The era of negative inflation shows up the strategic flaws made by central banks

A feature of the credit crunch era has been the expansion of the role of central banks which has mostly been symbolised by the rise in the size of their balance sheets. This has happened because they found that the interest-rate weapon ran out of ammunition especially for those who were/are unwilling to countenance negative interest-rates. Also the interest-rate weapon ran out of effectiveness as otherwise we would not be where we are. Accordingly what are called extraordinary monetary measures began and whilst the media obsesses on what the European Central Bank (ECB) will do next right now I note that with a Swiss Franc to Euro exchange rate of 1.2010 as I type this the Swiss National Bank (SNB) is very near to its 1.20 cap. According to market reports it has Euro bids and therefore Swiss Franc offers starting at 1.2008. If you think that this is just run of the mill currency intervention then take a look at this from Bloomberg News.

Holdings increased to 495.1 billion francs ($490 billion) from a revised 462.7 billion francs in November, the central bank based in Zurich and Bern said on its website today.

So we have a hint to the scale on which the SNB was intervening in December. But also I would like to draw readers attention to what it does with the money.

As of the end of the third quarter, the SNB held 45 percent of its reserves in euros and 29 percent in dollars. The bulk was invested in highly rated government bonds, with 16 percent in equities.

If we consider this there are three issues. Firstly when did central banks become equity market punters? The Swiss are very keen on referendums, did I miss it? Also leaping from the page is the phrase “highly rated government bonds” and I would be interested in readers thoughts as to how one defines that in these times. Of course if we look at their likely definition then on a mark to market basis profits will be reported. Thirdly you may note that the SNB buys mostly Euros but only holds 45% of its reserves in them so it is not only equities it is an apparent expert about.

What are central banker experts in or at?

The credit crunch era has led to many examples summarised by these lyrics from Genesis.

O Superman where are you now?

Indeed some of their moves have exhibited this.

Been haunted by a million screams

Indeed an example of the outright disarray that has often accompanied all this has been demonstrated by the Bank of England today. From the Financial Times.

Lord King, the former governor of the Bank of England, kept the governing body of the central bank in the dark on serious internal dissent, denied non-executive directors information about financial stability and fell out with them over alleged leaks, minutes from the financial crisis reveal.

This poses all sorts of questions including on whose authority did Governor Mervyn King do this? Also I note that we are seeing another failure here of the concept of non executive directors.This is before we get to the issue of “serious internal dissent”. About what?

So bad were things at the Bank of England at the time of the Northern Rock collapse that the Court of the Bank of England thought this about it.

(It had) “proven the sense and strength of the tripartite framework”.

I am not sure that even the apocryphal civil servant Sir Humphrey Appleby would have possessed the cheek to claim that! Also I am reminded of this from Animal Farm.

Several of them would have protested if they could have found the right arguments.

Perhaps Governor King presided over this type of business model described by George Orwell.

In future all questions relating to the working of the farm would be settled by a special committee of pigs, presided over by himself. These would meet in private and afterwards communicate their decisions to the others. The animals would still assemble on Sunday mornings to salute the flag, sing Beasts of England, and receive their orders for the week; but there would be no more debates.

Or as Governor King would prefer us to consider it.

What matters to the country are the decisions that we took, and those decisions prevented a repetition of the Great Depression and made it possible for the recovery that is now under way.

If that is so perhaps he would like to remind us why he was voting for an increase in QE (Quantitative Easing) at the end of his tenure as Bank of England Governor.

The Consequences of Reality

The problem is that however they try to rewrite history it is plain that central bankers have been living in the world described by Genesis.

This is a land of confusion.

An example of this has been seen recently by the disinflationary pressure being driven by the falls in oil and commodity prices. An example of this was demonstrated earlier if we skip down to New Zealand.

The ANZ Commodity Price Index fell a further 4.4% in December – the tenth consecutive monthly decrease in the index. The index weakened 17% over calendar 2014.

Added to this comes the news that the price of a barrel of Brent Crude Oil has fallen below US $50 this morning so there is more to come in the pipeline. This gives plenty of food for thought for the ECB as it peruses the latest consumer inflation data.

Euro area annual inflation is expected to be -0.2% in December 2014, down from 0.3% in November.

In its “land of confusion” the annual rate of consumer inflation was supposed to be between 0.6% and 2% when policy was set for now (March 2013). In spite of a relatively wide range their arrow has shot past the target. I do not wish to further embarrass them by also stating their forecast for the oil price because my point is that much of the future is uncertain and that as you control more and more things they make themselves and even more importantly us ever more vulnerable to this. But we do know that the consumer inflation rate looks set to fall further if the current level of commodity and especially oil prices is any guide.

Another factor which has surprised central banks has been the fall in many bond yields. Please do not misunderstand me I expect them to try to bask in applause from their policies. But in the longer-term with a weak political class I fear that our poor battered can has taken another beating as it is kicked to some unspecified future date. Meanwhile we see troubled countries like France experience downgrades and yet have a 0.75% ten-year bond yield.


Today is a lesson in be careful what you wish for. Central banks and their media cheerleaders keep pushing the “More,More,More” argument with the enthusiasm of Agent Smith from the Matrix films. However my point is that we are seeing a build-up of unintended consequences and side-effects from all of this. It is not so much the failure to forecast falling commodity and oil prices and the consequent disinflationary pressures that bother me as after all that is 20/20 hindsight now it is that so much depends on such matters. These type of events have increased in the credit crunch era and if you like there are a lot more Black Swans then there used to be. Thus policy right now has a dagger to its heart.

