Consensus Opinion Faces Skepticism Amidst Economic Uncertainty
Renowned British economist Bernard Connolly has raised concerns about the prevailing consensus that the U.S. economy is headed for a soft landing. The notion of a gentle descent, which has been driving the S&P 500 Index to new heights, is dismissed by Connolly as deluded. In his latest book, “You Always Hurt the One You Love: Central Banks and the Murder of Capitalism,” Connolly argues that central banks, particularly the U.S. Federal Reserve, have been responsible for a series of financial disasters over the past 25 years.
While Connolly’s views may be controversial, his critique of central banks’ economic models raises pertinent questions about the true state of the global economy. Connolly argues that the canonical framework used by central banks fails to account for the coordination of economic and financial activity over time. These models assume that the economy remains close to equilibrium and that any shocks are random and self-correcting. However, the real world is far from this ideal scenario.
According to Connolly, economic activities are intricately connected to future consumption and investment. When interest rates deviate from society’s time preference and corporate profitability, intertemporal coordination breaks down. Connolly believes that Western economies have been caught in a state of disequilibrium for more than a quarter of a century. He points to the mid-1990s, when rising corporate profitability should have been accompanied by higher interest rates. Instead, the U.S. Federal Reserve, under Alan Greenspan, kept rates low, leading to a stock market bubble. When the bubble burst in 2000, the Fed responded by lowering rates further, inflating the housing market bubble.
Connolly’s insights allowed him to anticipate both the 2008 Great Recession and Europe’s subsequent sovereign debt crisis. He argues that Western economies have become reliant on bubble wealth and debt-driven consumption, preventing central banks from returning interest rates to normal levels. Despite attempts to raise rates, the economy remains vulnerable, as demonstrated by the 2019 stock market plunge and the recent impact of the Covid-19 pandemic.
Connolly maintains that real interest rates are heading deeper into negative territory, which has significant implications for capitalism. He predicts that long-dated bond yields will eventually fall below short-term rates, leading to further economic coordination challenges. Without liberalizing economic reforms that boost productivity and allow interest rates to rise, Connolly warns that the trajectory is towards full-blown socialism.
Critics may argue that Connolly’s predictions are nothing new, as central banks continue to focus on containing inflation and remain oblivious to underlying imbalances. The similarity to pre-2007 conditions is striking, with the Fed’s policy rate back at 2007 levels. Connolly claims that the financial system cannot handle even this relatively “normal” rate, given the high levels of debt and bubble wealth. He warns that another financial crisis is imminent, and when it occurs, central banks will resort to their old tactics of cutting interest rates and boosting asset prices.
In light of Connolly’s analysis, investors seeking protection may find refuge in long-dated government bonds. U.S. Treasury Inflation-Protected Securities, for instance, offer a yield of around 2.4% for a 30-year maturity. While this may seem attractive, it hinges on the accuracy of Connolly’s predictions.
Although Connolly’s views challenge the prevailing consensus, they provide a thought-provoking alternative perspective on the state of the global economy. As investors and policymakers grapple with uncertainty, his analysis reminds us that consensus opinions may not always be accurate.
More detail via Reuters here… ( Image via Reuters )