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3 CREDIT BUBBLE
BULLETIN Fed's Hotel
California Commentary and weekly
watch by Doug Noland
At least for today
(perhaps because I'm a little under the weather),
when it comes to the Federal Reserve I'm about all
ranted out. So this isn't supposed to be a rant,
but more an effort to tie together some loose
analytical ends. Key facets of my macro credit
theory analysis seem to be converging: the myth of
deleveraging, "liquidationist" historical
revisionism, rules versus discretion monetary
management, and "Keynesian"/inflationist dogma.
The Ben Bernanke Fed last week increased
its quantitative easing program to monthly
purchases of US$85 billion starting in January.
"Operation Twist" - the Fed's clever strategy of
purchasing $667 billion of bonds while selling a
like amount of T-bills - is due to expire at the
end of the month. The Fed will now continue buying
Treasury bonds ($45 billion/month). It just won't
be selling any bills, while
continuing with $40 billion mortgage-backed
security (MBS) purchases each month. The end
result will be an unprecedented non-crisis
expansion of our central bank's balance sheet
(monetization). It's Professor Bernanke's
"government printing press" and "helicopter money"
running at full tilt.
During his Wednesday
press conference, chairman Bernanke downplayed the
significance of the change from "twist" to
outright balance sheet inflation. Wall Street
analysts have generally downplayed this as well.
Truth be told, no one has a clear view of the
consequences of taking the Fed's balance sheet
from about $3 trillion to perhaps $4 trillion over
the coming year or so. It's worth noting that in
previous periods of rapid balance sheet expansion,
the Fed was essentially accommodating
de-leveraging by players (hedge funds, banks,
proprietary trading desks, real estate investment
trusts, etc) caught on the wrong side of a market
crisis.
Does the Fed's next trillion's
worth of liquidity injections spur more
speculation in bonds, stocks and global risk
assets? Or, instead, will our central bank again
provide liquidity for leveraged players looking to
sell (many increased holdings with the intention
of eventually offloading to the Fed)? It's
impossible to know today the ramifications of the
Fed's latest tack into uncharted policy territory.
It will stoke some inflationary consequence no
doubt, although the impact on myriad credit
bubbles around the globe is anything but certain.
Clearer is that the Fed has again crossed
an important line. There has been previous talk of
Fed "exit strategies". I'll side with Richard
Fisher, president of the Federal Reserve Bank of
Dallas, who on Friday warned of "Hotel California"
risk ("... Going back to the Eagles song which is,
'you can check out any time you want but you can
never leave... '"). There has also been this
notion that the US economy is progressing through
a ("beautiful") deleveraging process.
Yet
there should be little doubt that the Fed has now
resorted to blatantly orchestrating a further
leveraging of the US economy. It will now become
only that much more difficult (think impossible)
for the Federal Reserve to extricate itself from
this inflationary process.
I've read quite
sound contemporaneous analysis written during the
"Roaring Twenties". There was keen appreciation at
the time for the risks associated with rampant
credit growth and speculative excesses throughout
the markets and economy. The "old codgers" argued
that a massive credit inflation that commenced
during the Great War (World War I) was being
precariously accommodated by loose Federal Reserve
policies. Chairman Bernanke has throughout his
career disparaged these "bubble poppers".
To this day the "liquidationists" are
pilloried for their view that there was no viable
alternative than to wring financial excess and
economic maladjustment out of the system through
wrenching adjustment periods. Through their
empirical studies, quantitative models, and
sophisticated theories, contemporary academics -
led by Bernanke - have proven (without a doubt!)
that the misguided "bubble poppers" and
"liquidationists" were flat out wrong. Our central
bankers are now determined to prove them (along
with their contemporary critics) wrong in the real
world. Yet there remains one rather insurmountable
dilemma: The contemporaneous credit bubble
antagonists were right.
The Dallas Fed's
Fisher stated Friday that the rate-setting Federal
Open Market Committee "is probably the most
academically driven in history". Well, I'll say
that a world of unconstrained market-based finance
"regulated" by inventive and activist academics
has proved one explosive monetary concoction. The
Wall Street Journal's Jon Hilsenrath (with Brian
Blackstone) had two insightful pieces this week,
"MIT Forged Activist Views of Central Bank Role
and Cinched Central Banker Ties", and "World
Central Bankers United by Secret Basel Talks and
MIT Connections".
Inflationary cycles
always create powerful constituencies. After all,
credit booms and the government printing press
provide incredible wealth-accumulating
opportunities for certain segments of the economy.
Moreover, it is the nature of things that late in
the cycle the pace of wealth redistribution
accelerates as the monetary inflation turns more
unwieldy. Throw in the reality that asset
inflation (financial and real) has been a
prevailing inflationary manifestation throughout
this extraordinary credit boom, and you've
guaranteed extraordinarily powerful
constituencies.