The first step to solving a problem is to realise you have one. Does anybody see any sign of central banks doing this?


13 thoughts on “The era of negative inflation shows up the strategic flaws made by central banks

  1. Hello Shaun,

    So assets and stocks are pumped up beyond their relative “real world” values are kept that way has prevented a repeat of the 1930’s ?

    Or is it more of the truth that “prevention” has been only to delay the problem?

    Which brings back an old question of mine – as debt is so high and the proclaimed cure is lots of growth – what happens when there’s no growth ?

    ( apart from the Gerry Mander’ed GDP figures we get – illusions will only shatter and make it harder for all )

    What is the solution ? debt forgiveness?

    ( let me know so I can borrow 200K and live the high life 😉 )


    Ps: even I would not buy all popcorn for 200K , Gold maybe , debt forgiven then, now I’ll be rich……

    • One man’s debt is another man’s savings.

      Write off the debt and the pension pots of millions of savers will disappear along with it.

      Cant happen until it’s forced upon us by circumstance and then the pain will be so much worse.

      • theres also the moral aspect as well

        but that leaves high debt to hang around for , what , 30 years or more ?

        interesting times


        • oh and if we look closely we see that asset/share support helps who the most ?

          The Banks of course

          Look what Iceland is putting up with from the rest of Europe /USA because they let their Banks feel capitalism and prosecuted errant bankers….

          Greece is being stripped now – if they leave the Euro they too will feel an “ill wind”


          PS: sit back and watch the show – there’s little you can do but watch

  2. Shaun,
    I enjoy the mixture of content today. The Mervyn Kimg story is entertaining, to learn how manipulative and inward looking they were/are. You right to place the context back to that time because our today situation is connected in a long chain to those original bank failures.

    Personally I think dis-inflation brings business/commercial opportunity in that the financial massaging is cast away and lowest producer pricing and proper markeplace economics come true. The Scots will have their high cost of oil output painted real for them. We can start to use copper for it’s metallic properties instead of being forced-out into substitutes like push-fit plastic pipiing.

    Bring it on, more reality please. But of course EU money printing will most likely only beget more from those around.


    • Hi Paul C and thank you.

      I have long argued that many central banks were a shambles when the credit crunch began ( If we move to the United States I recall one panic interest-rate cut back then for example). These minutes confirm one element of that and over time we will see plenty of others. They have been reading the play book of Sir Humphrey Appleby.

      I am sure that many readers will agree with you that it is nice to be able to buy things more cheaply. There was a time that advancement was associated with cheaper prices.

  3. Hi Shaun,

    We suffered high inflation during our six year recession / depression through a combination of King the Spin talking down the pound and high (speculative?) oil, gas and commodity prices, where this high real wage shrinking episode was classed as temporary, with BOE inaction allowing it to run its anything but temporary course.

    So I can’t see why it is a problem, where we have struggled up this mountain of ever bigger inflationary costs, and shrinking real wages, why we shouldn’t now have the downside of a free ride down the mountain with shrinking prices and hopefully at worst the level pegging of wages or even better increasing ones, so we get to improve our living standards.

    I remember years ago in a biology lesson covering the rise and decline of owl and mouse populations where one was a sine curve and the other a cosine. Now surely the same approximately applies to commodities, when they are in short supply, the price goes up and net profits go above 10%, so they are an attractive investment. More is invested in production, manufacturers find cheaper alternatives and suddenly we have a glut, prices fall, investment and production go down and prices recover due to the resultant shortage. I can’t see why this is a problem as it is normally a self-correcting cycle, with Japan being the exception to prove the rule! Or am I missing something?

    I understand the arguments that people might put off buying things, which is why shops are deserted when sales aren’t on, they are all waiting for the next one. I’ve decided I won’t buy petrol, gas or electricity as they should be cheaper in the future, who needs to buy food and popcorn to eat now, when it will be cheaper in 12 months time and as those gadgets get cheaper I can always buy them later, which is why new tech on release have no midnight queues and their lowest sales as we know they always get cheaper. Now Jeeves might see a flaw in all of this and and maybe even Wooster!

    • Hi Rods
      The message of ” more expensive is good and cheaper id bad seems very Orwellian to me although as JW regularly reminds us there are plenty of echoes of Brave New World there too.

      You are also correct to point out that the inflationary surge of 2010/11 seems to have been erased from history. By contrast some US Federal Reserve members have argued that any undershoot of inflation should be caught up. We are back to yet another example of asymmetry.

      Are self-correcting cycles still legal………..?

  4. Gordon claimed to have “saved the world from a 1930s style recession”

    We should remember the same clown claimed to have “ended boom and bust”, and claimed his pension heist would not damage pensions. And he was chancellor when CPI replaced RPI with the result of under reported house price inflation which has priced much of the younger generation out of the housing market.

    It took 11 years for reality to disprove the boom and bust myth, and I see little evidence to support the hubris that Gordo “saved the world”, despite massive subsidy and larcenous margins – the banks still look under capitalised, vulnerable and unreformed. I’d predict impending bank implosion simply because it’s the direct opposite of Brown’s claims …..

    • “And he was chancellor when CPI replaced RPI with the result of under reported house price inflation” – Yes and it is my theory that had RPI been retained it would have provided warning signals about an impending negative shock about to hit the economy/markets emanating from the housing market. However, I ask the question would the BOE have done anything about it even if it had the information and a mandate to act on that information?

    • He also changed from the BOE in charge of regulating banks with no serious problems from the city’s big bank to his tripartite disaster. Not to mention his sell low gold disaster.

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