In 2016, Central Banks Quietly Surrendered
Perhaps in some distant future history textbook looking back on our time, the year 2016 will be remembered and classified as the one where central banks surrendered. There will not be, like Ghent or Versailles, a formal declaration of reality, rather what is going on is the quiet sort of resignation that is some parts trying to make sense of everything gone wrong, while others tend to full CYA mode. Make no mistake, however, in their literature, discussions, and even policy settings it is there.
The latest was the ECB's "shock" decision yesterday to preannounce a taper to its QE. From a pace of €80 billion per month, the program starting April 2017, just beyond its second anniversary, will be slowed to €60 billion. To offset any "market" disdain for the decision, the Governing Council decided to extend the duration of the policy a little while longer, so that over time while it may be relatively slower it will end up relatively larger. This is the game central bankers will often play.
We are told that markets are disappointed by the move, and several traded indications might register such disapproval. I rather think it more helpful that at this late stage we define all our terms all over again. For example, one year ago the ECB "disappointed" markets by delivering more "stimulus" in the form of rate cuts to its money corridor but apparently not the rumored acceleration in QE that the ECB had in the months before failed to deny. As economist Stewart Robinson told the Guardian newspaper in the UK last December 3, "If it [the ECB] had said nothing (in October) and delivered this today, the market reaction would have been very different."
That's a very strange take, in my opinion, because what markets should want is an end to all stimulus, real and the more prevalent imagined kind, everywhere and for a very, very long time. The fact that central banks have felt it necessary to do more, then more, and then still some more is a negative commentary on both stimulus as a concept and the conditions with which those concepts are being applied. When the Federal Reserve in November 2010 undertook a second QE, for example, it was not something to be cheered as it was at the very least conditional admission of defeat for the first one.
In an August 2013 speech to a regional Chamber of Commerce in East Midlands, UK, Bank of England Governor Mark Carney told the assembled audience his tale of optimism and reborn hope. The topic of his discussion was titled, after all, Crossing the Threshold To Recovery, so it would have been very noteworthy had it been populated instead by persistent anecdotes of doom and gloom. Instead, it was forgotten because of all the ways in which it was usual, normal, even, for that time. There was little about the summer of 2013 that central bankers didn't view as so favorable, easily shrugging off all sorts of "overseas" currency (meaning funding, in "dollars") distress and even, as today, a great bond selloff.
"What I hear from businesses here and elsewhere is that a renewed recovery is taking hold amid a rising tide of optimism. The signs are that this recovery is broad based and set to continue. This is welcome and should be encouraged."
The job of England's central bank, as he saw it then, was, "to secure the fledgling recovery, to allow it to develop into a period of sustained and robust growth." To do so, he pledged, as the ECB is in kind pledging today, that monetary policy would remain "accommodative" until there was no doubt left that the fledgling recovery had bloomed in full.
Speaking earlier this week in Liverpool, Carney now says that the whole world is facing its "first lost decade since the 1860's." The problem, or at least one of them, is what he says is how, "Weak income growth has focused growing attention on its distribution." The target of populist ire because of that is globalization as a general concept. He may not be wrong in that claim given the last three major elections, Brexit, Trump, and now Italy, have all included serious elements of rejecting the economy as it is by connecting it to its development over the past two, three, maybe four decades.
To economists and policymakers (redundant) like Carney and Draghi, there is a logical fallacy behind this populism. They see it as incorrect ex hoc ergo propter hoc, where the aggrieved population confuses correlation for causation; in this case, the "weak income growth" being believed a result of globalizing economic forces. Economists claim that there are other factors that need first consideration and study, but what they less highlight is that popular grievances are now suddenly being taken seriously. Someone once said that elections have consequences, and in this case, for once, those consequences are reaching the heretofore impenetrable Ivory Towers of central banks and Economics (capital "E").
That is what has changed between Carney's August 2013 speech and his December 2016 global "lost decade" declaration. In 2013, as 2015 or 2009, economists refused any word to describe the economy except "recovery." Any legitimate criticism was met with either "green shoots" rhetoric, or, as the numbers that had to be attached to each and every QE program everywhere in the world show, some form of downplaying it as easily handled by (further) adjustments in monetary policy "stimulus." At no point was there anything more than faux considerations for what is now being broadly accepted as reality.
When central bankers talked about "exit strategies" in the early days after the Great "Recession" they did so in shorthand because everyone including the least attentive layperson understood what the word "recovery" meant. If the Fed had instituted QE and ZIRP in late 2008/early 2009 as a means of stimulus, then they were meant simultaneously to have softened the downside while, as Carney described of the BOE in 2013, accommodated the forming rebound. At the end of QE and ZIRP was supposed to have been an economy that looked like 2006, minus the housing bubble which would have been helpfully excised by the 2008 panic. The word normalization in monetary policy was meant to be literal, as parallel to the economy monetary policy is supposed to represent and guide.
