The Recovery Fantasy Has Officially Been Put Out of Mind
During the middle 2000’s when Alan Greenspan’s Fed endeavored to change the outward monetary policy stance to “tightening”, it was not unusual for some divergences to have emerged. One of those was between the federal funds rates, either target or effective, and Treasury bill equivalent yields. Under a hierarchical system, this was not unexpected or alarming except as when the distance between them became unusually large (2006). Federal funds are unsecured interbank transactions whereas Treasury bills are near equivalent to them except secured by lending cash to the federal government. One would expect bill rates to be some degree less than federal funds.
And so they are again in 2017 as the Fed embarks on another so-called tightening regime. This time, unlike 2004 to 2006, there is a corridor in place rather than a singular federal funds target. In this evolved arrangement, at the floor of that corridor sits the reverse repo (RRP) rate. Conceptually, the RRP is no different than any other repo except that you lend cash to the Federal Reserve (“reverse” denotes the perspective of the Fed). As a secured transaction, your cash is given UST collateral drawn from the enormous expanse of securities obtained by the product of the QE’s, there should be no reason why any market participant would lend cash at any rate less than it.
Yet, that has been the case on many occasions. Just last week in the shadow of a third “rate hike” that raised the RRP “floor” to 75 bps, the 4-week treasury bill yielded all of 68 bps. Last Friday, the 4-week bill rate was 71 bps, while the 3-month bill showed 73 bps. The GC repo rate calculated by DTCC for UST collateral has been since late last week hugging the RRP rate, but on several occasions in February it, too, was below the RRP rate and in one instance in mid-January above IOER.
Had this bill trading been taking place in the second half of 2004, it would warrant no mention at all. The fact of the RRP placement makes it an entirely different regime, and therefore calls our attention to it. In noting this, however, it is natural to try to categorize these conditions as either overly “loose” or overly “tight.” And while we may at times derive some benefit from the parsing, in truth it is more beneficial to simply call it unstable.
Markets, of course, are never stable at least insofar as they might exhibit something more like stasis. Therefore, we must define our terms, which is ironic because it is terms that are the problem. Unstable refers in this case to the breakdown of clear hierarchy, where the bill rate settles in expected ways to the rest of the overall regime. Rarely, for example, was the GC rate above the federal funds rates (again, target as well as effective) because why would it be? Secured transactions should cost less than unsecured. In any such instance where that hierarchy failed there would be dealers taking advantage of that miscasting imbalance so as to in short order bring it back in line.
Yet, in the history of the post-crisis era there has been no intrusion of monetary benevolence to accomplish order. As early as May 2010, the GC UST repo rate suddenly moved significantly above the effective federal funds rate and remained that way until February 2011. That QE2 occurred in between suggests not how the disparity was resolved but rather that the Federal Reserve noticed it, among others, and reacted in what it believed forceful fashion. Yet, only a few months later, among the FOMC’s emergency topics for discussion in early August that year, policymakers were considering what would have amounted to a bailout of the repo market. Why?
They never did the bailout, of course, and for several years after the 2011 crisis the repo rate behaved itself with respect to effective federal funds. That all changed again on October 15, 2014, a date which officially was all about computer trading and nothing more. Around the same time, interest rate swap prices began to fall particularly at the long end with respect to UST yields of equivalent maturities. Cross currency basis swaps began also to stray, deepening negative premiums that could enrich anyone with spare “dollars” – the very dealers who are supposed to be in there every day enforcing hierarchy but so clearly haven’t been and aren’t now.
We have been transformed from a hierarchical system where the paradigm was stable in that its definitions were clearly defined and far more often than not adhered to, becoming instead something…different. It is more a relativistic system that authorities have tried to characterize as “just the way it is now.” We might be tempted to follow their ignorant bliss if it was not for the nontrivial matter of how the last ten years have actually unfolded, and the enormous costs already paid in the incomprehensible reduction of economy.
Again, I find it quite unhelpful to describe the global money system at any one time as either highly liquid or highly illiquid (recognizing and fully admitting I am as guilty of the error as anyone). It is a shorthand tendency that in the long run obscures the fuller nature of the problem. After all, one could easily have claimed the domestic monetary system in late 2008 was overly liquid, described by a federal funds rate way below its target, and that would have been in agreement with the official policy position that attempted numerous times to “drain” reserves. Such a depiction, however, would have been just as wrong as demonstrated better by the events of the time.
Instead, clarifying the overly “liquid” conditions in federal funds throughout 2007 and 2008 by LIBOR and other indications (like the 30-year swap spread in late 2008) would be more properly acknowledged as a highly unstable monetary system through the means of deprived hierarchy. The panic and the resulting economic contraction were in perfect keeping with such a state.
