Notes From Underground: A Possible Solution to the Central Bank Dilemma

It’s been. another week in which headline inflation concerns has jolted markets, particularly in the interest rate space, but not as much as many investors and traders would have expected. The yield curves in the U.S. FLATTENED as markets seem want to believe that the FED will raise rates in an effort to CURB the enthusiasm of the stickiness of recent price increases. As Peter Boockvar pointed out in his piece on Friday’s Michigan Consumer Sentiment Survey, confidence declined due to rising concerns over the “escalating inflation rate and growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.”

Consumers noted that the time to buy a car fell to the lowest level on record dating back to 1978. Those thinking it is a good time to buy a home was the lowest rate since 1982 when mortgage rates were far different than today’s very low loan rates.

Learn more about CQG's solutions for financial markets

The problem for the FED and the Biden White House is that political reality has met the theoretical basis of Michael Woodford/Ben Bernanke’s forward guidance and portfolio balance channel, tools utilized to combat fears of deflation (thus creating a 1930s scenario). Remember, central bankers fear deflation far more than inflation. As Paul Volcker demonstrated, inflation can be stopped but the ravages of a deflationary spiral are much more difficult to alleviate. The most recent example is Japan, although the Japanese have done a good job of ameliorating the hardships but a poor outcome for stimulating growth. The FED and its foreign followers have created inflation, which is now grabbing hold of price increases outstripping recent wage gains. This is a CONUNDRUM for the politicians as headlines are causing voters to consider alternatives to the people in office.

Recent U.S. and German elections have shown voters looking at fresh faces with some new ideas. The Biden White House believes that the growing inflation concerns have sent the president’s popularity numbers to Trumpian lows. Kamala Harris’s numbers are approaching 25%, which was where President Richard Nixon’s approval rating sat on the day he left the White House in disgrace. (Let’s call it the Nixon Line, similar to the Mendoza line in baseball.)

The problem for Biden is that fears of inflation call into question whether Fed Chair Jerome Powell has done a “GOOD JOB” as the static money managers on Wall Street espouse. The POLITICS of Inflation meeting the ECONOMICS of FED POLICY and its flexible adjusted inflation targeting are colliding. The FED has been cheered on by politicians to do more and more — Senator Chuck Schumer once called them the only game in town. Tapering asset purchases over an eight-month period is child’s play next to RAISING RATES to slow the onset of inflation.

THE GOLD/CURRENCY SPREADS DISCUSSED IN THIS BLOG HAVE BEEN A MARKET RESPONSE TO THE LOOMING CREDIBILITY GAP OF ALL CENTRAL BANKS IN A FIAT CURRENCY WORLD. Listening to the recent speeches from ECB and FED members there still seems to be a race to be the greatest liquidity provider in a QE-dominated world. The move to buy the precious metals in the face of rising short-term interest rates is a response to concerns that the CENTRAL BANKS HAVE NO ANSWERS TO THE TRAP OF FORWARD GUIDANCE AND ITS MANTRA OF LOWER FOR LONGER.

Let me offer up one immediate solution for the G-7 finance ministers and their central bankers (Yes, Jerome and Christine, I’m talking to you): Call an immediate G-7 meeting similar to the Plaza Accord and announce a unified end to all QE programs NOW.

The asset purchase programs have not had any impact except to raise the levels of asset prices for those fortunate to own real estate, equities and various other hard assets. Powell has told us several times that RATES will not rise until QE tapering ends. The problem for the world finance system is that if the U.S. were to act UNILATERALLY the DOLLAR would rise, causing all sorts of deflationary problems as the world is so heavily FUNDED in cheap dollars because of the FED‘s decade-plus of PORTFOLIO BALANCE CHANNEL monetary distortions.

When it comes to funding, the world is in it altogether as the paroxysms of March/April 2020 showed. Dollar funding stopped moving in the face of deleveraging, which forced the FED to cut rates and announce massive DOLLAR SWAP LINES. The effort has to be in unison as the FIVE-YEAR GERMAN yield at NEGATIVE 70 BASIS POINTS is a barometer of the insanity of central bank policies. German inflation at 3% with a REAL YIELD of -3.7 % ignites concern about inflation. Again, the G-7 must act collectively in an effort to deal with the mal outcomes of rising inflation with exceptionally low real yields. The world’s workers do not have the tools like the upper 10% of earners to deal with the bad outcomes of what Irving Fisher called Monetary Illusions of Inflation.

Secretary Yellen was quoted in a Bloomberg article last week claiming that the FED won’t allow a repeat of the 1970s level of inflation. “People thought that policy makers wouldn’t bring it to an end, and inflation expectations became embedded in the American psyche. That isn’t happening now and the Federal Reserve wouldn’t permit that to happen.” Nice platitudes but not one suggestion for a policy.

In an Financial Times oped by Professor Ken Rogoff from July of this year (“Don’t Panic: A Little Inflation Is No Bad Thing”), Rogoff maintained that “after a decade of below-target inflation, a few years of it being mildly above target, say 3 per cent, might be positively a good thing.” The problem for Rogoff is that his THEORIES DON’T RUN FOR OFFICE. He also fails to understand the work of Dostoyevsky, which relies on the notion that 2+2=5 is also a beautiful thing. See? It ain’t rocket science, but human behavior. Finding investments in this difficult milieu is our challenge. Being patient in trying to discern the underlying fundamentals is the key to sustained profit.

Read more global macro content on


Trading and investment carry a high level of risk, and CQG, Inc. does not make any recommendations for buying or selling any financial instruments. We offer educational information on ways to use our sophisticated CQG trading tools, but it is up to our customers and other readers to make their own trading and investment decisions or to consult with a registered investment advisor. The opinions expressed here are solely those of the author and do not reflect the opinions of CQG, Inc. or its affiliates.