Thus, the second QE in 2010 was a warning however one chose to take it; for many, myself included, it was early evidence that QE wasn't what it was widely believed to be; for others, primarily economists and central bankers, it meant that "stimulus" just needed more time and boost. Whichever way you chose, it still amounted to a setback. But there were only to be setbacks time and again, year after year. For every "green shoot" or "fledgling recovery" was met by crisis, illiquidity, "dollars."
Because of that, the word "recovery" has now taken on a very different meaning than what many people still assume. In monetary policy terms, it's not as much a personal concept as it is broken down as technical conditions. Orthodox policy still operates on many levels with the Phillips Curve embedded. Central bankers see their task filtered by the tradeoff between inflation and unemployment; though, as they would claim, with much more nuance and complexity beyond the disastrous experiments with policy based on it in the 1960's that produced the Great Inflation. In very general terms, their job is to define recovery as the best set of circumstances where inflation and unemployment are balanced.
That task is guided by monetary neutrality, which is the belief that monetary policy doesn't determine the long run trajectory of the economy; money is neutral to potential. The potential economy, called "trend", is fashioned from innovation, demographics, and capitalism's secret sauce combining all of it. In the 1930's, standing within the pit of the global Great Depression, economist Alvin Hansen coined the phrase "secular stagnation" due to the US economy, in particular, referencing none of the three expansions that he suggested were its basis during the rapid years of the 19th century: 1. Territorial expansion; 2. Population Expansion; 3. Technological Innovation (Expansion).
For Hansen, because the US economy in the 1930's was in his estimation exhausted of all three, "stimulus" was in many ways just wasted effort for a baseline trend going nowhere. The Great Depression was not a single event, but to Hansen just the opening act.
Many economists today are thinking again in Hansen's terms, even where they don't explicitly take the full range of them. Demographics is the current bogeyman that has the most plausibility attached to it because it is at least moving in the right direction in order to be consistent with, again, reality rather than recovery. This is what was just a little while ago referenced as nothing more than "headwinds." In 2016, they are now given far greater emphasis, and not by choice.
If the Federal Reserve targets 2% inflation and that rate of inflation results when unemployment is at 5%, then that to the Fed is recovery and the goal of its policies. If 2% inflation results where unemployment is 10%, then "recovery" is not a straightforward concept. If 2% inflation shows up when unemployment is 5%, but only because the denominator of that statistic has been denied millions of people, perhaps as many as 10 or 12 million as it is now in the US, then there are very serious problems. But what if the unemployment rate is 5% because of those missing millions at the same time inflation can't even get to 2% despite five years with trillions in balance sheet expansion?
That is, in a nutshell, the past few years, attempting to make normal out of that which left normal behind long, long ago. Central banks have tried to define recovery on these terms, but these terms just don't fit past criteria. Up until this year, it was believed that the uptrend of the economy in all these places would bring those "missing", and not just Americans, out from the shadows and back into the labor force, thus creating more "demand" that becomes self-feeding and especially self-reinforcing well past any "fledgling" stages. Yet, the participation rate remains as low today as it was in the middle of 2014, half a percent less than it was when Mark Carney spoke in August 2013, and nearly two percentage points less than the official end of the Great "Recession" seven and almost one half years ago.
Carney should not be worried about a lost decade, as we have already just about completed one. And it is this condition to which monetary policy is now at long last being "normalized" to. If you believe that 2% inflation and a true 5% unemployment rate represents the right balance for the right economy, that is where you stop. If you believe that 2% inflation and a questionable 5% unemployment rate shows up, you might continue with "stimulus" in the belief that those questions will be answered with enough time and accommodation. If the 5% unemployment rate instead remains highly questionable no matter what, then monetary neutrality demands that you start to accept that that is just the way it is (I am using US numbers here in these examples, they are different, obviously, with different variations and mixes in other places).
This is the point upon which central banks are in 2016 surrendering. They have fought valiantly, in their estimations, and have been defeated by forces far beyond their control or ability to affect, leaving many to now ponder whether Alvin Hansen, or the concepts he brought up, was right to some extent. There is recovery in this view and unfortunately we are already it. Therefore, central bankers rush to defend globalization because it is in this view not the cause of the lost decade, it is instead related to some blend of trend forces nobody really understands or can identify beyond generalizations.
As if to perfectly underscore all of these points, Gallup released the results of an extensive study this week commissioned by the US Council on Competitiveness. What Gallup's statisticians found was of no surprise to the surrendering central banks, and perfectly expected by those who saw the second QE as not short of time but short of everything else. Titled No Recovery, the study issues no ambiguity. Gallup's CEO Jim Clifton writes in the introduction:
"Conventional wisdom - as reported in many major newspapers and media- tells us the U.S. economy is "recovering." Well-meaning economists, academics and government ofﬁcials use the term "recovery" when discussing the economy, implying that growth is getting stronger.
"The study ﬁnds there is no recovery. Since 2007, U.S. GDP per capita growth has been 1%."