Viewing the monetary system as chronically unsound has the effect of bringing up historical precedence, especially those of past depressions. It has become popularly confused about exactly what a depression is or was in the past. We are drawn by purposeful convention to the year 1929 and its immediate aftermath for any and all parallels, but in truth contraction is merely a part of the dynamic and in most other cases not even the most important one. What made the Great Depression was both its catastrophic downturn while also the lack of recovery following it; the 1920-21 Depression, by contrast, was nearly as severe in its contraction but left no lingering impression beyond the downturn.
Before the 1930’s, the name Great Depression was given to the later 19thcentury in the US but more so Europe. It remains to this day a controversial and argued subject, largely because it has become embroiled in political considerations as much as economic ones. As Milton Friedman and Anna Schwartz wrote in A Monetary History:
“Though declining prices did not prevent a rapid rise in real income over the period as a whole, they gave rise to serious economic and social problems. The price declines affected different groups unevenly and introduced additional elements of uncertainty into the economic scene to which adjustment was necessary.”
The Long Depression, as it is sometimes called, is often filtered through the lens of gold, and therefore becomes a hotly contested debate about the gold standard rather than the history surrounding it. What we do know is that prices did decline and that contemporary accounts claim it was a period of great economic dissatisfaction. We also know that gold played a role in both.
It is a reflection of the difficulty in reconstructing what happened in the disagreement not just over whether there was a depression but more so when it might have begun or ended. It is traditionally believed to have started in 1873, but there is considerable disagreement even among economists who believe it was a depression as to when (or how) it terminated. In the United States, the year 1896 is commonly cited as the endpoint for that was when economic estimates uniformly suggested a great and sustained upturn from that year forward.
Using 1896 as the ending date is also ironic in that it was the election of William McKinley that ultimately settled the monetary debate of the era – the US would be committed fully to the gold standard and only the gold standard. It has been proposed that the US’ return to the gold standard after the Civil War (the “Crime of 1873” referred to the Coinage Act of 1873 which purposefully omitted silver dollars, effectively demonetizing silver) and the resulting deflation are what caused the Long Depression and made it last. Again, there is no debate that in general prices declined but for those who suggest there was such a thing they, like Milton Friedman in the quote above, have to square falling prices with rising output and national income (at times rapidly rising).
I believe the focus on the gold standard is misplaced, for what mattered was not that it was re-imposed but more so how. The Crime of 1873 began what was known as “silver agitation” where politics kept bimetallism alive but in a state uncertain until McKinley’s defeat of WJ Bryan finally settled all matters. And it was not just the United States where this was an enormous conflict.
In Germany, for example, the new German state was an agglomeration of separate smaller principalities that were not uniformly conditioned (money as well as culturally). At the conclusion of the Franco-Prussian War, on November 23, 1871, Otto von Bismarck forced French war reparations purposefully in gold. That effectively set in motion what would become in July 1873 the Imperial German goldmark. Many of the former independent German states had operated exclusively in silver, and not just in silver but also on a fractional system (referring to denominations).
Before Germany’s shift to gold, several other European countries had in 1865 formed the Latin Monetary Union. France, Belgium, Italy, and Switzerland, joined in 1867 by Greece, tried what was a forerunner of both the EU as well as the euro, but on a bimetallic standard of fixed silver to gold. In January 1874, the LMU was forced to suspend silver convertibility due to the worldwide collapse in the price of silver. Silver minting was abandoned completely by 1878.
The collapse of the LMU was indicative of the troubles currently experienced with the euro. Specifically, countries would print banknotes supposedly backed by either gold or silver though far above what the individual country (or bank) held as its reserves; meaning that paper notes were issued in greater quantities in some places expecting that prudent reserves of other places would be left to pay them off.
It was in many parts of the world a very messy period. Though much of it had been put on the gold standard, and the classical gold standard, that was not the full extent of the story. For years and decades, monetary uncertainty largely related to silver but also with various forms of paper (including Greenbacks) prevailed. There was as much experiment and evolution then as what took place a century later. Though the gold standard is supposed to be the very exemplar of stability, and it can be, the politics of the time made it anything but.
That point seems to be reflected in the economy of the time. Whether US, UK, Germany or whoever else, what you find almost in synchronized fashion is that before the 1870’s economic growth was highly stable – almost a Great Moderation of its own age. From the early 1870’s until the later 1890’s, economic growth happened but was suddenly and hugely uneven, often interrupted by these sharp contractions that would trace to banking panics derived from some form and degree of monetary imbalance.
Only a few months into what would become the Panic of 1893, bringing with it the second great contraction in the US of the Long Depression, President Grover Cleveland said:
“At times like the present, when the evils of unsound finance threaten us, the speculator may anticipate a harvest gathered from the misfortune of others, the capitalist may protect himself by hoarding or may even find profit in the fluctuations of values; but the wage earner - the first to be injured by a depreciated currency and the last to receive the benefit of its correction - is practically defenseless.”
