The Fed Falls to Inconsistent and Contradictory Depths
Speaking earlier this week, New York Federal Reserve President Bill Dudley indicated a growing frustration with what he termed the "concentration of mortgage origination volumes at a few key financial institutions". In other words, the man charged with executing monetary policy for the entire Federal Reserve monetary system is upset that what is ostensibly a banking cartel may not be adhering to monetary policy intentions. Perplexing and aggravating Mr. Dudley is the record spread between wholesale and retail mortgage money, a spread that has appeared and grown coincident to Federal Reserve monetary interventions into the mortgage space.
The FOMC policy that is being called QE 3 is nothing more than an ongoing purchase of mortgage bonds, with "bonds" being the key word for the entire affair. Though Chairman Bernanke broached the idea of aiding the mortgage market more directly through the Discount Window over the summer, it was likely shelved due to legal considerations over Fed rules in favor of a more conforming unconventional measure. This means QE 3 is an indirect entrance into the mortgage market since the Fed is buying derivative mortgage instruments of particular structured finance (GSE packaged debt creations). This secondary position means that the Fed is, once again, relying on its primary dealer network to carry forth monetary debasement into credit easing.
The net result has been a new arbitrage trade for mortgage bonds, a spread or scalping to pick up without passing on the "savings" to the intended recipients. Wholesale mortgage rates, the "price" the Fed is paying the banks, have fallen. Retail mortgage rates, the "price" paid by everyday mortgage borrowers, have barely moved. Monetary policy in the new QE 3 is rendered as impotent as QE 2 by the very same banking system since money "dies" at only the second layer of banking hell.
Given the circumstances post-2008, Mr. Dudley, on behalf of at least the New York Fed if not the whole of the FOMC, should exhibit more awareness on this issue else he opens the entire QE affair to the charge of obtuseness. The old Latin adage cuius est solum eius est usque ad coelum et ad inferos, an anachronistic legal doctrine regarding property law, seems fitting and proper as a description here. Translated it means that whomever owns the soil also owns the sky over it and the depths under it. While it fell out of favor in the modern age as airplanes became more prevalent and mineral rights more valuable, it seems that the Federal Reserve might be far more attuned to such wide-ranging ownership when it comes to the very system it created according to its own modern monetary philosophy.
This cartel of banks that has become suddenly so abhorrent did not come from nowhere. The concentration of assets, let alone the culling of the banking herd in which the Fed will conduct primary business in mortgages, was not an accident. Everything in the age of activist central banking favors large and larger. The issuance and disposition of monetary debasement these past five years has not been anywhere close to uniform, and the pattern is not unduly difficult to discern among even the most casual observer. The US central bank has been favoring and showering the Wall Street investment banks (a term that now applies only to their preferred business model since their sudden conversion to "depository" institutions in the panic of 2008) really since the conversion from reserve targeting to interest rate targeting in the late 1980's. That trend became parabolic in this current age of unconventional super-activism. Monetary policy runs through the cartel by design.
Whether or not real power lies in the cartel or with policymakers is the stuff of conspiracies, but there is no denying that the Federal Reserve has found itself on the short end of the banking crisis in far more ways than the current QE 3 mess. For all the balance sheet expansion (money printing) in QE's 1 & 2, the wider economy remains constrained of credit money due to cartel hoarding, as did the ultimate dispersion of "quality" dollar-denominated collateral.
In a larger sense, however, the methodology of using the banking cartel as the primary tool for transmitting monetary policy has always carried this embedded potential contradiction. Investment banks, by their very makeup and nature, are speculative systems. They are not confined to any notion of traditional intermediation or even investment. These mega-banks will seek out money and opportunity wherever it exists, and are far more free to run far afield of even the best monetary intentions.
We have seen something like this before, in the annals of Japanese monetary debasement in the 1990's and 2000's. With each successive step backward into its "lost decade", the Bank of Japan responded by successive "stimulative" episodes. The Bank of Japan promised much the same as does Ben Bernanke and the FOMC, but the large international banking cartel began to engage in what is known as the yen carry trade. Banks were able to borrow money at zero cost, thanks to Japanese ZIRP that never ends, and shift and convert zero-interest yen into any other currency offering a positive spread. As long as the yen didn't appreciate too much, the carry trade was a leveraged winner regardless of the deleterious impact it has had on the Japanese economy (can economies ever fully recover when money is siphoned off in such large quantities to be "invested" elsewhere?).
The Bank of Japan responds with more yen and a confused shrug of "what can we do?" In Bill Dudley's obtuse complaint lies the answer to the riddle confounding Ben Bernanke. The Fed Chairman was also speaking earlier this week, this time to an international audience in, ironically, Tokyo. Not all central bankers around the world are pleased with QE 3 in the US and the ECB's parallel open-ended promises.
Mr. Bernanke took a two-pronged approach toward answering his critics:
"I am sympathetic to the challenges faced by many economies in a world of volatile international capital flows. And, to be sure, highly accommodative monetary policies in the United States, as well as in other advanced economies, shift interest rate differentials in favor of emerging markets and thus probably contribute to private capital flows to these markets. I would argue, though, that it is not at all clear that accommodative policies in advanced economies impose net costs on emerging market economies, for several reasons.
