Why the stimulus can’t be stopped

The market is one hell of a drama queen

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The stock market is one hell of a drama queen Nick Hubble | 18 Aug 2021 Dear Reader, My daughter, much like the stock market, is at that age when she can't quite communicate what she wants, but all hell breaks loose if she doesn't get it. It may be as simple as a particular spoon, bouncy ball or snack. But trying to figure out what it is that she wants is often incredibly difficult. And so… the drama queen's screams begin, despite our best efforts. This becomes very funny because her go-to word when expressing any emotion strongly felt is "Anpanman!!!" That's the name of a Japanese cartoon character. Inexperienced family members often presume she wants her Anpanman teddy or Anpanman ball when this happens. But it's just her default word through which a more meaningful tone of outrage and despair can be expressed. Now the premise of the Anpanman cartoon, as far as I can tell, is that the main character rips off pieces of his head and feeds them to his fellow superheros in order to provide sustenance when they're feeling hungry. Given that "pan" means "bread" in Japanese (and Spanish), and there is a line of children's bread snacks branded after Anpanman (called Anpanmanpan), I presume that Anpanman is literally made of bread and cannibalism is not the central theme of the children's cartoon. You may be interested in Is the Bitcoin bull market over?   Over the last decade, media sources have pronounced Bitcoin dead no less than 400 times. They still can't see the obvious...   It's not going away...   Cryptocurrencies are not a fad...   And I predict we haven't even seen the biggest gains yet...   Including TWO crypto plays – one that could turn £500 into £10,865!   Here's how early investors could take advantage.   Capital at risk. Forecasts are not a reliable indicator of future results. Cryptocurrency is high risk and unregulated. I bring all this up because the central banks of the world face much the same set of circumstances as I do at home. The stock market is one hell of a drama queen, but it doesn't exactly tell you what it wants. Nor do the stock market's demands necessarily make sense. And, just like my daughter, these days the stock market is entirely dependent on those providing for its welfare. Which creates a real problem when there's any confusion, let alone a lot of it. When central bankers tried to wean markets off stimulus in 2013, markets reacted a lot like my daughter would if you tried to take away her frozen grapes. It became known as the taper tantrum. Since then, and especially today, we face a constant standoff between what the stock market wants, whether the central bankers can figure out what it wants, and an imminent tantrum if they don't get it right. But now, like when I went to the playground without the right snacks in the back of the Anpanman scooter, the central bankers have cornered themselves. Inflation is rising, and so central bankers are supposed to withdraw their stimulus. But how will the stock market react to its goodies being taken away? Will it throw another taper tantrum and crash in a wail of "Anpanman!!!"? Of course, it's not just the stock market which is a drama queen. All investments are dependent on central bank money these days. Including bonds and property. Which leads to an interesting conclusion. There is just too much riding on central bankers keeping things smooth. They've spoiled the child and now it has the rod. The controversial hedge fund manager Crispin Odey reckons that the Bank of England will never raise interest rates, even if inflation does take off. The reason is a surprising one. The Bank of England itself would lose money. Now, if Odey is right, this would be a rather extraordinary idea. Not because of the bit about the Bank of England going bust, but because keeping rates at zero has extraordinary implications for inflation and bonds. But first, what's the reasoning behind the claims? That was explained in such an obtuse way in a Daily Telegraph article that I had to ask my colleague John Butler who it was that had misspoken, misquoted Odey, and or just confused me. But here is the original argument: Crispin Odey, the hedge fund manager, has said that the Bank of England will "never" put up interest rates despite a warning that post-Covid inflation will soar to 10-year highs in the coming months. Mr Odey said that because of the way the Bank of England had borrowed, raising interest rates would hit its own finances. He said: "The heart of the story is that the Bank of England has issued deposits, essentially, in order to buy the long end of the bond market. "So the Government has a very short duration book. Their borrowings are very, very linked - like the whole of the country - to interest rates. Which tells you they are never going to put up interest rates. [And] because they are never going to put up interest rates, they have to hope and hope that inflation is only temporary." I think the word "Government" in the last paragraph is supposed to say "Bank of England" instead. And I think "short duration" is supposed to say "long duration," because they've bought a lot of bonds with many years to maturity. If I've got it right, here's what all of the above really means… The central bank has bought a load of government bonds. If those bonds fall in value, the Bank of England's assets would be worth less. It would make a loss, if it chose to recognise the market price of the assets it holds instead of pretending that they're worth a lot. The value of bonds depends largely on interest rates and inflation. But the central bank only has direct control of interest rates. Bond prices are the inverse of interest rates. In plain English, this means that if the Bank of England raises interest rates, the value of its bonds would fall. This would trigger the losses that I just mentioned. Do you think central banks would make a decision that causes them to make losses? To tip themselves towards insolvency? Will they take inspiration from Anpanman and rip off a piece of their balance sheet to save the economy from inflation? Or will they take the easy way out and claim inflation will be short lived and there's no need to raise rates. If they don't sacrifice the state of their accounting books and inflation gets out of hand, the crash in bonds and the Bank of England's balance sheet may happen anyway. Because bonds don't like inflation, they could drop in that scenario too. It's not entirely clear what it means for a central bank to be insolvent, by the way. Given that buying bonds and fiddling with interest rates is basically just what central bankers do anyway, it may not really matter. Nobody is going to legally call out the central bank for being insolvent… are they? It's certainly not the government going insolvent, as the Odey quote above suggests. Nevertheless, the government could be called on to bail out the Bank of England if the financial position of the latter becomes too bad. Imagine that – the government bailing out the Bank of England. It'd be wonderfully ironic given that the Bank of England has been bailing out the government. It would be especially ironic given that the Bank of England's tightening would make borrowing, and thereby the bailout of the Bank of England, more expensive for the government. This is getting as absurd as a Japanese cartoon… Nick Hubble Editor, Fortune & Freedom

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