Indeed, some estimates put the unemployment rate at 3% in 1892 but 18.5% by 1984. But what Cleveland said was not merely applicable to that one cycle, or even how that single cycle might situate in the Long Depression. It is a timeless stamp of monetary instability. The symptoms of that are easily identifiable, as are its burdens. And in his address on the repeal of the Sherman Silver Act that year, President Cleveland, a Democrat but not a populist one like Bryan (in those days populism at least in the US meant for government intervention in money through silver, the agitation), further said:
“The people of the United States are entitled to a sound and stable currency and to money recognized as such on every exchange and in every market of the world. Their government has no right to injure them by financial experiments opposed to the policy and practice of other civilized states, nor is it justified in permitting an exaggerated and unreasonable reliance on our national strength and ability to jeopardize the soundness of the people’s money.”
It would be, again, left to McKinley, a Republican, to act out what Cleveland proposed against Bryan’s silver platform of 1896. Only then did the Long Depression end in the US, though it may have continued until, and contributed toward, World War I elsewhere.
The primary condition of the global economy in the 2010’s can be characterized as a combination of President Cleveland’s assertions and the recreated content of the Long Depression. We have witnessed over the past decade an unusual increase in volatility, including market volatility, in sharp contrast to the preceding period which a great many economists claimed as a Great “Moderation.” This is the economy of one step forward, two steps back, or even at times one step forward and one step back. It lurches between periods of what look like might be growth again and periods that will never be confused that way.
The differences between them are punctuated by these eruptions in global monetary deformation, those further classified by the obvious lack of hierarchy and therefore dealer capacity. The eurodollar system “broke” in August 2007, creating an initial contraction in early 2008 but one that was believed by many over with by summer 2008; only to have that cautious rebound, as policymakers were claiming, rudely interrupted by more monetary instability that September leading to the great collapse at year’s end and to start 2009.
And so it has gone in the years since then; “dollar” problems in 2010 and 2011, leading to worldwide slowdown in 2012 (with some places, notably Europe, relapsing into full-blown recession). The next great money problem grew out of the middle of 2013 so as to be manifested more completely in 2014. I wrote in March 2014, three years ago this week, what it was and what it meant in the form of China’s currency:
“What all this data shows, as opposed to conjecture about the supernatural powers of central banks, is that yuan’s devaluation may be directly tied to dollar shortages. In fact, as I argue here, it is far more plausible that a dollar shortage (showing up as a rising dollar, or depreciating yuan) is forcing the PBOC to allow a wider band in order that Chinese banks can more “aggressively” obtain dollars they desperately need. Worse than that, the PBOC itself cannot meet that need with its own “reserve” actions without further upsetting the entire fragile system.”
Again, the imprecision of the language is palpable in the wider context of this review. It may be the case of an actual “shortage”, as that is surely what it seems to be in any number of ways. However, in the form of a virtual currency where there is no thing that might be audited and physically tallied, it is more precise to classify it all as a grave, threatening “dollar” instability.
For the global economy, the “rising dollar” would bring down the last of the orthodox expectations for recovery, such were its proportions and final implications. At the start of it, the Fed was worried about “overheating” and a high pace for its “liftoff”; by its end, if it has actually ended, the Fed was quietly bowing out of monetary policy in recognition there would be no overheating at all and therefore no recovery. The global economy had in 2015 and early 2016 taken another big step back (or two), leaving no longer any doubt that the Great “Recession” was a full rupture rather than a recession.
The race among central bankers is on to figure out why, though in reality it had already started ten years ago with no special powers required to figure out; only enough sense not to be completely captured in the ideology of Economics.
Eruptions in monetary instability have thus been always followed by economic recidivism, and on a global scale. The resulting condition is very much like how Milton Friedman described the Long Depression, where output can be growing and at record highs yet what has resulted from it has been more like what President Cleveland lamented especially with regard to labor. If there has been one consistent feature of this era, apart from monetary instability, it is the sudden lack of labor utilization, a deficiency from which so-called safety nets have only been partially successful in mitigating. Unlike the latter 19th century, the periods in between these monetary disruptions feature no rapid growth at all, leaving the global economy to languish with unstable slow growth, where each reinforces over time the other. The T-bill rate matters today in a way it didn’t ten years ago.
It may be now that officially the recovery fantasy has been put out of mind that in some years distance the current age will become the resurrected argument of the Long Depression. And why not? With things as they are now even after ten years there is no sign of stability anywhere on the horizon; no McKinley’s on the R side to put into action the commitment of the Cleveland’s on the D side. We are stuck only with WJ Bryan’s on all sides, experimenting with a system they don’t understand or recognize. History never does repeat, but boy does it sometimes rhyme, right down to the perfect pace and inflections.