I have no doubt that his statistics are correct, as they are representing not just the economy in the US but also the global economy that has in just the past five months produced nothing but "wrong" (from the established perspective) election results. I believe his framing of them is dated and surpassed in official capacity by the events of the last half of 2016, where "well-meaning economists, academics, and government officials" will be using the term "recovery" in vastly different fashion from how it was used just last year. Even the Federal Reserve, which in all likelihood will "raise rates" for a second time next week, is not doing so because it sees the recovery of 2009 but rather because it defines the 5% unemployment rate coupled to the intractable participation problem as the concluded end of its mandate no matter what.
Janet Yellen wondered out loud in a speech in October what it might mean now that the FOMC is just hoping, not any longer certain, that they will be able to get the federal funds rate up to 3% at most sometime before the next decade. That is far from "normal" and it would perfectly represent an economy that is to stay that way.
I call that a depression, but doing so often leads to very emotional responses. After all, when envisioning depression, most people go right to the crash part and think little or nothing of what follows it. A depression after the crash might still see growth, but it is not growth in the same way it was before the event. A recession is a temporary deviation in the economy, but one that remains true to the prior trend, meaning potential. Output falls sharply, rebounds just as sharply (symmetry), and then slows when output meets potential all over again (the 2% inflation, 5% unemployment goal). A depression is where all that goes away and what is left are only questions of the sort Alvin Hansen once asked. Again, that doesn't mean there won't be growth, it's just "growth" rather than growth that leaves a rising tide of populism in the wake of a lost decade full of positive GDP and lower unemployment rates.
The surrender of central banks on this point, though they will never, ever call it what it is, is very significant. I believe that one of the interpretations of all this from the "market" perspective is that there has been a belief going back to July and the Bank of Japan "helicopter" rumors that finally this official admission that QE didn't work would lead to the next set of "stimulus" which would then produce the full recovery and normalization that the last set based on balance sheet expansion did not. This expectation or just hope, in my view, is what has been underwriting this "reflation" dream that has swept the world of late (it should be noted, however, that though reflation has been intense, it is, importantly, to this point still far less intense than the last time in the middle of 2013).
The primary danger to it is not that central banks might disappoint in that next round of "stimulus", but rather that there won't be a next round at all. There appears to be a pervasive belief that markets, or certain ones or even certain parts of them, are still expecting recovery as it once meant, craving only the right polices that will deliver it from out of the resurrected legends of past myths where geniuses inside central banks can and will think them up. But secular stagnation wasn't a temporary and wrong academic infatuation, it has become instead a growing means from inside orthodox circles by which to explain how the whole world could have lost a decade despite their genius efforts. That is the salient point not just being discussed but being acted out right now! Even economist authorities are accepting that the decade was lost and in all great likelihood means for us a vastly different future.
The more proper time to ask "why" would have been when there was a second QE in the US, concurrent to other forms of "stimulus" in Europe. The best time for this kind of full examination would have been at least during the panic in 2008, if not June 2003 when Alan Greenspan challenged the assembled FOMC committee to really think long and hard as to whether they really could do everything they thought they could do. As he asked of them more than thirteen years ago:
"What is useful, as has been discussed, is to build up our general knowledge so that when we are confronted with the need to respond with a twenty-minute lead time-which may be all the time we will have-we have enough background understanding to enable us to make informed decisions. We need to know how the system tends to work to be able to make the necessary judgments without asking one of our skilled technical practitioners to go off and run three correlations between X, Y, and Z."
That is, to their shame, exactly what happened and not just in 2008. The QE's themselves, in all their iterations, were ad hoc programs that belie the notion of the term used as their label; there was nothing quantitative about them, apart from the number being pulled out of some rushed, last minute correlation of X, Y, and Z.
That indictment applies far more broadly than just as failed stimulus. It used to be common knowledge that depression was born from money, or at least contraction in money. The whole point of the Federal Reserve in 1913 was to be able to avoid the bank panics like that of 1907, but more so like 1893 and what resulted from it that long ago first took the term Great Depression. Even the 1930's Great Depression was at root money and debt. It isn't an intuitive leap to realize that if QE wasn't stimulus, it might not have been money, either. In fact, if it wasn't money, then it could never have been stimulus.
For the Gallup study, the question of why was left a question. In place of an answer was just a catalog of all the various orthodox critiques that are owed to preserving monetary neutrality at the expense of a lost decade. The study's second chapter is titled asking the only question that has been worth asking, Why Is Growth Down?, but leaving it still a mystery without once referencing money, let alone eurodollars.
Recovery used to mean recovery, now it is synonymous with a lost decade and no longer just among the purported fever swamps of the contrarians. After assuring the entire world starting in 2007 that there wouldn't be panic and great dislocation in the global economy, already calling into question their knowledge and proficiency surrounding monetary affairs, central bankers and economists then spent the balance of the next seven years pledging full reclamation. And now in a technical trick of semantics and subjective interpretation, they still suggest recovery but one that is defined instead by rising social disorder, political upset, and the ECB tapering QE not because it worked but because they have come to realize in all probability it never will.