By Eric Peters, CIO of One River Asset Management
The Fed presides over the world’s largest economy. Treasury claims otherwise, but the Fed is also guardian of the world’s reserve currency. From this position of power, global central banks were drawn by force of gravity to adopt Fed policies. Over the past decade, global central banks gravitated to the Fed’s policy mix, lowering rates, expanding liquidity, spurring a historic rise in global debt and leverage. Entering 2020, the world had the most homogeneous policy mix since Roman rule. And, as in all things living, lack of diversity reduces resiliency.
Fed policy dominance had complex, unintended consequences, some of which we can observe. For instance, it relieved politicians of the task of governing. Each crisis was easily solved with monetary magic, pulling future demand to the present. This allowed politicians to avoid making tough choices between spending for today versus investing for tomorrow. Without such vital debates, we borrowed from our youth to spend on our ageing. Student debt is one of the many such manifestations. Wildly inflated asset prices are another.
Monetary policy dominance taken to its logical conclusion leads to a world where the entirety of future prosperity has been pulled to the present. At that end point, no matter how many monetary magic wands are waved, the real economy is unresponsive, monetary policy is utterly impotent. As you approach this point, monetary policy gradually losses effectiveness. Somewhere close to the end, politicians are forced to start governing again, making choices. But unlike central bankers who are all the same, each politician is uniquely different, heterogeneous.
As politicians fill the vacuum left by impotent central bankers, they deploy different tools - fiscal, tax, trade, exchange rate, regulatory, immigration and military. They try to coordinate with central bankers, but this produces only illusory benefits because monetary policy once impotent remains so until the system reboots. Today, we are transitioning from a world led by homogeneous central bankers who used a few identical policies in similar ways to one led by heterogeneous politicians who will be using a wide range of policies in wildly different ways.
Global central bank homogeneity produced an era of policy predictability. This encouraged economic actors to leverage balance sheets and business strategies to a stable future. Their actions, like share buybacks and just-in-time manufacturing, were reflexive in that each incremental investment dampened market and economic volatility, reinforcing expectations for a stable future. Naturally, reflexive processes lead to extreme outcomes. Without quite realizing it, economic actors accepted increased systemic fragility in exchange for higher profitability.
Trends unfold when the world changes. Prices adjust as we recognize that the future is likely to look different from the past. Underlying change is often driven by natural cycles. They include cycles in weather, debt, leverage, capital investment, innovation, politics, population, international relations. In late stage, they are sometimes amplified by mass hysteria. Systematic trend-following strategies just finished their worst decade of performance in 120yrs. So did long volatility strategies. It was a decade of homogeneity, policy predictability. It’s over.