This War Is Ours (The Guillotine II)
So many times, people are afraid of competition, when it should bring out the best in us. We all have talents and abilities, so why be intimidated by other people's skills? – Lou Holtz, American Football Coach
It's difficult to dispute that competition drives economic progress. It's no coincidence that human flourishing accelerated alongside expanding personal and economic freedoms; it's more a direct consequence of heightened competition and market dynamics.
However, it's also unsurprising that industry leaders often advocate for regulatory protections for their particular sectors, justifying barriers to market entry under the guise of "consumer protection."
This discussion is currently unfolding within the news industry. There's a noticeable debate regarding whether governments should compel social media companies to enhance content moderation to combat the dissemination of disinformation. Proponents argue that in the current "information age," news spreads more rapidly than ever, posing a potential threat to democracy.
Notably, among the primary advocates for increased regulation are traditional players in the news sector: broadcasters and newspapers. These established media entities are actively promoting this agenda. As articulated in a recent article in The New York Times:
In a world of unlimited online communication, in which anyone can reach huge numbers of people with unverified and false information, where is the line between protecting democracy and tramping on the right to free speech?
To be frank, the quote aptly captures the mindset prevalent among individuals within traditional media. Those operating within the social media sphere, masquerading as "experts" or "journalists," often lack credibility.
Apart from the traditional media, the government is another significant advocate for increased content moderation and regulation. While government involvement in determining truth from falsehood raises numerous concerns, including the potential for active censorship and propaganda, the alignment of these two entities on this issue shouldn't come as a surprise.
This scenario mirrors past occurrences when "creative destruction" upended entire business sectors, giving rise to new enterprises while incumbents lost dominance. Therefore, it's plausible that the convergence of big media and government isn't solely about combating misinformation; rather, it represents a classic struggle for government control over news flow and for big media to safeguard its market share.
It's worth noting that the media itself has been guilty of disseminating misinformation to further specific agendas. Wikipedia even hosts a lengthy article titled "List of The New York Times controversies." Misinformation isn't a recent phenomenon; it has existed for a considerable time.
Therefore, it's plausible that the primary motivation driving big media's attempts to limit news accessibility on social media is the fear of competition. As the NYT article astutely observes, the barrier to entry into journalism has significantly lowered, allowing virtually anyone to contribute and cover various topics. Nevertheless, when barriers to entry in a specific market diminish, it's evident that there may be some adverse repercussions.
However, mechanisms such as "community notes" on platforms like "X.com" can swiftly identify misinformation, as was glaringly evident last weekend. Major media outlets worldwide propagated a false story about Donald Trump issuing a warning of an impending "bloodbath" if he failed to secure re-election. In the past, rectifying such errors would have been arduous. Yet, in the era of social media, most of these outlets were compelled to retract their statements. This highlights the transformative power of competition – it fosters an environment where the overall consumer experience and quality are enhanced. Perhaps this is a challenge that central banks should also confront.
Since my last article, significant developments have unfolded in central banking, warranting further discussion. However, beyond the events concerning the ECB and the Fed, I'm keen to shift our focus to another central bank in the East, where a notable shift has occurred:
The Bank of Japan scrapped the world’s last negative interest rate, ending the most aggressive monetary stimulus program in modern history, while also indicating that financial conditions will stay accommodative for now.
This move didn't come as a surprise, as various reports had already hinted at the planned adjustment of the upper bound of the overnight rate from -0.1% to 0.1%. Nevertheless, analysts had been anticipating this shift even before those reports surfaced, leading to a sell-off in USD/JPY in early March until the news was officially confirmed.
Several indicators suggested that the Bank of Japan would need to take action. One such indicator is the recent surge in Japanese stock prices. The current bull market commenced in 2012, coinciding with the bottoming out of the Nikkei and USD/JPY and the subsequent devaluation of the yen, which provided additional momentum for Japanese stocks. This propelled the Nikkei from below 10,000 points in 2012 to the 40,000 points range, marking a year-to-date gain of approximately 20%.
Another indicator was the recent uptick in inflation, which has exceeded the Bank of Japan's 2% target since April 2022. However, following a peak above 4% in January 2023, inflation has since moderated to 2.2%. Within the Keynesian framework, also adopted by the Bank of Japan, there are concerns regarding the sustainability of higher inflation, mainly due to significant recent wage increases:
This year’s spring wage negotiations involving major Japanese firms have delivered strong pay increases, with...average hike standing at a 33-year high of 5.28%, according to Japan’s largest labor organization...That is considerably higher than last year’s preliminary figure of 3.8%.
However, the recent adjustment of interest rates to zero percent does not necessarily indicate a definitive shift in tides. The cessation of negative interest rates merely signifies a return to the expansive monetary policy that the Bank of Japan has pursued since the early 2000s. Despite the Bank of Japan's decision to raise interest rates for the first time since 2007, short- and long-term interest rates will likely remain at post-GFC levels, signaling a return to "less of the same."
