Stephen Roach has new things to say

In case you haven't been reading him lately...

I worry increasingly that history will not treat the recent record of central banking kindly. Inflation may well have been conquered — a conclusion financial markets are actively debating again — but that was yesterday’s battle. Over the past six years, monetary authorities have turned the liquidity spigot wide open. This has given rise to an endless string of asset bubbles — from equities to bonds to property to risky assets (emerging markets and high-yield credit) to commodities. Central banks have ducked responsibility for this state of affairs. That could end up being a policy blunder of monumental proportions. A new approach to monetary policy is urgently needed.

Modern-day central banking was born out of the Great Inflation of the 1970s. Led by Fed Chairman Paul Volcker, monetary authorities became tough and disciplined in their efforts to break the back of a deeply entrenched inflationary mindset. Price stability became the sine qua non of macro stabilization policy. Nothing else really mattered. Without inflation, it was argued, economies could realize extraordinary efficiencies that would enhance resource allocation and maximize returns for the owners of capital and providers of labor (see, for example, Alan Greenspan’s 3 January 2004 speech, “Risk and Uncertainty in Monetary Policy”). Who could ask for more?

The subsequent disinflation was a major victory for central banking. It was also a major victory for the “monetarists” who argued that inflation was everywhere and always a monetary phenomenon (see Milton Friedman, A Theoretical Framework for Monetary Analysis, 1971). In retrospect, central banking’s finest hour came in the early days of this struggle -- in the immediate aftermath of the wrenching monetary tightenings that were required to break the vicious circle of the inflationary spiral. Unfortunately, the authorities have been much less successful in “managing the peace” — steering post-inflation economies toward the hallowed ground of price stability. By focusing solely on the inflation battle, there is now risk of losing a much bigger war. That’s what the profusion of asset bubbles is telling us, in my view. The great triumph of central banking rings increasingly hollow in today’s bubble-prone environment...

...America’s Federal Reserve is increasingly isolated in arguing that asset markets should be ignored in the setting of monetary policy. In fact, its new chairman is the academic high priest of inflation targeting — embracing an even tighter rules-based approach than his predecessor. Asset bubbles are, at best, an after-thought in a strict inflation-targeting regime. Therein lies the potential for a strategic policy blunder: The US central bank has yet to develop an exit strategy from the multi-bubble syndrome that the Fed, in its zeal for inflation targeting, has spawned. Moreover, as one bubble begets another, excess asset appreciation has become a substitute for income-based saving — forcing the US to import surplus saving from abroad in order to sustain economic growth. And, of course, the only way America can attract that capital is by running a massive current-account deficit. In other words, not only has the Fed’s approach given rise to a seemingly endless string of asset bubbles, but it has also played a major role in fostering global imbalances.

It's not good for the near term...but I suspect that everything will look like an asset bubble or nothing will look like an investment.

Update:
Also: Jerome a Paris says a similar thing with lots of nice graphs.