Bernanke's Grand Experiment Reduced to 'Nice Try'

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And so the slump plays on, as the titanic American economy is bereft of recovery for another year, sliding further downward despite all garish assurances toward better seaworthiness. Economists have endangered themselves of being associated with Lucy and the football, forever yanking the promise of a kick toward recovery out from under any that has foolishly charged to do so. Time and again the Recovery Summer is upon us, only to vanish by springtime.

The FOMC in its modeled wisdom severely downgraded the US economy to just 2.1% to 2.3% for 2014. In September 2012, when QE3 was the anointed savior, expectations for 2014 GDP ran just about to 4%. Now, apparently, the largest economy in the world is so incredibly fragile as to have sunk perhaps as low as a 2% decline on only winter weather. That would suggest failure of QE not just in its immediate efficacy but in many more points and fashions beyond.

The Fed and various orthodox national and supranational agencies have clustered their downgrades of global and national growth in both the near term, and more poignantly and even dangerously, longer-term. That, again, was sharp in its contrast to not just unbridled enthusiasm that flirted with the end of last year, but the unshakable faith in which it was all proffered. It seems very much as the age of QE is finally coming undone.

Bernanke's successor, Janet Yellen, has been far less of a vocal proponent of the Fed actually trying to regain lost economic glory, and far more of a managerial steward that might accept any fate, depressing or not. And as any bond market observer will tell you, that is exactly what credit is positioning toward. Bernanke's grand experiment is being reduced to, "nice try." None of which he had promised has come to pass, starting with that inflation expectations engineering to that mythical 4% growth marker. Even the housing action of the past few years has retrenched and further threatened to renew more disastrous speculation about where the bottom actually resides.

Stock prices are at record highs, but so are Venezuela's which makes a nice comparison given the record of employment and wages since the middle of 2012. Real average weekly wages in May 2014 were 1.5% below those of May 2010, which neatly frames exactly the manner in which Bernanke's preferred method of "pump priming" was fully directed. Corporate debt issuance and lending remains relatively intact despite all that has happened these last seven years, and so does their preferred means of disposing of cash - repurchases.

Those critical of stock buybacks, like me, would be far less so if they were in actuality tied to the basis by which they are presented. But repurchases, which now looks to far surpass half a trillion on a trailing twelve-month basis, are not high when prices are low, but rather exorbitant when prices are at records. This is not a "useful" allocation of resources to redress the potential undervaluation of shares in specific areas; it has become the anthem of "wealth effect" circulation in the 21st century. The expectations of profit and their relation to the economy have been altered by "something", a durable and maybe even permanent bend in the trajectory.

Only a few months ago, Eric Rosengren, president of the Boston branch of the Federal Reserve, allowed his audience to flavor what had largely been "unthinkable" candor during Chairman Bernanke's tenure:

"My guess is that we will see some pickup as we get into the second half of the year, but the longer we go without getting the 3% growth that many people had in their forecasts, the more concerned you have to be that there are other things going on that we hadn't fully appreciated."

So now, one more time, growth in a calendar year (or in any time frame in which you wish to measure) will fall far below that 3% bogey. In reality, it will be a miracle just to reach the current and much downgraded estimation of "central tendency." According to my own calculations, the economy will need at least 3.1% growth in the remaining three quarters of this year just to get 2.1% (actually 2.05%, to give the Fed's economists the benefit of rounding up). Should the first quarter's harsh winter indeed be revised to a -2% effect, then that growth prescription moves upward to 3.7% for each of the remaining quarters without fail or fault.

Faced with Rosengren's choice, it might finally be time to start looking for the "other things going on." After all, how many years of subpar growth will it take to convince anyone to admit there is a problem on a very basic level, and not just of execution? Maybe seven will be enough this time, though you could really roll back toward the end of the 20th century, particularly in light of labor market conditions and economic flow outside of stock repurchases and home equity.

In his own kind of reflection, Paul Krugman in 2010 looked back on the panic and the persistence of "emergency" that immediately followed and made an observation that I think creates the starting point for all of this:

"I've always considered monetarism to be, in effect, an attempt to assuage conservative political prejudices without denying macroeconomic realities. What Friedman was saying was, in effect, yes, we need policy to stabilize the economy - but we can make that policy technical and largely mechanical, we can cordon it off from everything else. Just tell the central bank to stabilize M2, and aside from that, let freedom ring!"

I believe that is largely correct, apart from being in denial about the role of government (what he calls "macroeconomic realities"). Monetarism was the desire to look into the assumed faults of the market-based economy and render the judgment that some centralized aid was more than appropriate - without going so far as Keynes and reserving all assistance to be a government intrusion. The Friedman approach to the Great Depression "riddle" preserved, for the orthodoxy, the idea that capitalism could be saved from the government wolves via mechanical money, bred by the technocracy of the banks' best and brightest.

In theory, it was a step forward from the socialized fate of the economy. Given where we were in the decades immediately following the Great Depression, the New Deal and the ascent of socialization of so many pieces of the economic puzzle, maybe that was the best possible theoretical course to dig out of that hole. Where I cannot help but gain puzzlement is why that was abandoned so easily (and quickly) and the shocking absence of any counterforces to bring it back on course?

