Cheer Up, There's a Booming Economy Somewhere
Lost amid the fuss over the FOMC's latest public attempts at Greenspanisms (saying nothing while saying a lot about a little; "patience" vs. "considerable time" in this instance) was news of the latest attempt at establishing a rate floor. The ECB's rate floor has garnered a great deal of attention, of course, simply as a fact of its nominally negative rate - a world's first unleashed in June. The Federal Reserve would very much like to replicate that operative function, though not quite as yet as a negative rate.
Instead, the FOMC is desperately trying to convince the world it wishes to broach the other direction, out of ZIRP and into that Hollywood-style ending. Bernanke got all the accolades for "saving" the system (from what? Itself?) and now the newly established regime wishes to cap it off in grand style. There is a booming economy somewhere, though nobody can seem to find it.
Since the monetary apparatus in the orthodox, activist age is distinctly concerned about semantics, perhaps there needs to be a better definition of "booming" and, for that matter, "economy." Given the public solidarity among economists and certainly stock analysts over their descriptions of what the economy looks like right now you would think it far easier to locate. However, even the FOMC, whose entire existential directive at this moment rests upon "booming", seems unable to latch onto anything tangible. All they could manage at that December meeting was, "Although a few participants suggested that the recent uptick in the employment cost index or average hourly earnings could be a tentative sign of an upturn in wage growth, most participants saw no clear evidence of a broad-based acceleration in wages."
Yes, GDP and all that. But GDP is not an economy, nor is the unemployment rate. The fact of the unemployment rate's denominator driving the fraction is again another mystery upon which the "booming" economy has yet to solve. The sad fact of this age of activism on the part of global central banks is that economy is supposed to be wages and earned income, but has not been in quite some decades - most especially since the turn of the century.
To supplement that deficiency, the orthodox textbook unequivocally prescribes debt and credit production. The banking system that was undergoing a conversion to shadow, wholesale finance in the 1980's and 1990's was only too happy to oblige as interest rate targeting removed almost all regulatory restriction on balance sheet expansion (the real printing press of this modern age). Thus, "aggregate demand" could be filled, and GDP could rise, where wages were lagging and households growing further and further toward impoverishment.
The current mainstream thinking on the subject is relatively straight-forward sounding, in that this is simply a temporary "deleveraging" process among households and businesses (who haven't). Once that passes, and it has been declared past already several times, the economy is supposed to resume its debt-laden pace of the pre-crisis era. Fortunately, that has not happened as that would be another colossal mistake in age already littered with them. But this "re-leveraging" has not been for lack of trying, constantly and persistently as central banks all over the world have embraced "unconventional" monetarism for exactly that fashion.
The global economy took a negative turn in the early months of 2012, which was met again all over the world with yet another iteration of monetarism - the ECB had LTRO's and Draghi's open ended promise to "do whatever it takes", the Fed decided on QE 3 and then QE 4, and the PBOC added banking "capacity" of half the size of the existing US banking system. The entire world seems unified in "coordinated" central bank interventionism.
There is one notable exception among major central banks in 2015. The People's Bank of China (PBOC) took a far different turn in late 2013 that has yet to be fully appreciated by much of the rest of the world (or even inside China itself). The communist government took a look at the vast stretches of industrialized and developed wasteland created in such a short space of time, the mythical ghost cities and whatnot, and actually understood the gravity of the mistake. The PBOC had followed all the rest of the monetary world in the aftermath of the Great Recession to unleash the credit impulse and monetary agents with historic vigor, but without actual wage growth in the US none of it matters.
Without any sizable export growth, the Chinese made a conscious decision to turn away from direct monetarism lest they follow the Japanese fate. The worst-case scenario was thought to be one with huge and massive monetary bubbles and no growth, but in 2013 the Chinese found another terrifying element to the worst case: massive asset bubbles, no growth and no hope for future growth from a global renaissance.
In fact, that had been the orthodox strategy all along, from the very depths of 2008 and early 2009 the crux of all this monetary showing was easily contained in the simple, and applicably derogatory, term of "extend and pretend." Central banks would do whatever they could to push up asset prices, inflation and plain optimistic feelings in the unwavering expectation that growth would come along behind and take over the primary economic role from "loose" policy. That such "loose" policy might involve more asset bubbles and meaningful financial imbalances was a risk that monetarists, including those at the PBOC, were more than willing to accept.
