We Know Where More of the Same From Central Bankers Leads
If there was some small entertaining distraction from the gathering events in 2014, it was watching economists try to explain bond yields. Economists don’t get bonds; they never have, not for lack of trying. Since the media defers to economists on finance as well as economy, when it has been proven it should defer to them in neither case (economists are statisticians and little more), the vast bond market goes about its business incomplete in the market service it more fully provides.
Expectations were established very early on that year. It may not be memorable now, but the big thing was Ben Bernanke’s retirement from the Fed and ultimately the transfer to Janet Yellen. Like Presidents, the Fed Chairman is often viewed as a lightning rod, for both good and bad. We are told, incessantly, that markets don’t like disruption, so Yellen’s takeover was set in the media under those terms.
In her first major policy event, the FOMC press conference following the March 2014 meeting, she made what appeared to have been a rookie mistake. Speaking perhaps too plainly, the new Chairman let it slip that policymakers were thinking of a six month window for when they might begin to “raise rates” after ending the last of QE expansion.
The arithmetic was therefore suddenly easy; everyone could calculate that QE would be done by December 2014 if not before should the Fed continue to gain confidence. That would mean early 2015 for the “exit” procedures to start, mid-2015 at the very latest.
For Treasury bonds it was believed written in stone. With “rate hikes” clearly in sight, interest rates had nowhere to go but up.
Except that they didn’t. Bond yields, on governments and quality corporates anyway, spent the balance of that year plus all of the next falling. Economists were appalled. How could such a vast marketplace, spanning the entire globe, be so stupid?
By that December, however, it was policymakers and not bond investors who were becoming less confident. They had to explain an unexplained “buying panic” in the Treasury market (which they didn’t), growing turmoil overseas in currency markets, the Russian ruble in particular at that moment, and then a sharp crash in oil prices which outwardly if awkwardly officials tried nervously to welcome (it was supposed to have been due to a “supply glut” that would greatly benefit consumers).
The FOMC responded to such widespread and “unexpected” turmoil by changing the wording of its policy statement however subtly about when it might actually begin what appeared less than nine months before a foregone conclusion. “The committee judges that it can be patient in beginning to normalize the stance of monetary policy” was the new added phrase, quickly followed by the hollow reassurance that it “sees this guidance as consistent with the previous statement.” Everyone knew that it wasn’t.
To offer further encouragement, Janet Yellen at that press conference addressed the Russian situation. She declared first that falling oil prices were “certainly good” at least for workers and their household budgets, and that any exposure here to turmoil in Russia was “actually relatively small.” Like bond yields, her arrow of causation was backward in that instance, too.
The problem for Russia at that moment, indeed Switzerland or China, was not that our exposure to them was small but that their exposure to “us” was enormous. It did not come about through economic channels, either, at least not directly. The real issue was clearly monetary, and if it was spreading all over the global it could be nothing other than the “dollar.” If falling bond yields weren’t enough of a clue, then the oil price crash and clear currency chaos should have been.
But Economics is not a science. Though markets are imperfect observations of what is happening in places that will never be observable, they are the most robust evidence of conditions, the closest to science that economics may ever hope to achieve.
Time and again, however, policymakers have chosen their own views at the expense of helpful market data that would have shown them beforehand to be wrong. This has been, in fact, repeatedly tested (starting all the way back in early 2007 when the FOMC disdainfully declared the eurodollar futures market to be similarly erroneous when it wasn’t).
For central bankers and monetary policy, the way they believe it all works is for them to set future expectations and for the conditions that arise from those expectations to further confirm them (rational expectations theory). They reduced rates (ZIRP) and did a bunch of what they believed was money printing (QE), all theoretically which should have had the effect of raising inflation expectations out there in the real economy far from prying eyes.
That is what Chairman Yellen was still focused on in December 2014. The New York Times helpfully characterized her thought process in an article from that time summarizing her statements.
“They [policymakers] believe expectations about future inflation, and labor market slack, both exert a powerful influence over the actual pace of inflation. Surveys show little change in expectations and so, as the labor market continues to tighten, Ms. Yellen and other Fed officials expect that inflation will increase.”
