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4D inflation podcast (part 1): Paul Volcker, central banks, and the UK

With inflation still the word on everyone’s lips, 4D Infrastructure’s latest podcast will be published in two parts. Part 1 deals with the impact of inflation on the current macro environment, and part 2 looks specifically at the US’s new Inflation Reduction Act.


In part 1, Greg Goodsell (4D’s Global Equity Strategist) speaks with Dave Whitby (Bennelong Account Director) about how most developed economies are dealing with inflation – and how the UK differs.

  • 0:53 – How recent history helps explains current events
  • 2:56 – The establishment and role of central banks, and how they’re managing inflation now
  • 5:29 – Why recent events in the UK have raised eyebrows
  • 7:27 – Where to from here, both in the UK and the rest of the developed world


The content contained in this audio represents the opinions of the speakers. The speakers may hold either long or short positions in securities of various companies discussed in the audio. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the speakers to express their personal views on investing and for the entertainment of the listener.


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David Whitby:

Hello and welcome to the 4D global infrastructure podcast for October 2022. My name's Dave Whitby from Bennelong Funds Management, and joining me today is one of the co-founders and principals of 4D, who also acts as their global equity strategist, my old friend, Mr Greg Goodsell. Hello sir, how are you today?

Greg Goodsell:

Hi David. Thank you for the introduction. Great to be here. Looking forward to having a bit of a chat.

David Whitby:

Definitely. Greg, there is just so much going on in the world at the moment. It hasn't been a fun time, it's been very challenging on the markets for both direct investors and also for fund managers. We are in the midst of some very difficult economic times. Can you just give us your take on what is going on in this macro environment?

Greg Goodsell:

Sure. So yeah, you're definitely right David. These are difficult economic times at present and really the issue on everyone's mind is inflation and the inflation threat for the global economy, which interestingly reached a 40-year high in the US though it's a real problem. And this as everyone would've noted has seen central banks around the world raise interest rates to tighten monetary policy to try and fight it.

Now, just before we talk a little bit about that, I just wanted to, if I could just regress a little or digress a little back into some recent economic history, which will hopefully put today's environment and actions by the central banks into a little bit of context. So in 1981, the US was in the midst of its second brutal stint of double digit inflation. In less than a decade, gas prices were high, mortgage rates were high, and the job market was weak as well. So it was in a very, very difficult place.

Now this crisis would end, and most economists give credit for it ending to Paul Volcker, who was chair of the US Federal Reserve from ‘79 to ‘87. And so what Volcker did was he got inflation under control by some very tough monetary policy, raising interest rates, which basically engineered two massive but brief recessions in the US. And by the end of the ‘80s, the US inflation had ebbed as a result of these recessions and the US economy was booming. So everyone looks at that period, 20, 30 years ago now, that's the rule book on inflation treatment.

And so to put this in perspective, so the Federal Reserve Board, led by Volcker, raised the Fed funds rate which had averaged 11% in 1979 to a peak of 20% in 1981. So these guys had a real swing at inflation with interest rates in that time. And that led to the recession, which not surprisingly created a huge amount of protests in the US at the time because of the damaging impact recessions have on the economy. But nevertheless, he stuck to his guns and he drove inflation out of the US economy and out of the global economy.

This process helped establish the precedent of independent central banks, and what an independent central bank is, is one that doesn't bank direction from government on what to do on monetary policy. So a government cannot instruct an independent central bank on what to do with interest rates. And the objective of that is very clear – to get politics out of monetary policy, very simple, very sensible process. Independent central banks can't be influenced by government. Therefore there's no politics in monetary policy.

And just to put it in context, in Australia the RBA was given its independence by the Howard government in 1996. And I can well remember Paul Keating, Mr Howard's predecessor, talking about supposedly having control over the RBA. Among the very famous quotes was that he had the RBA in his pocket. Prime ministers can't say that anymore, or don't say that anymore, because the RBA is now completely independent and makes its own decisions.

And also, this period in the ‘80s also set the process of establishing an inflation goal, inflation targeting. And the RBA again, to put in local context, has a 2 to 3% inflation target, and that was established in 1993. So you can see a lot was learned from these Volcker years in terms of what to do with inflation. So with that backdrop and the experience of the ‘80s, I think we'll continue to see central banks continue to tighten monetary policy as a means of fighting inflation, because it was proven to have worked in the ‘80s. And it may well lead to an economic slowdown, but the reason inflation is such a target for banks and governments is that it's seen to be very corrosive to economies if it gets out of control.