Kazuo Ueda's notably dovish remarks during the press conference caution investors against assuming that further rate hikes will promptly follow. He emphasizes that the Bank of Japan (BoJ) will exercise caution in implementing rapid interest rate increases and will continue purchasing government bonds, considering the current economic outlook and Japan's recent recessionary phase.
Despite the BoJ's confidence in maintaining consumer prices close to the 2% target, the money supply paints a different picture. The recent upsurge is attributed to robust, broad money growth in 2020 and 2021, which has since reverted to pre-2020 levels. Consequently, while some interest rate hikes may occur, a return to significantly tighter monetary policy is unlikely, in my estimation.
While the Bank of Japan has recently initiated its (likely short-lived) rate hiking cycle, the European Central Bank (ECB) stands on the verge of commencing its easing cycle. Since the ECB's rate hiking cycle began, it has also commenced reducing its balance sheet, albeit maintaining its asset purchase program to stabilize yield spreads in the periphery.
Last week, the ECB released a statement announcing changes to its operational framework for monetary policy. As per the statement, the ECB will persist in decreasing the bond holdings acquired through its PEPP and APP programs, albeit with a twist. The statement indicates that the ECB will engage in short-term Main Refinancing Operations (MROs) and longer-term financing operations (LTROs) at certain junctures.
Moreover, the ECB will maintain the minimum reserve requirement for banks at 1%, with no remuneration for minimum reserves. Additionally, the ECB has not only formally declared its intention to continue bond purchases indefinitely but has also essentially signaled the end of a neutral approach to monetary policy:
To the extent that different configurations of the operational framework are equally conducive to ensuring the effective implementation of the monetary policy stance, the operational framework shall facilitate the ECB’s pursuit of its secondary objective of supporting the general economic policies in the European Union – in particular the transition to a green economy – without prejudice to the ECB’s primary objective of price stability. In this context, the design of the operational framework will aim to incorporate climate change-related considerations into the structural monetary policy operations.
That implies the ECB will prioritize "green" bonds to facilitate the "transition to a green economy" (their words), essentially entailing increased central planning. This approach aims to lower costs for businesses and governments investing in green projects by artificially reducing yields.
The statement hints at a potential shift by the ECB to a higher inflation target in the coming decade. Despite Christine Lagarde and her colleagues' repeated assertions regarding their commitment to curbing inflation below 2%, providing additional liquidity to support markets suggests a sustained increase in monetary growth rates, leading to potentially higher inflation.
However, it's worth noting that the ECB may not yet acknowledge this possibility, as it remains convinced that the recent inflation surge is primarily driven by "supply-side factors" such as disrupted supply chains.
This perspective was reiterated by Philip Lane during the "ECB and its Watchers XXIV Conference" in Frankfurt this week. In his presentation, Lane mainly highlighted where inflation has materialized in his presentation, attributing these price increases directly to inflation.
However, Lane inadvertently showcased the ECB's confidence regarding criticisms that it acted too late in addressing inflation. According to him, the ECB acted at the right time, asserting that an earlier move would have weakened the economy. Notably, he relied on the same models that failed to predict the inflation surge in 2021 to support his argument.
It's somewhat amusing, though sadly ironic, that the ECB employs several hundred economists, yet not a single one seems capable of thinking beyond the confines of the prevailing New Keynesian framework. Perhaps this reluctance stems from the acknowledgment it would entail – that the ECB bears responsibility for the recent inflation surge owing to its loose monetary policy.
However, if the ECB were to do so, it would also necessitate a backtrack on what Christine Lagarde has made her favorite topic: using monetary policy to combat climate change, a significant departure from other central banks. Consider Jerome Powell, the head of the Federal Reserve, for example. At this week's FOMC press conference, when asked about criticism suggesting that high rates hinder the deployment of renewable technology, his response essentially dismissed it as beyond the Fed's mandate.
So, let's pivot from the ECB to Wednesday's latest FOMC press conference. Following the last FOMC meeting, where Jerome Powell ruled out a rate cut in March, the US 10-year yield rebounded above 4%, reaching 4.3% this week. Consequently, the market scaled back its expectations of six rate cuts this year, now anticipating 2-3 cuts, more or less aligning with the Fed's dot-plot.
As anticipated, the Federal Reserve maintained interest rates at 5.25-5.5%, making no significant changes to the initial statement. New economic projections indicated a decrease in the expected rate cuts in the coming years, suggesting higher interest rates in the longer term. Furthermore, the FOMC revised its growth and inflation projections for this year.
However, as customary, all eyes were on the press conference following the decision, anticipating insights into the potential trajectory of monetary policy. While I have been critical of Jerome Powell's previous press conferences, I found his performance in this one quite commendable.
