Once the power to manage
expectations has been lost, the central bank bag of tricks is empty.
No
one knows precisely how and when the global unraveling will impact their corner
of the planet, but we do know one thing with absolute certainty: central banks
are out of tricks.
Like
all good conjurers, the major central banks will claim that their magical
powers to inflate asset valuations and inspire the animal spirits of risk, borrowing and spending are unimpaired, but this time the audience knows
the truth: their magic is threadbare and their trick-bag is empty.
Obfuscation and doublespeak are primary
components of central bank magic. The magic is largely semantic: if the Federal Reserve claims it
can restore the economy and the stock market with reverse repos and other
financial legerdemain, the corporate media is always ready to repeat this
dubious claim until it is accepted as self-evident.
The central bank magic is fundamentally a
mind-trick of managing expectations. If the Fed (or other central bank) announces a quantitative
easing or market-goosing program, punters buy assets anticipating the success
of the bank's program, effectively creating the very push higher the bank
intended.
This
rise draws in other traders, and the program is declared a success as the
market generates a self-reinforcing logic: the market's response is evidence
the central bank's program is a success, which then inspires more risk-on
buying and further market gains.
Once
a central bank program fails to generate a self-reinforcing rally, the
mind-trick's power is broken. Once expectations of a
sustained rally are crushed by the failure of the rally to achieve
virtuous-cycle lift-off, the magic no longer works: once traders take a wait
and see stance rather than rush to place panic-buy orders, the initial rally
soon fizzles, and the expectations of effortless gain are replaced by gnawing
fear of more losses.
Once expectations revert to caution, the
central banks lose their power to move markets with pronouncements. Unfortunately for believers in the omnipotence of central
banks, monetary legerdemain has little power over the real economy. Once the
power to manage expectations has been lost, the central bank bag of tricks is
empty.