I don't think it very controversial at all to state that the Fed has been acting far outside any mechanical regulation of the money supply. At the very least, one has to acknowledge that targeting money at any level ended in the 1980's, after having been "discredited" in the early 1970's as an orthodox policy approach. In the current parlance of monetary policy, practitioners may claim a distinction between a "rules based" regime and one based on "discretion", but if opinions are the basis for setting the "rules" there really is no difference. Neither approach comes close to conforming to Friedman's ideal of automated operations.

The entire evolution of banking since Friedman's seminal work was published in 1963 undermined that very premise. The gold standard had been effectively neutered in 1933, and even on an exchange basis under Bretton Woods there was immense margin for monetary "discretion" in creating foreign reserves. That was the basis of the eurodollar market, which banks saw as the next step out from under any form of hard constraint. If you research the history of that era and the radical monetary changes taking place you cannot help but see the collusion of politics in it.

As it was, eurodollars supplanted gold and rendered any idea of a mechanical Fed or central bank wholly and maybe irreparably anachronistic - which was decidedly the point. It was a bipartisan affair where the role of some central authority and policy was to take on a leading role, or what Krugman dismissed as irrational fear of, "the thin edge of the socialist wedge."

And so it became framed as such, where the Keynesians stood on one side and represented the IS-LM understanding of the economy, which posits that the free market is actually destructive without having grounding in government. On the other side, supposedly, were the monetarists representing free market ideals.

But as history progressed and banking evolved, the Federal Reserve moved further and further into its newfound activist role, which was almost blatantly political. The idea of banishing the business cycle is exactly that, represented by the ludicrous assertion of a statutory "dual mandate." If read properly, Congress has told the Fed not to allow recession under any circumstance. In what way is that not the free market is actually destructive without having grounding in government?

The mechanical nature of central banking that had won Friedman's championing was based on hard money limitations. What Alan Greenspan himself once wrote as the "shabby little secret of the welfare statists" was that gold represented an area of private life totally off-limits from government approach and reproach. The end of the gold standard meant that monetarism and Keynesianism would eventually fuse into the same thing conducted through different means - there was no free market for money at that point.

Some may argue, as a relevant aside, that the Federal Reserve is not properly an agent of government, and that is fair. However, you cannot call it an agent of the free market either, particularly since its role is intentionally intrusive (though you can make the same argument about a mechanical central bank too, which is a big part of the point I am trying to get at). If you are left arguing only about the level of intrusion, then you have left the free market "reservation" already.

The basic idea in that frame of reference is that if the economy is in a slump then the natural rate of interest is below the market rate of interest; since the market rate of interest is purportedly zero, then the natural rate has to be negative. That is guiding proposition of all policy angles, there is nothing to represent what can fairly be called an alternative. You either accept the premise of a negative natural interest rate and the centralized solution or find something else to do with your time.

The prescription for a negative natural interest rate is, arithmetically, higher inflation expectations with the view toward making market interest rates negative on a real basis. That was the point of QE from its very beginning. Since this was all very mathematical and had no basis in actual free market behavior, there was little theoretical work to actually figuring out if consumers and businesses actually acted like the spreadsheets predicted.

In December 2013, economists at the Boston Fed finally began putting two and two together without worrying that an answer of four might upset the "calculation" of the negative natural interest rate.

"In general, there are a number of reasons why the effects of inflation expectations on spending may be less economically significant and less robust than theory (and participants in some recent policy debates) might expect. While some of these reasons, such as nominal rate illusion, were discussed by Bachmann, Berg, and Sims (2012), a prime culprit not much discussed in the existing literature concerns income expectations."

Income expectations are more than a little tricky, particularly in relation to "inflation." We are counting not just whether you expect to get paid more last year, but the relative condition of earned income next to all economic factors beyond just prices. If you were laid off in 2009 from a $50,000 job and came back in late 2010 at $40,000 (or worse), inflation expectations are not necessarily the primary impediment. And even where inflation does count, it may not be in the fashion predicted by such policy equations.

Gas prices have largely been stable for several years now, but that "lack" of "inflation" is not comprehensive enough as an economic factor. If you earn less money now and gas prices are still nearly double what they were when you were earning more, that is a major impairment regardless if prices are now stable at the higher plateau. Oil prices that remain about $100 are still too high, as in relation to income they would be less intrusive only back down toward $50 and below.

The entire flow of the economy has been redirected by something other than the free market, based on a mathematical model that even its creator, John Hicks, eventually called a "classroom gadget." The constant appeal of debt on top of debt, with a further helping of credit, is not what Friedman's monetarism was supposed to be. I think it easy to say that nothing could have ever gained such a pedestal, because simply arriving at the basic idea of attempting any central monetary role necessarily placed that endeavor on the path toward, to borrow Krugman, acting as the thin wedge of socialism. Power gained will always be power abused, unless checked. Without gold or some other basis of free market, hard money, there was never going to be an effective limit.

Instead of taking the consequences of severely degraded economic system as a serious rebuke, the combined socialized policy class of monetarists and fiscalists are busy at work "fine-tuning" their spreadsheets and regression models to recalculate the negative natural interest rate and how best to push "market" rates below them. It amounts to a pejorative punishment of markets, not freedom as once imagined, as resources are allocated based on bastardization. If anything is bending the trajectory of long-term growth downward, it is the idea that money has been left without an option except as a tool for political policy.

 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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