When Bob Dylan released his seminal album Blood on the Tracks in January 1975, the US economy was in recession and suffering 12% inflation. The inflation appeared transitory and fell below 5% in 1976. Alas, the political and macroeconomic die had been cast for another inflationary spasm as recovery took hold. This time, it lasted the rest of the decade, peaking at over 15%. Sound familiar?
Today’s central bankers have competing goals: on the one hand, to forestall banking crises and contain financial contagion; on the other, to bring inflation down to target. The first requires monetary policy easing, the second monetary policy tightening.
Of course, it’s central bankers’ job to project confidence. Here’s European Central Bank President Christine Lagarde on 22 March: “There is no trade-off between price stability and financial stability. We have plenty of tools to provide liquidity support to the financial system if needed and to preserve the smooth transmission of monetary policy.”
A trade-off
In fact, there is always a trade-off between monetary stability and financial stability – but that trade-off is particularly acute when inflation is in the high single digits and financial institutions are disappearing.
Central bankers have convinced themselves their inflation and financial stability objectives are distinct. Rate hikes to fight inflation. And liquidity provisions to preserve banking stability. But sooner or later all these support packages look like quantative easing.
Since May 2022, the US banking system has lost $700bn of deposits. This mini-banking crisis has caused a sudden tightening in credit availability and lending criteria.
To offset this tightening, the Fed has sluiced the system with “temporary” liquidity, unwinding more than half of last year’s quantitative tightening.
Ultimately, central bankers’ primary goal of controlling inflation takes a back seat when it begins to threaten the stability of the financial system. Higher inflation is the least painful option when the alternatives, in extremis, could echo the 2008 financial crisis or even the Great Depression. But first the man on the street needs to feel enough pain to beg for the mercy of the monetary firehose. We are getting closer to that point. Time to seek shelter from the storm.
Ajay Johal is an investment director at Ruffer
Related articles
