Let's not mention the war

The latest in a series of monthly reflections on the war in Iran.

Six months ago the United States began the largest military campaign it has fought since 2003. It killed a head of state on the first morning. It has struck more than eleven thousand targets. Eighteen American service members are dead and 757 wounded. The Strait of Hormuz has been closed (again) since 11 July.

You would barely know it.

That is not an accident, and I do not think it is simple neglect. The silence is the most informative thing that happened in August.

Weekly Energy Update

 Status

• Petrol prices - elevated but stable in August. 
• Singapore refined - elevated
• Crude prices - elevated 
• Natural gas - above early Iran war prices

Charts

Who Fights Inflation

Australian inflation took off in 1973 and did not get back below five per cent, and stay there, until 1991. Eighteen years. Germany peaked at 7.9 per cent and was under 5 within three. The United States peaked at 14.8 and took nine. We peaked at 17.5, and the Reserve Bank's own 1992 conference on disinflation ranked Australia poorly on the unemployment cost of getting there, putting it down to high real rigidities.

Australia has an inflation problem

 Underlying inflation is running at 4.9% annualised and climbing.

QE and the Estimated Neutral Rate

TL;DR

Money for long-term borrowing moves freely across borders, so liquidity is a global phenomenon. QE bought bonds from asset holders and paid in cash. With this cash they bought other assets, everywhere and in every class. Asset prices rose worldwide, including in countries that never ran a QE programme of their own.

That was inflation, in a market the consumer price index does not cover. And bidding an asset's price up is bidding its yield down, so the same event was a global fall in borrowing costs.

None of this began in 2009. Bernanke saw low rates in 2005 and diagnosed a global savings glut as the cause, favouring a structural explanation over a liquidity one.

Most econometric models that estimate the neutral rate are fitted to consumer prices, output and interest rates. Asset prices are not among the inputs. So the figure they report is the rate that is neutral for groceries, and it has nothing to say about whether borrowing was running ahead of the capacity to service it.

There is a second problem underneath. The models infer the rate from two relationships that a decade of successful stabilisation had flattened, leaving the history of the policy rate itself as the main thing to lean on. Policy rules then took that estimate as an input, and naturally recommended something close to the policy already in place.

Estimation needs variation, and stabilisation exists to remove variation. A central bank that succeeds gradually erases the evidence it needs to keep doing its job.

The liquidity story does the work of several. It explains why asset prices boomed where no programme ran, why consumer prices stayed quiet and then surged in 2021 when the same mechanics reached households instead, and why every country's estimate fell together despite different demographics, deficits and growth.

For a decade, the rate that would have kept borrowing serviceable sat far above the one the models report. That is not a measurement problem. It is a specification problem, and a specification problem returns a confident number to the wrong question.

US Bonds Crisis

Everyone is panicking about the US bond market. Here is thirty years of data on the thing they are panicking about.  

Weekly energy update

Crude

Cheap oil isn't coming back anytime soon.