By now, "activist" central
banking doctrine - with pegged rates, aggressive
market intervention/manipulation and blatant
monetization - should already have been
discredited. Instead, policy mistakes lead to only
bigger policy mistakes, just as was anticipated
generations ago in the central banking "Rules vs
Discretion" debate.
Today, a small group
of global central bank chiefs can meet in private
and wield unprecedented power over global markets,
economies and wealth distribution more generally.
They are said to somehow be held accountable by
politicians that have proven even less respectful
of sound money and credit. In the US, Europe, the
UK, Japan and elsewhere, central bankers have
become intricately linked to fiscal management. As
such, disciplined and independent central banking,
a cornerstone to any hope for sound money and
credit, has been relegated to the dustbin of
history.
Considering the global monetary
policy backdrop, it's not difficult to side with
the view of an unfolding inflation issue. At the
same time, the "liquidationist" perspective - that
to attempt sustaining highly inflated market price
and economic structures risks financial and
economic catastrophe - has always resonated.
The markets' response to Wednesday's
dramatic Fed announcement was notably
underwhelming. This could be because it was
already discounted. Perhaps "fiscal cliff" worries
are restraining animal spirits. Then again,
perhaps the more sophisticated market operators
have been waiting for this opportunity to reduce
their exposures. After all, the Fed moving to $85
billion monthly of quantitative easing five years
into an aggressive fiscal and monetary
reflationary cycle is pretty much an admission of
defeat.
I've argued that, primarily due to
unrelenting fiscal and monetary stimulus, the US
economy has been avoiding a necessary deleveraging
process. Some highly intelligent and sophisticated
market operators have argued the opposite. They
point to growth in incomes and gross domestic
product, while total (non-financial and financial)
system credit has contracted marginally. I can
point specifically to total non-financial debt
that closed out 2008 at $34.441 trillion and ended
September 30, 2012, at a record $39.284 trillion.
But the deleveraging debate will not be resolved
with data.
The old "liquidationists" (and
"Austrians") would have strong views about
contemporary "deleveraging". They would shout
"inflated price levels", "non-productive debt",
"unsupportable debt loads", "excess consumption",
"distorted spending patterns and associated
malinvestment", "deep economic structural
imbalances" and "intractable current account
deficits!" They would argue that to truly
"deleverage" one's economy would require a tough
weaning from system credit profligacy.
Only by consuming less and producing more
can our economy reduce its debt dependency and get
back on a course toward financial and economic
stability. The "bubble poppers" would profess that
in order to commence a sustainable cycle of sound
credit and productive investment first requires a
cleansing ("liquidation") of unproductive ventures
and unserviceable debts. It's painful and,
regrettably, shortcuts only short-circuit the
process. I'm convinced that they would hold
today's so-called "deleveraging" - replete with
massive deficits, central bank monetization and
ongoing huge US trade deficits - in complete and
utter disdain.
In a CNBC interview on
Wednesday evening, the Wall Street Journal's Jon
Hilsenrath called Bernanke a "gunslinger". Our Fed
chairman is highly intelligent, thoughtful,
polite, soft-spoken, seemingly earnest and a huge,
huge gambler. And he's not about to fold a bad
hand. Almost four years ago, I wrote that Fed
reflationary measures were essentially "betting
the ranch". This week they again doubled down.
With his perspective and theories,
Bernanke has pushed the envelope his entire
academic career. He is now surrounded by a group
of likeminded "Keynesian" academics, and they
together perpetuate groupthink in epic
proportions. These issues will be debated for
decades to come - and who knows how that will all
play out.
But as a contemporary analyst
and keen observer, there's no doubt these
unchecked "academics" are operating with
dangerously flawed theories and doctrine. It's not
the way central banking was supposed to work.
Ditto capitalism and democracies. Whatever
happened to sound money and credit?
WEEKLY WATCH The S&P500
slipped 0.3% (up 12.4% y-t-d), and the Dow
declined 0.2% (up 7.5%). The Morgan Stanley
Cyclicals gained 1.4% (up 16.7%), and the
Transports rose 1.2% (up 3.3%). The Morgan Stanley
Consumer index declined 0.4% (up 10.6%), and the
Utilities fell 0.8% (down 4.9%). The Banks were
little changed (up 25.1%), while the
Broker/Dealers were 0.5% higher (up 5.9%). The
S&P 400 Mid-Caps slipped 0.1% (up 13.9%),
while the small cap Russell 2000 added 0.2% (up
11.2%). The Nasdaq100 was down 0.5% (up 15.4%),
while the Morgan Stanley High Tech index gained
0.5% (up 14.9%). The Semiconductors increased 0.4%
(up 4.6%). The InteractiveWeek Internet index
gained 1.1% (up 15.4%). The Biotechs rose 0.5% (up
40.6%). While bullion declined $8, the HUI gold
index recovered 0.8% (down 12.3%).
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