It would also be consistent with higher interest rates and Treasury yields. More inflation, in the form of expectations, should have translated into interest rates have nowhere to go but up. But as they instead fell lower, rather than heeding the message, these Economists set about to trying to explain in some manner that wasn’t blatantly contradictory.
Most prominent among these efforts was former Chairman Ben Bernanke, who one year into his retirement took to his blog at Brookings to attempt to shed some comforting light on how lower yields could be still positive. It was a ridiculous effort (if the best you have is questionable term premiums, you have nothing) that reeked of desperation at the time, and has aged even more poorly since it was written.
The economic problems of these mistakes are well-worn by now. There was actually a near recession here in the US where only recovery and accelerating growth was predicted. The unemployment rate has only fallen further, but only because few Americans have joined the labor force (leaving some 15 or 16 million of them fallen out of the statistic but not out of the economy) for those real economic conditions. There has been neither wage inflation, nor price inflation in the calculated rates (with recent labor data on wages and employer costs suggesting not an end to slack but its clear persistence).
And yet, for all of this and all of the same that happens in repeating fashion, economists continue to be held up as exemplars of knowledge about economy and finance. They can’t get bonds right, which is no small thing for a central banker and money, but still they write all the narratives. Americans have noticed how these predictions always fail.
To one side, they have furthered the mistrust of institutions and this professional class. To the other, the embrace of socialism has skyrocketed here in the US. What’s most distressing about economists is not their impotence in monetary conditions, which they have empirically established, but their charge of the narrative. Not only are they still afforded respect no matter how much it becomes unearned, they are so often described as the ideal capitalists.
The message therefore being sent far and wide is not just that capitalism has failed but also that its high practitioners have no idea how or why. The people who are supposed to defend the system are those who can’t ever get it working and often refuse to even acknowledge that it might not be. They have called a depression a recovery for ten years, no matter how many millennials it has left in the modern breadlines of their parents’ basement.
The tone deafness of their misplaced confidence could not be more devastating in some quarters. To the disaffected, can they not be forgiven for believing the whole system is wrong?
A survey conducted in March by the American Culture and Faith Institute suggested that 40% of all Americans now prefer socialism to capitalism. That’s bad enough on its own, but what makes it worse is that many of those in the other 60% can’t comprehend why they might be in the shrinking majority. Instead of looking honestly at the economy for the most obvious reason, they have been told by economists not to bother because it is doing fine (thus the “rate hikes”).
We have seen it elsewhere, too. The Mayor of New York City, Bill de Blasio, told New York Magazine not that long ago private property was for him a huge problem.
“What’s been hardest is the way our legal system is structured to favor private property. I think people all over this city, of every background, would like to have the city government be able to determine which building goes where, how high it will be, who gets to live in it, what the rent will be. I think there’s a socialistic impulse, which I hear every day, in every kind of community, that they would like things to be planned in accordance to their needs.”
That last bit should be utterly terrifying, for it is straight out of Marx. Most people have never read a single word the man actually wrote, but understand intuitively what Marxism represents. One phrase he did write was, “from each according to his ability, to each according to his needs.”
For de Blasio, this is nothing new. The man like last year’s Democrat runner up Bernie Sanders is a known and avowed socialist. For him to make such a statement is unsurprising; for him to suggest that it is well received in the community is in this day and age very likely more than the usual blustery rhetoric.
It used to be called political economy for a reason. The real danger to the American system is not strictly GDP at $18 trillion rather than the $22 trillion it would otherwise had been if the Great “Recession” had actually been a recession. What’s missing is more than the $4 trillion in diminished output, it is the ability to credibly (to a larger audience) claim capitalism is the only answer. It is leaving too many people behind and giving these same people all the wrong ideas about what it really is (those markets telling central bank socialists what is wrong and what to do about it), and what it truly is not (a small group of regression specialists ignoring them).
So long, however, as free markets remain at the core of this system, no matter how much it may have been buried by decades of incompetence and more so misconceptions, an answer is possible. Scientists (real ones, not economists) are always surprised by how life itself seems able to find a way to survive and flourish even in the most hostile of environments. Free market answers are likewise so flexible, fluid, and potentially robust.
