April 29, 2016
Today a legend who oversees more than $170 billion warned that the world may now be facing “catastrophic consequences.”
Rob Arnott: “We are overdue for a U.S. equity bear market and if we get a bear market it will have ripple effects across other asset classes. But the other thing that worries me even more than that is the central banks losing credibility and losing control.
Massive Wealth Expropriation
Let’s suppose that headline inflation, already up to 2.3 percent in the last 6 – 8 months, hits 3 percent in the next 6 or 8 months. All the sudden the central bank (the Fed) has lost control. The central bank can’t keep interest rates down at zero when inflation is running around 3 percent. That winds up being a massive wealth expropriation from anyone with savings.
The government is intentionally engaging in wealth destruction for the affluent savers. That’s the essence of negative real interest rates. But if you are trying to carry zero interest rates in a 3 percent inflation environment, it stimulates all sorts of crazy behavior on behalf of the general public, and it winds up defeating the purpose of low interest rates, which is to stimulate the macroeconomy.
The Hairy 1970s
So, ironically, you could have the Fed’s efforts to stimulate the economy with low interest rates having the unfortunate effect of stimulating hoarding instead of stimulating inflation in the macroeconomy. And you could have inflation get out of hand anyway so that you wind up with the worst of both worlds — a stagnation in the macroeconomy and outright recession, paired with renewed inflation. It’s called stagflation. We had that in the 1970s and it was brutal. That’s a risk. It’s certainly possible and if the Fed loses control, watch out.”