There was a lot that happened in 2013 that was convincing to anyone outside blind orthodox ideology that the major expectation of growth resuming, and therefore creating enough margin for imbalances to be corrected in an orderly and determined fashion, was wholly false. At the very outset, there was that 2012 slowdown that nobody "expected" (except anyone who believed the economy was wages and not GDP), and then all manner of financial and "dollar" irregularities centered on "taper." These "anomalies" began almost as soon as QE 4's first settlement, as repo collateral became strained right out of the gate.
By March 2013, the deficiency was apparently enough that derivatives dealers began to fully reshuffle positions, especially in swaps markets, in opposition to the idea that QE was at that time "open ended." In other words, the financial plumbing problems created by QE 3 and QE 4, which were not new, began to act in a manner which counteracted how the FOMC expected QE to "work." And though Bernanke's regime was careful to that end by cleverly, so they thought, representing "forward guidance" it was totally and fully useless in the internals.
When then-Chairman Bernanke was first quoted with the word "taper", it was a credit nightmare, especially in MBS. The resulting operative changes in dealer proclivities combined with the profit realities of an historic selloff to alter the behavior of systemic liquidity in the entire, global "dollar" system. There was a fair amount of downstream carnage in currencies around the globe, which was closely followed by financial crashes and foreign bond market commotions. Whatever was done in the middle of 2013, though, has now been surpassed, by perhaps an order of magnitude, in dysfunction and financial danger in 2014 and into 2015.
That makes the PBOC's sudden and resolute commitment to "reform" downright prescient. The Chinese monetary officials saw, correctly, that orthodox cyclicality as represented by "extend and pretend" was only a recipe for dangerous monetary imbalance alone. However, they realized the predicament all too well, meaning that they were not willing to just head off in the opposite direction, pop the bubbles and be on their merry way. They would instead commit to a measured approach to "tightening" because that was (and is) the only hope.
They began 2014 by "allowing" several small defaults, including credits tangentially attached to Wealth Management Products. The intent was obvious, even in contemporary analysis, that the PBOC was probing for "market" reaction to a downside case, however small at the outset. The response was almost immediately violent, as the yuan suddenly devalued once "dollars" stopped flowing to China (it is still unrecognized and appreciated that China's corporate sector, and thus banking sector, is a large participant in the global "dollar" short as a consequence of at least trade terms since 2008). The counter response by the PBOC was couched in the mainstream as relenting of any reform impulse, but rather what they actually did was to undertake specific measures to ensure strength in only financial sectors deemed useful toward long run growth and stability.
This included something called the Pledged Supplementary Lending program (PSL) and various targeted modifications aimed at the big, regulated banks (like China Development Bank). The PBOC also seemed to "allow" unregulated "dollars" in through Hong Kong as faked invoices for commodity trade were again spotted by September and October 2014. That all seemed to have ended by November, as more bankruptcies appeared likely (and then happened) and Hong Kong grew dark in trade terms. The PBOC then cut rates (which was not a rate cut) cheering "markets" only to turn around and essentially delist more than half (half!) of all repo collateral in a massive tightening. The yuan, as you might expect, began to sharply devalue once again in participation with the rest of the world on the furious end of the dollar short (in play since June 2014).
From the standpoint of "reform" it all made sense. The PBOC was acting to again fortify the "good" parts of the system (the rate cut was a targeted measure) while at the same time trying to remove "froth" in the speculative parts (financed by repo). Instead, the Shanghai stock exchange turned nearly vertical in a euphoria that put Europe and the US to shame. Thus is the challenge the PBOC faces in trying to extricate itself from past monetarism.
Throughout all this contrary monetary experimentation in China, the economy there has fallen further (slower) than anyone imagined. Not only does that say a lot about what is driving Chinese stocks, in a commentary that is far more globally shared than most admit, it also drives home this point about "reform." The Chinese priority before 2013 was growth above all else. That has clearly been shifted as fighting bubbles is now the priority even above economic growth. That point cannot be overstated, not just in how the PBOC will operate going forward, but again about what that says about growth in the rest of the world, especially China's favored customer the United States.
The Chinese have, in their reckoning about existential dangers from their bubbles, given up on the US economy saving them from having to make that choice. To that end, the communists in China are now far more "market" oriented than all of their "free" West cousins.
The truth about recession is that it is not necessarily predicated on financial irregularities, but financial irregularities will far more often than not produce and amplify recession. That is an incongruity or asymmetry that "dollar" markets grasp and project. Ever since the middle of 2013, funding markets have essentially determined that the Fed's version of "reform" in the context of "normalization" is all but impossible. Funding market pessimism in that respect was joined on November 20, 2013, by the rest of the credit markets, but particularly the yield curve in the treasury market.