If the problem has been the global money system, ten years later there are any number of monetary solutions being studied, tested, and offered right now. Cryptocurrencies like Bitcoin are rising not because they are a funny little geeky modernity, but because deep down people know intuitively what is wrong. It’s not difficult to figure out that if Janet Yellen is full of it, then in all likelihood so is everything the Federal Reserve does. You need not know a single thing about rational expectations theory or the role of QE in the TBA (MBS) market to suspect as much.
In money terms, most if not all people don’t really care too much and that is totally understandable. In truth, we should spend very little time analyzing or theorizing on the topic. The best systems are those that are simple; by that I don’t mean they can’t be complex, rather, even in complexity the terms of it are understandable and honest.
Convenience in money has won the argument. We would rather be able to purchase what we want when we want using a debit or credit card right on the spot; and there is nothing really wrong with that. We don’t give it a moment’s thought about how that actually works. I suspect the majority of people in the world still believe that those balances tied to whatever form of plastic are still today like they were fifty or a hundred years ago (thanks to Economics in what little education is offered).
Does it matter that when you use a credit card, for example, the financial resources allowing you to do so are some complex ABS trust structure? Yes. These used to be totally off-balance sheet, of course, but even though they are now placed on one it still matters how they are structured. The expansion or contraction of offered credit, and the systemic liquidity required to let those happen, is all governed by a modern form of money unrecognizable to tradition.
The amount of actual currency or cash in a particular bank’s vault is immaterial to anything other than the behavior of its depositors. That bank’s operations are governed by other parameters, starting with this “liquidity.” Depositors might tomorrow descend as a hoard on this bank and withdraw it dry of cash, but it will still be in business the day after that and with new sources of cash to draw on – so long as it can meet the requirements of this new money system.
Should it experience a loss of deposits, it might replace those liabilities with something like repo or currency swaps. If the assets it holds are acceptable as collateral in sufficient volume, the level of deposits is again immaterial to its continuing operation (costs and profitability are another matter), meaning that for all intents and purposes collateral is the real currency here.
But should it, or the system, experience instead problems in collateral or repo, there is no other recourse. In the case of collateral, a shortage or systemic re-assessment of terms (like MBS in the aftermath of early 2007) would lead to higher interbank liquidity preferences, including the often desperate purchase of UST’s (October 15, 2014) having more to do with this money condition than anything else. Yields on them would therefore fall even if policymakers and all the so-called expert economists declare there is no way that they might.
There are so many more ways in which systemic monetary tightness can manifest, and has repeatedly manifested, to where central bankers believe one thing when in reality the opposite has occurred. The economy suffers for it not because economists and central bankers are powerful, but because they are impotent and can’t solve the problem – and so a good many people start to believe it is unsolvable short of doing something totally different.
One thing is for sure: the system will transform one way or another. This last decade has been in many general ways a repeat of the thirties, suggesting that should it continue on long enough a repeat of the forties is no remote nightmare. That’s the real downside.
On the positive side is further development, free market development, of competing currency ideas. The biggest banks in the world have started and added resources to working groups studying blockchain technology, among other things. It’s positive not because we might want these eurodollar banks to dominate what comes next, but because these increasingly former eurodollar banks might finally be seeing the writing on the wall.
The answer to monetary issues is always distilled in the mainstream into some other version of a top-down model; replace the eurodollar with another eurodollar type? No thanks. It may seem like the eurodollar was itself a product of unregulated free markets, but it was actually unregulated monopoly markets. Monopolies can perform a service, but they really don’t work well when they no longer work well.
If capitalism is to thrive again in economy as well as the public imagination, the way out is the same as it has always been since the rise of mercantilism buoyed human prospects for freedom and prosperity. Competition is the answer. Let the cryptos battle it out in new ways and innovations that haven’t even been dreamt up yet. Perhaps Bitcoins convertible into gold, or reservable Ethereum as a blended mix of cattle futures and franc basis swaps. Who knows? That’s the beauty.
We know where doing more of the same leads. The longer the eurodollar continues, the greater the economic costs, the more capitalism will wrongly be blamed, and the higher the de Blasio’s of the world go with the permanent damage they might do. The dangers of prolonged economic problems have never been strictly economic.
