behaviour amongst equivalent ranks all vying for the same promotion slots, graft, outright theft and institutional laziness.

And yet, there's still the view in society at large that corporations, banks, governments, etc which employ 10s of thousands upto millions of people can ever work well....

Kinda reinforces the view that no social structure bigger than a modest sized village can organise it's own affairs with any degree of competence, don't it?

 

Tue, 05/28/2013 - 13:05 | 3604075 MeelionDollerBogus
MeelionDollerBogus's picture

The bias you're missing is that you can have a giant number of people all doing the same thign with little contact in various stations (buildings) around the world and also report information up via computer and have the stats managed via servers, computers, with a manager there to take the blame if it goes wrong, to decide where to re-deploy inventory.

See, corporations don't do what armies do, and each model & industry of business is unique.

That's why we need a market, and in theory have one, to ensure each part and each total corporation is mediated by ALL the market, stopped from shortage of funds if it's doing things wrong. This allows the hierarchy, parallelism & total size to adapt to market needs. Not management needs. MARKET needs. Management should be SUBJUGATED to the market.

In the military that's precisely opposite: the field is to be subjugated to the MANAGERS (commanders, generals) & if it isn't then someone else's commanders (enemy) is in control.

That's not how markets work. There's analogies but the differences are important. The market is supposed to be in charge, not the managers, and this is inverse to military operations

Sun, 05/26/2013 - 23:08 | 3600529 decentralizedsc...
decentralizedscutinizer's picture

That's interesting and brings up just one more reason for discouraging the proliferation of bureaucratic entities in general. The more I look into the "nature" of incorporation the more facets I find. None are favorable.

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