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Is This the 30s or the 70s?

11/11/2014 10:45 GMT | Updated 10/01/2015 10:59 GMT

Premature rate hikes in the thirties caused a double-dip depression, following the 1929 stock-market crash and ensuing financial crisis, which probably played a part in precipitating World War 2. In contrast, in the seventies the Fed was constantly 'behind the curve', allowing inflation to display great volatility and to get out of hand, with US CPI ranging from 2.7% in 1972 to 13.3% at the end of 1979. This culminated with Volcker's famous hike in Fed Funds to 20% in early 1980, to squeeze inflation out of the system. One could say he was successful, laying the groundwork for the next three decades, during which inflation was contained for virtually the whole time between zero and 5%.

Which set of mistakes are major central banks about to repeat? If we compare and contrast, then it seems the smart money surely has to be on a repeat of the 1970's experience-admittedly for different reasons-we are thankfully no longer plagued by dreadful labour relations and all-powerful unions, leading to wage/price spirals, and for now at least the oil price is heading steadily south.

Taking the most important central bank first, notwithstanding the slightly hawkish nuance one may read into the last Fed meeting, the Fed seems to be unwaveringly dovish in outlook-at least where it matters; at the 'top'. Yellen, Dudley and Fischer rule the roost, and even the normally hawkish Bullard recently rushed to suggest that a delay in QE tapering may be in order because the stock markets had fallen 10%. These guys lived for years with Bernanke-a renowned expert on the thirties-whispering sweet dovish nothings in their ears, and it seems to have made a deep impression on them! At the margin they are worried about deflation and about the lack of robust average wage growth, and the strength of the dollar will be doing nothing to assuage their fears-these guys will be happy to become the US strike force in the global currency war-albeit as stealth troops of course, as the Treasury has official responsibility for FX policy.

The risk that the Fed is too late to hike is exacerbated by its tendency to an assymetric reaction function with regards to inflation outcomes. How far forward in terms of timing and how more aggressive in terms of the quantum would rate hikes become if inflation started to overshoot soon-maybe 2 or 3 months earlier, and maybe 25-50bp per annum quicker? But if inflation fails to revive as expected, then hikes will be delayed until 2016 and, if it heads down at all, then QE will be back on the table before you can say, 'Start the helicopter, Janet'.

What of that bastion of monetary correctitude, the ECB? Maestro Mario's performance at the Nov. 6th press conference contained at least four important hints with regard to the possibility of and prospective timing for full-blown 'public' QE-i.e. the purchase of sovereign bonds. 1) he said ECB staff have been tasked with 'ensuring timely preparation of further measures to be implemented', 2) he confirmed the Governing Council's unanimity over the statement's key messages, 3) he emphasized that the ECB balance sheet will keep expanding, even if others contract, (in other words, 'please sell EUR/USD'), 4) he confirmed that the ECB's target for balance sheet size would be the level as at March 2012; thus confirming the much vaunted Eur 1 trn increase desired from here. We should see public QE by the end of Q1 2015.

The Bank of England also seems to have turned rather dovish, with fears over the health of the Eurozone the culprit. Although there have been two persistent dissenters on the MPC, the ruling cabal, comprising the Governor, his 'staffers', and his deputies, will all vote together. Carney remains dovish, as does his Chief Economist, Andrew Haldane, judging from recent speeches.

Finally, the Bank of Japan. On Oct 31, Governor Kuroda announced a surprise decision to increase the annual amount of net JGB buying by JPY30 trillion to JPY80 trillion, (USD 700bn). This reflected fears that the BOJ would not meet its 2% target for CPI in 2015 and will also help to mitigate the effects of a second hike in sales tax. Debate abounds on the direction of causality here, i.e. did Kuroda act because he couldn't persuade Abe not to hike the tax? My view would be that there is no significant division between these two; they designed 'Abenomics' together, they continue to implement same, they both want to tame Japan's deficit and debt, they both want inflation higher, and they both want the Yen lower, and they won't waver until they achieve these aims.

So, in summary, it's difficult to see a repeat of the mistakes of the 1930's. If there is a mistake, it will be of the other variety in which inflation rises too far-no bad thing for countries still saddled with too much debt, governments may think, but this is a dangerous game, built upon a strongly held belief that there is still much slack, or output gap, to consume and whilst this may very well be true in the Eurozone, slack is notoriously difficult to measure.

For example, the UK 'think-tank', the Resolution Foundation, recently said official figures do not capture some 4.5 million self-employed workers, leading them to conclude that, "Our analysis suggests that at different times we may have both overstated and understated, often significantly, how much workers have been earning", with the overstatement coming between 2008 and 2012, and the understatement ever since then.

Other survey data shows that UK starting salaries are rising at the fastest rate seen since at least late-1997, with widespread skill shortages in almost all sectors, and Markit say that 47% of survey respondents reported that the availability of permanent staff had deteriorated since May, (5% reported an improvement), with the dearth of candidates the worst since Markit began compiling this survey in 1997.

Meanwhile, the drop in the oil price will provide yet more boost for most economies, and geo-political upheavals will only lead to yet more QE.

Where does this all end? Very probably in a familiar combination of asset bubbles and risk mis-pricing, with a crash to follow. In the meantime, feel free to enjoy the ride; risk assets look to be set fair for a while, but don't sell gold to bet on USD strength.

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