Epsilon Theory's Ben Hunt is one of our favorite commentators and market analysts. He is a very rational, even-keeled and objective observer and trader of the capital markets, no matter how broken or centrally-planned they may be. Which is why we were disappointed to see that the two most recent appearances by the world's foremost central-planners, Draghi and Yellen, managed to incense him as much as they did.
From Ben Hunt of Salient Partners (pdf)
I was watching the Draghi press conference the other week, and I had to turn off the TV. I found myself getting so … angry … not just at what Draghi was saying, but also the live blog reaction and the live market reaction, that I decided I was better off stepping back from the actual event and trying to figure out why I was having such a powerfully negative emotional reaction to the entire charade. It’s not the charade itself. I mean, if I were outraged by every inauthentic display of central banker “communication policy” and the media lapdog response, I’d be in some sort of permanent apoplectic fit. In fact, neither the central bankers nor the media even pretend any more that extraordinary monetary policy has any sort of material impact on the real economy, which I suppose is actually progress on the authenticity scale in a perverse sort of way.
I travel a lot speaking to investors and allocators of all sizes and political persuasions. I also read a lot from a wide variety of sources, also of all sizes and political persuasions. What I’m seeing and hearing on every issue that concerns capital markets and economics is not only an accelerated polarization of policy views between the left and the right (greater “distance” between the views), but also – and more troubling – a polarization (and in many cases a non-modal distribution) of policy views within the left and the right. The kicker: I think that this polarization is almost entirely driven by monetary policy and the power/wealth inequalities it creates. Central bankers are not only planting the seeds of truly systemic instability, they are watering and tending and nurturing this particularly virulent strain of “green shoots” with their entirely intentional and entirely successful efforts to inflate financial asset prices and mandate reduced volatility in capital markets.
The fact is that maintaining massive debt and creating massive wealth – which is what central banks DO – is a political exercise, pure and simple. It’s nothing else. It’s not social science. It’s politics. Yellen and Draghi are the most powerful politicians in the world, and what makes me angry is their unwillingness to confront the essential nature of their actions, to call what they do by its real name. It makes me angry because the longer the High Church of Central Bankerdom denies and ignores the raw political impact of their actions, the more likely it is that we will have a structural political accident that will destroy every bit of the debt maintenance and wealth creation that the High Church has labored so hard to build. I think we’re getting very close to that sort of political accident.
I’m pretty sure that I agree with absolutely none of Thomas Piketty’s policy prescriptions. And the impact of his bugbear – tax policy – on wealth inequality is laughably minor compared to the impact of a triple in the S&P 500 market cap or central bank purchases of trillions of dollars of bonds. But if you don’t recognize that Piketty has a point when he says that today’s wealth inequality is both outrageous and poisonous, you’re just not paying attention. Increased wealth inequality always leads to increased political polarization, within and between countries, within and between political entities. That was true in the 1870s, that was true in the 1930s, and it’s true today.
What happens when you get greater political polarization? The center does not hold. You get Bizarro world. You get political outcomes that cannot be anticipated by econometric or median voter models. You get political outcomes that will be perceived as illegitimate by a meaningful number of citizens. You get the New York Times writing encouragingly that even with a more aggressive tax regime, the Federal government could still “allow” citizens to take home 50% of their income. Wait. What?
Here’s a fairly typical example of the polarization phenomenon I’m talking about, this from the Pew Research Center based on 1994 – 2014 data. Everything in this chart is significantly worse today, and the same chart could be drawn for every other country on earth (including one-party states like China). You could also draw a chart with exactly the same dynamic for Congress. Or FOMC voting member views on raising rates. Or financial advisor views on liquid alternatives. Seeing polarization is like seeing the homeless … once you start looking for it, you will see it everywhere.
It’s not just the distance between the median Democrat voter and the median Republican voter that concerns me, it’s the shape of the Democrat electorate and the shape of the Republican electorate. A consensus outcome, where a significant majority buys into a final decision, is more difficult when the median voters are farther apart, but by no means impossible. It’s the lack of a single modal “peak” near the median voter within each party that makes consensus so very, very difficult. Why? Because the human animal has designed any number of effective preference aggregation schemes (elections and markets, for example), but none of them work very well at all when preferences are all over the map, when there is no “peakedness” to the preference distribution. There is no voting scheme that can identify a consensus when there is no consensus to be had, and that’s true whether you’re talking about the Republican party or the American electorate at large or the FOMC or the Chinese Politburo. On the contrary, the only thing you are guaranteed to have in a “non-peaked” system is a majority of unhappy members with ANY single construction or faux presentation of consensus.
In practice, one of two things happen in this sort of non-peaked social system. Either a new political dimension is constructed such that a peaked distribution emerges and a consensus outcome can be supported (this usually takes the form of identifying a common enemy, like Commies or Billionaires, or of appealing to a higher power, like Allah or Science), or you get a political accident where fundamental rules of markets and government shift drastically. I’m not looking forward to either.
What does this mean for investors? It means that at some point in the next year or two, I think we are all going to have a Henry Hill “Goodfellas” moment, where we think that we understand the conversation going on around us, where we think that we’re engaged with our social system in the usual way … and then everything will go sideways in a split second, and we will suddenly and with extreme clarity realize that we don’t understand anything at all except that we’re sitting at a table with a maniac. Or if you want a more light-hearted metaphor, we will all have a George Costanza moment where we come to the realization that all of our instincts are wrong. Most of us, of course, have already endured more than a few of these George Costanza moments here in the Golden Age of the Central Banker. I think you ain’t seen nothing yet. It’s not the Minsky Moment I’m worried about, where some credit bubble internal to markets wreaks havoc as it pops. No, it’s the Sideways Moment that I’m worried about, where a political accident external to markets wreaks structural havoc on the entire market system.
Do I understand why Draghi is doing what he’s doing? Do I understand why the Fed is getting colder and colder feet about raising rates? Sure. They’re watching inflation expectations continue to collapse. Here’s the latest chart for the primary metric for US inflation expectations, 5-year forward rates, courtesy of the St. Louis Fed.
Inflation expectations are THE most important data point in the Fed and ECB models that drive monetary policy decision making. And those models, driven by this chart, say that you’re a fool if you raise rates now. Or if not a fool, then at the very least you’re taking on significant post-Fed career risk. Hard to see some big hedge fund shelling out the big bucks for another ex-Fed Chair if this is what makes everything go sideways.
What Draghi and Yellen are doing is exactly what happens when you abdicate social policy to models, when you pretend that you’re just a technocratic financial regulator, and I suppose that’s what makes me angriest of all. I can see where this is going politically. Everyone can see where this is going politically. And maybe we’re already too far gone to change the politically polarized course we’re on. But we have to try. We have to speak honestly about the political dimensions of extraordinarily accommodative monetary policy in its maintenance of massive debt and its creation of massive wealth. Because if we don’t speak, then others will speak for us. And we won’t like what they have to say.
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Our advice to Ben, do what we do: instead of getting angry at the central planners who know the game is almost up, just laugh at them. It drives them nuts.