Mark Carney, former governor of both the Bank of England and the Bank of Canada, and Zachary Cefaratti, founder of Dalma Capital and the financial thought leadership platform AIM Summit, brought to light the key issues that would influence today’s investment decisions at a webinar Cefaratti hosted in 2021. A central concern was that fiscal policy stimulus, though key to navigating the economy through the Covid crisis, had to be rapidly scaled back to normal levels. “I think the driver of recovery is going to be investment, investment, investment,” Carney said. “And that’s going to come from business, not from the government.”
Carney, a former Goldman Sachs banker who now serves as chairman of both Brookfield Asset Management and Bloomberg Inc., was also skeptical of the long-term benefits of monetary easing – a view that was proven right the following year when out-of-control inflation forced central banks in developed countries to hike benchmark rates rapidly. “The policy stance was supportive during 2020,” he said. “But what drives economic growth is labor force participation, how many businesses will turn over capital stock, and what will happen with business investment and productivity.”
“Now the tough work has to begin,” Carney added. He argued for a sharp change in fiscal policy from supporting individuals to providing the framework for business investment and sustained growth – a change accelerated one year after this conversation by the resurgence of inflation.
Cefaratti suggested that fiscal policy is too politicized to replace modern technocratic central banks, which can turn on a dime, and did beginning in 2022. By comparison, fiscal policymakers have continued to run up record deficits, with apologists relying on the fashionable MMT economic theory that holds that spending does not have to be constrained by borrowing limits. This idea looks more far-fetched as ten-year Treasuries, auctioned in 2021 with yields around 1-1.5%, must now yield 5% or more to attract buyers.
Carney agreed. “Fiscal policy has to pivot, and monetary policy will have to be exceptionally deft to manage out of this.” One of his main concerns was that central banks might cause a sharp tightening of financing conditions, which has happened in everything from government debt to mortgages and leveraged finance since he aired his worry.
Carney noted that quantitative easing and near-zero interest rate monetary policies during the crisis were correct but dangerous. “To be candid, it was really the only option.” That’s because fiscal policy is too cumbersome to use as a stabilization tool in the heat of a crisis. “I worked on eight budgets when I worked at the Treasury in Canada, and fiscal policy is just not nimble enough to use as a stabilization policy,” Carney said. “What’s not taken into account in the MMT discussions is that you’re not just consistently trying to adjust spending, but also taxation. If my corporate tax rate is bouncing around, for example, or my personal or wealth tax is, what does that uncertainty do to my incentive to put capital to work?” There’s also the practical reality of “fiscal drift,” he noted. “That’s the polite term for it being very easy to put programs into place but very hard to take them away.”
The reality is that fiscal policy has become increasingly politicized, Cefaratti noted. In the early 1970s, 75% of fiscal spending was on direct or productive investment, and 25% supported individuals. Now those figures have reversed.
While agreeing that central banks are far more nimble than fiscal policymakers, Zachary Cefaratti warned about the impact of QE on inflation and how inflation would affect global asset allocation.
Carney and Cefaratti noted Some other dangers in disproportionate QE and loose rate policies, including the risk of forcing yield-chasing investors out of positions in government debt and/or moving them out on the risk curve either in duration or credit risk. The failures of SVB, Signature, and First Republic in early 2023 were functions of duration risk, while increasing default rates in the leverage loan and junk bond markets, as well as in commercial real estate, are primarily a result of credit risk – combined with the structural move to working from home in the CRE example.
Carney and Cefaratti’s 2021 discussion showed how difficult it is to anticipate the consequences of unprecedentedly loose monetary policies, as those seen ever since the 2008 Great Recession. Carney, again speaking before the unexpected inflation crisis in 2022, predicted a long and slow unwinding of QE and said that the Federal Reserve would hold off on raising interest rates until it finished tapering its QE purchases and shed part of its portfolio. “It probably will take a year to taper,” Carney said. “All of a sudden, you’re into 2022 and 2023 before the window opens to raise interest rates.”
That timetable, telegraphed appropriately by the Fed, would have created certainty for people to make sensible portfolio decisions, an outcome that could not be achieved once the central banks were forced to react rapidly to inflation in 2022.
Zachary Cefaratti asked about the outlook for the U.S. dollar’s role as the world’s reserve currency and how shifting to a multipolar world would affect global equilibrium interest rates. Carney said he expected it to remain the leading reserve currency despite more countries expanding their portfolios of Euros and Renminbi. “The problem is that when the U.S. economy is strong, and emerging economies are not, there’s a tightening of financial conditions for those emerging economies that need to borrow in dollars. That creates a huge tension in the system.” He predicted this would become a problem as more flows to emerging markets go through market-based asset managers.
Another nettlesome issue is which currency will be the dominant one for digital commerce going forward. “If it is the dollar, it will reinforce the existing asymmetry,” Carney said. “If it’s the renminbi, we’re just swapping hegemons. But it could be a synthetic currency, or a basket of currencies, using digital wallets, which could move us to a much more multipolar world.”
Zachary Cefaratti said he is also concerned about the major international organizations’ lack of concern about the sustainability of debt and deficits. “The IMF and OECD are saying ‘spend now, worry about debts later.’ What are your concerns as we increase these debts with rising interest rates on the horizon?”
“I think embedded in that question is a mass consensus among major international organizations that budget constraints have been eliminated,” Carney responded. “That’s overlearning the lessons of 08 and 09 when it was a boom-bust recession, and we had to lean into it. I think fiscal policy was tightened too quickly back then.” In 2020, the U.S. had essentially turned off large amounts of its economy due to the Covid crisis. Carney said the country should cut back on fiscal stimulus and raise rates when it comes back. “I don’t think perpetually large deficits are consistent with low rates over the long term.”
Cefaratti asked whether the U.S. risks “Japanification” – getting trapped in a situation where the government owns large amounts of its own government debt and a hard-to-shake deflationary mindset takes hold, blocking growth.
Carney agreed that this was a risk, though a small one. Japan is in a dire position. They did not do enough to offset the deflationary mindset, and the country’s demographics are not helping. “Japan’s example shows the limits of stabilization policy – governments and central banks can help bridge through a crisis, but they need to set the stage for economic investment and growth driven by the private sector.”
Zachary Cefaratti also raised the issue of the stock market’s dependence on the technology sector for its outsized gains. “What are your concerns about the dislocation between markets and Main Street conditions – could there be an equity market correction?”
On this point, Carney was moderately optimistic. Any time in forward-looking markets, there can be a disconnect between where markets think things are going and where the situation is today, he noted. But, yes, there are risks. A significant risk is that macro policy doesn’t adjust properly. However, although pockets of froth will be corrected, he did not see this as a systemic risk. “It’s not fun if you’re caught long and wrong, but it’s not like having problems in debt markets. It doesn’t have a multiplier effect throughout the economy,” he said. “Markets have been doing their jobs and will pull us out of this.”
