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Saker Nusseibeh

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Should central banks regulate the growth of economies?

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“We at the 300 Club like to question things that people take as accepted truths. We’re trying to be controversial,” Saker Nusseibeh, chairman of the 300 Club and CEO and Head of Investments, Hermes Fund Managers, tells Hedgeweek. “We want to individually and collectively question the foundations of financial theory on which markets are built today.”

The 300 Club, established in 2011, comprises a small number of leading global investment professionals, whose modus operandi is to ignite debate within the industry at a time when it believes modern financial theory and practice is letting investors down. Up against the might of the financial industry, they take their name from the 300 Spartans who successfully fought off a huge Persian army invasion in 480 BC.

The club’s latest white paper, authored by Dylan Grice, a global strategy research analyst at Societe Generale, is entitled ‘A Call for Honest Fools’. At the heart of the paper is the contention that central banks dictate economic policy on some rather shaky ground and faulty reasoning and that this has led to the creation of recent crises because of inflationary asset bubbles developing in the system.

Grice’s argument is twofold: firstly, where is the evidence that shows that controlling interest rates and setting narrowly defined CPI inflation targets actually works; secondly, the idea that central banks can efficiently manage the economy on the basis of forecast behaviour has been proven incorrect.

Why, says Grice, should the Federal Reserve explicitly target 2 per cent inflation? Who decides on that number and where is the evidence that controlling CPI inflation leads to a robust, stable economy? Grice makes a nice analogy by referring to the actions of central banks as being akin to a driver focusing on the speedometer, not the actual speed: if the speedometer (read ‘economy’) is broken, you could find yourself in trouble.

“So focused were they on the stability of the Consumer Prices Index, and so confident and convinced that it was the be all and end all of inflation, they completely missed what was happening in the credit markets,” writes Grice in relation to Fed Reserve’s actions in the 1920s. The result: the Great Depression.

Central banks obsessing with CPI inflation leads to the creation of inflationary asset bubbles in the credit markets: just as we saw in Japan in the 1980s, in the 1990s tech bubble and more recently the real estate bubble that initiated the 2008 credit crisis.

“I want to hear the debate,” says Nusseibeh. “We take it as a given that that is what central banks do, that there is a natural rate of inflation because that’s the economics we’ve been taught. But, if you look at the evidence, as Dylan has shown, if you look at what happened for example in Japan, there is a question mark. If what Dylan is saying is so absolutely absurd, let’s hear the counter-argument.”

Continues Nusseibeh: “My feeling is we’re mixing up the cost of living with inflation. I’m willing to concede that CPI gives you an idea about the cost of living. However, I’m not sure it gives you an idea about the level of inflation in the system.”

Nusseibeh admits that central banks have an important role to play in how banks behave; in his mind, regulating the safety of the system makes sense. But the idea that they should also regulate how much growth is in the system, and are somehow in control of inflation, is open to question.

“The overarching issue here is the idea that economies are complex systems and there is evidence mounting that complex systems do not improve by adding a complex layer of regulation on top of them. This paper addresses one of the issues relating to complexity. We’re trying to regulate economies, but with no evidence that such regulation is successful.”

As for central banks setting tight CPI inflation targets, the very premise on which this is done is flawed. Economic models use historic data but how far back should one look? Fifty years? Three hundred years? The CPI figure is arbitrary; it changes based on one’s terms of reference.

Writes Grice: “Policy makers have fallen into the trap of fooling themselves. They have assumed that inflation can be proxied by the CPI because it is easier to do that. They have assumed that 2% is somehow the right rate for inflation, and they have assumed they’re capable of setting interest rates at the “appropriate” level. Central banks have assumed the distortion of the credit system was unlikely and a market crash would not be a problem, leading to the belief that if one were to occur they could fix it.”

Trying to control CPI inflation does appear to be a dangerous precedent, if indeed it is done without looking at the amount of real money in the system. This seems particularly pertinent when you consider the amount of new money that has flooded the UK and US economies under the programme of quantitative easing.

Says Nusseibeh: “Economics is not a science. Maybe central banks can control economies with a lever on interest rates and inflation. What Dylan is saying is ‘I don’t think so’. All we’re saying is read the paper and if you think it is completely wrong, and have proof, well…let’s talk about it.”

‘A call for honest fools’ can be downloaded here

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