The speed and intensity to which the yield curve has flattened is matched only by periods just prior to recession. That funding markets in "dollars" have tightened to a degree far beyond even what was witnessed in 2013 is an echo of that pessimism (with some cause in funding to the effect in yield curves). And ultimately that pessimism is as the PBOC proclaims, that "reform" in the dollar context is an impossibility, and thus there is no recovery because all that monetarism creates is artificial and fleeting (at best).
That leaves the FOMC imagining the economy it wishes in direct contrast to every "dollar" and credit market in existence; a fact not lost upon some of the committee members. The only argument they can find that maintains the possibility of consistency with their economic view, which includes that admission about the continued lack of wage growth, is some mumblings about "term premiums" in TIPS. The whole of the US Treasury curve has collapsed (time premiums), eurodollar markets have dried up (just ask the Russians) and liquidity has been disruptive almost in perpetuity since mid-June (October 15 being the most stark example of liquidity problems) and the Fed's "best and brightest" refer to term premiums?
With such interbank market messes acting as a scaling agent against the monetary program, you can begin to at least understand the Fed's fixation on establishing a rate corridor like that in Europe. Throughout the second half of last year, the Open Market Desk has been running tests on its Term Deposit Facility, or what it expects to control that rate floor. If the discussion about such a rate floor sounds familiar, that is because it has been "answered" by the Reverse Repo Program (RRP) before it and the Interest On Excess Reserves (IOER) before that. Neither of those had much by way of even minor influence on enforcing a minimum interbank rate, with the RRP failing rather spectacularly between June and October 15.
The magnitude of testing on the TDF reached about $400 billion by December. Since this was an "absorption" factor, any bank bidding for acceptance was debited their reserve account, and thus the cumulative impact at the height of the test was to reduce the quantity of bank reserves domestically by $400 billion; a not insignificant sum. Nobody seemed to miss it, which only serves to highlight why the quantity of bank "reserves" has very little impact on credit, liquidity and just general financial function. But in the context of the intended rate floor, the TDF's minimal impact again shows that they don't know what they are doing - all that was mentioned in the December FOMC minutes about that $400 billion was, "these operations may help alleviate some of the volatility in short-term rates that would otherwise be expected around the year-end." Softening "some" interbank capriciousness at year-end is about as far from a rate floor as you can get and still qualify as a monetary program.
To financial credit and funding markets, another failure in this respect is just more confirmation of that year-and-a-half old pessimistic assertion about no order to an exit. These markets are perfectly clear, and you can add oil and industrial commodity prices to that as well, that there is very little expectation for economic growth and financial regularity in 2015. The two go hand in hand - a robust economy would produce robust financial function; artificial economy equals perpetually disruptive finance. That places the Fed in direct opposition from "markets", a perspective which economists have eagerly embraced especially since 2007. The Fed wishes to engineer an economy and recovery as it was in the mid-2000's, and markets are saying that such an effort is not just pointless and fruitless, and now not even likely, it is downright dangerous.
So the Federal Reserve and its central planners have set about trying to undo any market influence from "inflation expectations" or even just plain commentary about the state of the domestic economy. It is a level of disingenuousness that is quite common in a command economy, which somehow now is in sharp contrast to the admitted central planners of even Chinese communists. At least the communists there are honest and open about the economy and not so attached to monetarism as to be blind to even the smallest suggestion of failure. This is not to say that capitalism and true freedom are close to breaking out on the other side of the Pacific (and certainly not Japan, a people that just overwhelmingly voted to destroy their own economy still further via the suicide of yen instability), only that the contrast between the PBOC and the Fed is highly disheartening.
In so many ways, the Fed's fumbling focus on the rate floor is emblematic of trying to fix the wrong problem. The emphasis is always financial, and thus the economy is expected to take financial cues. It just doesn't work that way, but especially after all this monetarism these past seven years and we still don't get any wage growth. Wages are the representation of the basic building blocks of true wealth, as in the exchange of labor in the capital process. Central banks, including now a much lesser extent via the PBOC, want to build nothing but credit and so everything is designed to that end. That even credit markets, driven in no small part by banks themselves, the very agents the Fed is counting on to deliver its vision, are so comprehensively rejecting the effort is more than revealing.