For example, it is very damaging and hurts mostly people that can least afford to bear it – so the low income earners or fixed income earners such as pensioners, they get left behind with inflation because their incomes don't go up anywhere near the rate of which prices of goods and services go up. So they're the ones that really get hurt and they're the ones ... it's a really corrosive element, which is why we fight so hard or why central banks fight so hard irrespective of some economic downturn that could occur in fighting inflation. So that's sort of the backdrop to where we are. I think they'll continue to stick to their guns and forge ahead to fight inflation going forward.

David Whitby:

Okay, from that Volcker style approach, Greg, going across the pond there over to the UK now, they seem to be following quite a different path. What's going on there?

Greg Goodsell:

They introduced a mini budget and that led to chaos in asset markets as we saw, it's a really strange thing to do. And they’ve reversed some of those actions now and they're talking about doing more. But this actually followed very harsh comments from people such as the Bank of England, the IMF and Moody's. And just again to briefly digress to put what the UK has done into context, so there's two institutions broadly to manage economics in a developed economy. So you've got central banks managing monetary policy, which we've already spoken about, and they're now independent. And then you've got governments running fiscal policies, so taxing and spending, and that's their domain in terms of managing an economy.

What do we have in the UK? Well, we have the Bank of England following Volcker policy if you like in raising interest rates to fight inflation. Then all of a sudden along comes a new British prime minister promising massive unfunded tax cuts, which is very expansionary in an economic sense because it gives people more money in their pockets, they go and spend and that can potentially drive inflation. So what you had in the UK is you had a central bank tightening monetary policy, raising interest rates, tightening monetary policy, trying to slow the economy down.

And then a government comes in with expanding fiscal policy, trying to drive the economy faster to increase employment, etc, etc. So you had the two policies available to governments or central banks diametrically opposing what they were trying to achieve. One was trying to close the economy per the Volcker monetary policy theory as is the rest of the world, and then along comes the UK fiscal policy trying to expand the economy.

So you had these two policies directly contradictory to each other. Asset markets just said, “Well, what the f’s going on here?” You've got these two things that are completely contradictory, what's going to happen? And so we had crazy huge volatility, particularly UK asset markets, but fundamentally we had this crazy situation where you had the two arms of policy for government going in the opposite directions.

David Whitby:

So where to from here, do you think, Greg?

Greg Goodsell:

Well, I think at this stage, I mean all that will depend how far back the UK backflips, although there will be a competence issue there. You'll need to look at it in two perspectives. As I've said at the start, I think the rest of the developed world will stick the Volcker monetary policy and fight inflation because of its corrosive nature and it must be eradicated, the pain it can cause. So I think they'll stick to that and that will mean an economic slowdown, maybe a recession, remains to be seen what will happen there. But I think the central banks, the ECB, RBA in Australia, Fed in the US, they'll stick to their guns and they'll keep hiking interest rates to what's needed.

Looking at the UK, well, they're a little bit different obviously. Now if they do a whole bunch of backflips and get back with consensus, then that might be a different story. But if they were to persevere with this policy of expanding fiscal policy and contraction monetary policy, then who knows where they're going to get up? It puts the Bank of England in a very difficult position because they're trying to fight inflation, so they're trying to slow the economy and then the government on the other hand's expanding the economy. What does the Bank of England do? Do they try and tighten monetary policy even further to offset what's happening from the government? It's a very difficult position the UK are in, where they will end up really I'm not sure. But I think the rest of the world, rest of the developed world serving with independent central banks will stick to their guns, they'll fight inflation, and ultimately that will succeed.

David Whitby:

Okay. Well, great. Well, thank you very much for that, Greg. That was very insightful. So no, very much appreciate your time today. Thank you.

Greg Goodsell:

Thank you, David. Thanks for your time.

David Whitby:

Thank you again. And also thank you to the listeners and to our investors in 4D, very much appreciate the support. If there is anything further that you need, please let myself know or one of my colleagues, your designated account director, whoever you have there. But thank you very much again for the support, much appreciated.