Are central banks exposing themselves to a Volkswagen-style crisis?
Just as Volkswagen is struggling with the fall-out from its emissions scandal, central banks may find their current policies create a bigger problem further down the line Central banks continue to risk forcing the world into a prolonged downturn with their economic interventions, according to Newton fund managers Nick Clay (pictured) and James Harries.
Drawing a parallel between the recent emissions scandal at German carmaker Volkswagen and the policies of central banks, the law of unintended consequences can turn round and bite you. With Volkswagen, the drive to become the world’s largest carmaker led to a misguided decision to install emissions-beating software that provided misleadingly low nitrox-oxide read-outs. Now they have been found out and the consequences for Volkswagen are far worse than if they hadn’t rigged the system in the first place.
Central banks are attempting to do something similar in the sphere of macroeconomics. By attempting to create a state of market equilibrium that does not exist in nature they are opening the door to a bigger set of risks and ultimately a more fragile system. The central banks tend to think the economy is something you can control like a machine; that you pull some levers and it responds in expected ways. But it doesn’t work that way.
Similarly, central bank interventions are fundamentally altering the market ecosystem. Zero and negative interest rate policies coupled with quantitative easing are boosting confidence, driving up spending and pushing up leverage, he says. While this may be viewed by the market as a positive in the short term, the long-term outcome is the creation of asset bubbles which, when they burst, lead to increased volatility, rising defaults and ultimately prolonged low growth.
We believe central banks are protecting unreconstructed economies from market forces – and this is unsustainable,” he says. “It’s hard to make sense of the recent turmoil in the market unless you hold this view. Despite their aspirations to omnipotence, central banks are frequently overtaken by events. Time after time we see it: Central banks promise one thing; but get caught out by. It happened in Switzerland where they promised to peg the Swiss franc to the euro. It happened in China when policymakers talked stockmarkets up; then started arresting people when the markets fell. Now we’re in a cycle that is very long in the tooth with the third longest bull market in history. The question is: where do we go from here?