First, the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted. Even in normal times, differences in growth prospects among countries--and the resulting differences in expected returns--are the most important determinant of capital flows. The rebound in emerging market economies from the global financial crisis, even as the advanced economies remained weak, provided still greater encouragement to these flows."
In other words, the emerging economies are a victim of their own success. Because of the malaise in the US and Europe, money will seek out better returns elsewhere. Therefore, successful economies should expect inflows of "capital" (I would not use that word).
Second, perhaps more telling, Chairman Bernanke offered this hierarchical glimpse into the order of monetary operations:
"Finally, any costs for emerging market economies of monetary easing in advanced economies should be set against the very real benefits of those policies. The slowing of growth in the emerging market economies this year in large part reflects their decelerating exports to the United States, Europe, and other advanced economies. Therefore, monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well."
The Federal Reserve needs monetary margin from emerging economies in order to "stimulate" the engine of global growth - US consumers (and European). What this boils down to is the doctrine of US credit money as the engine of global growth. The corollary or collateral damage of such a doctrine is that secondary producer or material economies need to accept the inflationary cost of "stimulating" US debt for consumers. If the Fed fails to get banks to lend money to US households, then there are no customers for the emerging market economies, according to Bernanke, so it all fails anyway.
There is a high degree of plausibility to that doctrine; up to a point. A healthy US consumer is undoubtedly a primary driver of global economic activity. The questions remain as to what constitutes healthy consumers and how to achieve them.
Mr. Dudley's primary speech this week concentrated exactly on the weak recovery. First, acknowledging it as such was an implicit admission of failure. Before getting that far, however, Mr. Dudley admitted that private economic forecasts have been consistently wrong throughout the recovery period:
"Two aspects of this exhibit are noteworthy. First, forecasters have consistently expected the U.S. economy to gather momentum over time. Second, with only one exception, the growth forecasts for each year have been revised downward over time, as the expected strengthening did not materialize."
He also indicated that the inability to forecast was not limited to the private sector:
"Although I have focused on the private forecasting record here, the FOMC participants' forecasts show a similar pattern. It is on the growth side where there have been chronic, systematic misses."
This consistent shortcoming where policymakers and economic observers keep expecting the US economy to perform better than it eventually does - in some years, particularly 2012, they expected far better - should be far more emphasized than it is because it offers a hard truth. These forecasts are largely constructed in the exact same manner as the models that predicted the success for the American Reconstruction and Recovery Act (the "stimulus" bill). Economic predictions simply assume monetary policy always works, so the creation and execution of monetary stimulus in various forms over the past four years are uncritically assumed to be effective beforehand. The very act of debasement leads the economics profession to assume economic vigor in the near term.
Therein lay the trap for both monetary policy as Bill Dudley sees it and as Ben Bernanke preaches for the rest of the world to just grin and bear it. Rather than assume or accept that monetary policy is at best ineffective or at worst deleterious, monetary debasement is always the answer. If the desired results are not achieved, the independent variable to be adjusted is not this continuous appeal to monetary intervention, it is always a question of size. Bill Dudley gave this unsurprising verdict toward the end of his speech, noting that, "monetary policy, while highly accommodative by historic standards, may still not have been sufficiently accommodative given the economic circumstances." It is never enough for them.
That statement was heard loud and clear in China, India, Brazil and all the countries whose central banks find themselves in a flood of "hot money". Nowhere in these canned, uninspired rationales for dramatic debasement is any hint of a consideration to understand or measure the "carry trade" effect that comes from creating monetary infrastructure through a global bank cartel. Monetary models and economic forecasts do not account for these kinds of inefficiencies, let alone even acknowledge them. This is ultimately a question of leakage.
Bill Dudley admitted as much in his irritation over mortgage spreads. The answer according to Bernanke and Dudley is that we should all accept leakage as the monetary cost of doing economic business. Brazil should be fine with double digit inflation because eventually some money might filter into the hands of US consumers as mortgage refinancing, meaning that they might, after retiring their own existing debts, spend some of it on imported goods from China who will buy more raw materials from Brazil. This is far, far from the most efficient global economic system, but it is a boom for the speculative cartel scalping spreads created directly from monetary inefficiency. The bottom line is that the Federal Reserve is supplying all the leverage necessary to make spreads and carry trades far more enticing than lending into the real economy.
Leakage is typically a question of how much money or resources are siphoned off of a productive endeavor into waste. In this sad state of global economic and monetary arrangements, leakage is how much actually gets to where it is intended. Cartels engaged in speculation with a potential torrent of zero-interest money do not strike me as the precursor condition for fixing that leakage problem, assuming credit is actually the answer in the first place. There is just as much doubt as to whether this lack of "demand" can efficiently be supplemented, once again, through creating more debt.
The remedy to any condition of inefficiency is not more of that condition. In that regard there is an almost zero probability that such a diagnosis will ever be rendered by either the Washington or New York ends of the Federal Reserve/FOMC policy apparatus. While Chairman Bernanke was busy telling the rest of the world that their problems would be fixed by a strengthening US economy, Bill Dudley was on the same day partially attributing US weakness to the rest of the world. If you own the soil of inefficiency, you also own the cartel-colored sky above and the inconsistent and contradictory depths below.
