The Failure of Monetary Policy

http://www.morganstanley.com/GEFdata/digests/20060522-mon.html#anchor0

I have a lot of faith in the fact that this period of time with be of great interest to economic historians. Steve Roach is 110% on track when he identifies the fundamental failing of central bank monetary policy in his most recent article.

Inflation targeting hasn't worked and the CPI has not been an accurate measure of monetary expansion. This thinking will not survive past the coming recession.

Contractions

Anyone who follows this blog will know I regularly quote Stephen Roach at Morgan Stanley. Steve seems to have had a slight change of heart, the following is an except from his latest weekly article:

"No, I am not prepared to give an unbalanced world the green light. But it’s time to give credit where credit is due: First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns. Third, to the stewards of globalization for facing up to the imperatives of architectural reform. And fourth, to Asia -- especially China -- for recognizing the unsustainability of export-led growth models. Notwithstanding the risks noted above -- all of which need to be taken very seriously -- I am delighted that the global economy finally seems to be taking its medicine. Let’s hope the cure works."

http://www.morganstanley.com/GEFdata/digests/20060501-mon.html#anchor0

"Second, to central banks for collectively embarking on policy normalization campaigns."

The US Federal reserve embarked on "policy normalisation" in 1928 and 1929 in an attempt to reign in the prevailing market exuberance. There were three interest rate rises in 1928 and another 50 basis points in 1929. We are at the same stage of the monetary cycle.

Frankly, I feel I need to state this plainly; nothing any government or central bank can do can now avert a serious worldwide and US centric recession. The grossly excessive monetary expansion of the 1995-2005 period will correct itself. The damage has already been done. We are now at the beginning of a monetary contraction and it is inevitable that at some time market confidence underpinning asset prices will collapse.

I normally agree with Steve, but his most recent comments go very much like this:

I have been smoking cigarettes for 30 years. Just lately I started to cough up blood. But I realised my mistake and quit the smokes last week so everything should be fine.

Well things are far from fine. governments and central banks can undertake whatever surgery or remedial procedures that see as possible and necessary to try and minimise the impact of the of the monetary contraction, but the consequences of the expansionary excesses cannot be avoided.

It might sound a perverse thing to say but I am praying for a severe recession. The only reason I say that is that I don't want to live through a depression.