Stuck in reverse
Many in the finance sector now put more faith in the pronouncements of central bankers than they do market signals, laments Andrew Davis. He asks: how has this role reversal happened?
There are plenty of reasons not to like the way the financial system is run nowadays. Some cannot bear the way that borrowers' profligacy is condoned while savers are forced to accept ever more meagre rewards for their providence. Others regard today's central bankers as little better than terrorists bent on debasing paper currencies and unleashing an inflationary tsunami that only those with sufficient gold and guns will survive. Some see bubbles forming all around them. Others warn that we stand, Japan-style, on the brink of a deflationary slump.
Spend enough time on the internet and you will find complaints like these and many more besides, occasionally expressed with as much eloquence as conviction. I sympathise to a degree with many of them but my own pet gripe is different. The experiments that central bankers have been engaged in since 2007 may well have staved off something much worse than the downturn that ensued, but as far as I'm concerned there has been one major downside that shows little sign of disappearing: we are now condemned to live in a world teeming with amateur macro-economists. A greater waste of time and human ingenuity would be hard to imagine.
How did we get here? I think it goes something like this.
In the years since the wheels came off, our world has been turned on its head. Once upon a time, economies and financial markets went about their business day after day producing and consuming, buying and selling, and in the process generated vast flows of information that central banks and governments used to help them decide what to do. If things were looking a bit racy, rates might go up; if the opposite, they might be cut. Of course, it's naïve to pretend that information flowed only one way, but the general point stands: market signals were the chief source of information on what was actually going on in the economy. "Somewhere along the way, the ascent of the central bankers has turned us all into amateur macro-economists"
Nowadays, the formula runs backwards. Instead of markets providing the primary source of information to central banks, the bankers are now the main source of information that guides the markets - look at the feverish debate over the exact meaning that the Fed Open Market Committee intends to convey with the phrase "considerable time", when it discusses how long markets should expect to wait for the first interest rate rise in the US, or the intense speculation on whether or not the European Central Bank would announce full-blown quantitative easing at its meeting on 2 October.
Banking on central guidanceGreat numbers of the world's most highly paid professionals hang on the words of the central bankers, deciding how to invest on the basis of what they think they just heard or what they believe they are about to hear. The most learned commentators are called upon to interpret slight changes in the way the financial mandarins express themselves. The system that we have relied on for many decades is stuck in reverse. Assumptions about what central banks will do and when have replaced questions of price and fundamental value.
Instead of market signals, today we have 'forward guidance', perhaps the ultimate attempt to make water flow uphill. This tautologous construct effectively enshrines the reversal that now sits at the heart of the system, asking us all to believe that if the central bankers say things will go a certain way then they will, regardless of what the evidence from the economy and financial markets might suggest. Inconvenient truths such as the patchy records of central banks as forecasters and the ultimately mysterious nature of a system as complex and chaotic as a modern economy are left to one side. Forward guidance will light our way.
It's hardly surprising that endeavours such as these should have unintended consequences, but in retrospect, it's blindingly obvious that if central bankers have become oracles whose pronouncements guide the markets, then there will be no shortage of wise men and women to interpret their utterances for the benefit of the rest of us. Which brings me back to the curse of the amateur macro-economists.
Giant echo chamberMaybe I just spend my life reading the wrong things, but I can't help feeling that far too much effort is devoted to commenting on and explaining the words and actions of central banks. Granted, what central bankers say matters more than pretty much everything else, but central bank watching is now a cottage industry and one that generates gargantuan amounts of commentary and opinion, most of it shallow and repetitive. It's like living in a giant echo chamber - somewhere along the way, the ascent of the central bankers has turned us all into amateur macro-economists, opining on subjects about which we know little or nothing of any real substance. It seems a dreadful waste of talent. There must be better things for smart people to be doing than repeating each other's opinions on economics.
We've moved from a world in which economists spent their time attempting to understand people to one in which people spend their time attempting to understand economists. It's a strange state of affairs and it makes far less sense to me than the world we've left behind.
The original version of this article, written by Andrew Davis, was published in the September 2014 print edition of the Review.