In his opening remarks, which essentially reiterated what was already published before the press conference, he emphasized that the Federal Reserve will need to evaluate incoming data to determine future steps while also indicating a continuation of balance sheet reduction, albeit potentially at a slower pace.
The most intriguing aspect of these press conferences lies in the questions that follow the opening statement, and this time was no different. As a European observer, I couldn't help but notice that Powell's responses are on a completely different level compared to those of ECB Chair Christine Lagarde.
Powell denied it in response to the first question about whether the latest changes in inflation projections and the outlined policy path imply that the Fed will tolerate higher inflation going forward. He attributed the uptick in inflation expectations among forecasters to strong economic data but maintained the Fed's stance of seeing good progress.
This theme of responses persisted throughout the entire press conference, where Powell consistently reiterated his views on inflation and the labor market. While he acknowledged that the latest inflation figures weren't favorable, he largely attributed them to seasonal effects. Regarding the February numbers, he added:
The February number was high, higher than expectations, but we have it at currently well below 30 basis points core PCE, which is not terribly high. So it’s not like the January number...But I take the two of them together and I think they haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road toward 2%.
Regarding the labor market, Powell also emphasized that despite its ongoing strength, the Fed wouldn't hesitate to act sooner if any weaknesses surfaced. While Powell correctly asserted that this doesn't imply the Fed currently perceives any cracks, it underscores the Federal Reserve's vigilant monitoring of the labor market to detect potential vulnerabilities. Powell also noted that wage growth is further decelerating and nearing alignment with the Federal Reserve's 2% inflation target.
Many analysts also scrutinize the labor market to bolster the argument that the economy remains robust, though some harbor considerable skepticism about the accuracy of the published data. For instance, the Legislative Analyst's Office reported last week that job growth in California was substantially lower than initially indicated.
Between February 2023 and February 2024, job growth was only 50,000 compared to the initially reported +235,000. Moreover, revisions primarily affected higher-paying industries, while sectors such as other services, health, and government jobs were underreported. Therefore, while positive job reports may buoy the stock market in the short term, caution is warranted regarding initial figures over the medium term.
However, the fact that job growth stemmed solely from an increase in part-time positions shouldn't be overinterpreted, and it could also reflect a preference shift towards less work and more leisure, valued higher than the wage loss resulting from the transition from full-time to part-time employment.
Lastly, I'd like to revisit a topic I discussed last week: the assumption that the US has already entered a phase of fiscal dominance, with higher interest payments and government spending driving nominal growth and long-term interest rates higher. I questioned this narrative, which is widely propagated within specific segments of the financial community.
Proponents of this theory argue that while households held fixed-rate mortgages refinanced at ultra-low levels during the pandemic, their interest income from interest-bearing assets increased rapidly, thereby boosting net interest income. However, this week, Bloomberg published an article investigating the development of US households' net interest income.
The findings starkly contradict this assertion and support my analysis from last week. Moreover, the authors concluded that the current situation markedly differs from previous tightening cycles, where net interest income indeed rose. In this tightening cycle, however, households experienced a swift decline in net interest income, highlighting the restrictiveness of monetary policy, a point often disputed by proponents of the "fiscal dominance" theory.
Therefore, it appears that the net gain from fixed-rate mortgages is largely negated by rising interest rates and the growing proportion of consumer credit, where rates adjust swiftly. While aggregate figures may overlook certain nuances (some households may have indeed seen a rise in net interest income), it still contradicts the assertion that the US is already experiencing a period of fiscal dominance.
Hence, I believe that a closer examination supports the argument that the economic landscape differs from what the headline numbers might suggest. We seem to be in a phase where interest rates will likely stabilize, and stocks may receive another boost before some underlying economic challenges surface, prompting reactions from central banks. Moreover, I maintain the view that the Federal Reserve under Jerome Powell will endeavor to postpone this transition for as long as possible, consequently placing pressure on other central banks, particularly the ECB, to take the lead.
I may sound repetitive, but the recent apprehension that inflation in the Eurozone, Japan, and the US will somehow remain at current levels is still unfounded. It is solely based on the New Keynesian models employed by economists and central banks, which failed to predict the inflationary trends of 2021 and 2022. Consequently, it perpetuates the belief among central banks that they must remain at the forefront of the battle against inflation, oblivious to the looming threat that contradicts their forecasts once again.
Yes I will see you, through the smoke and flames
On the front lines of war (we have to find a better way)
And I will stand my ground until the end
Till we conquer them all (we have to find a better way)Escape The Fate – This War Is Ours (The Guillotine II)
Have a great weekend!
Fabian Wintersberger
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All my posts and opinions are purely personal and do not represent the views of any individuals, institutions, or organizations I may be or have been affiliated with, whether professionally or personally. They do not constitute investment advice, and my perspective may change over time in response to evolving facts. It is strongly recommended to seek independent advice and conduct your own research before making investment decisions.