We're All Redistributionists Now, So We'll Fail Together

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You have to wonder what on earth NASA is doing funding a "study" that examines global resource distribution and weaknesses in modern industrial society. Perhaps most fitting of the entire affair is that the actual funding, government tax dollars at work, for this terrestrial examination originates with the Goddard Space Flight Center. Nothing says the new NASA like massive facilities dedicated to leaving the earth taking on the task of appealing to economic "fairness."

The last word is my own, and not how the report concluded, but the implications are obvious. The premise here, in the words of the Guardian, itself no stranger to such appeals, is that of "the prospect that global industrial civilisation could collapse in coming decades due to unsustainable resource exploitation and increasingly unequal wealth distribution."

We don't really need to guess where all this is going, since the last clause of the last sentence gives away the game. The folks that were once believed to be the best and brightest in science and engineering, in a facility named after a rocketry pioneer that helped those best and brightest put Americans on the moon, now tell us "scientifically" the government needs to take a stronger hand in the economy. Going back a hundred and fifty years ago, you might have to explain how that happened, but I highly doubt anyone would actually be surprised today.

Looking out over the dimming economic landscape, you can understand (to a point) the appeal here. If it's not Martin Wolf demanding a government guaranteed minimum salary, there are protests over fast food wages (albeit where the number of media typically outnumbers the protesters) as if a person were meant to spend their entire life and career working at McDonald's or Burger King. All of sudden rent theory has been re-revived, taking a modern form no different than its ancient disharmony, yet cloaked in the apparent genius of an intelligent critique of the current state of "capitalism."

And what a state it is. The current Chairman of the Federal Reserve, a government organ that has appropriated the appearance of "market", appeals to an upward trend in inflation that somehow never appeared despite the best efforts of her predecessor. Quantitative easing was supposed to be inflationary, and that was supposed to be mighty helpful in restoring economic growth and employment. Yet inflation, defined by convention as narrowly defined in the official measures, has persistently fallen below all expectations and, worse, currently runs at less than half of the official-unofficial target (the PCE deflator for the fourth quarter of 2013 was 0.98%).

The upshot of all this dysfunction is that everyone is searching for the same answer to the same problem; and that is the problem. Leftists are gaining from the very evident failures of an economic system they decry as unfettered capitalism, making their persuasions toward government more, in their minds, persuasive. Those on the right, at least the mainstream of it, want Yellen to do what Bernanke couldn't, demanding more inflation via monetary intrusions and control. In other words, both "sides" want exactly the same thing - redistribution.

In so many cases, it sounds just that easy, like engaging a starter to turn the pistons until the motor can obtain successful and sustainable combustion. In point of fact, that is often exactly how it is presented, as if someone in Washington is simply asleep at the switch and only need be awoken. Go back to former Chairman Bernanke's (in)famous oped in the Washington Post introducing the skeptical American public to what was already embraced at the governmental level on all sides. His prose left no mistake about what was expected, in that QE would reduce interest rates, create a little inflation (good!), push stocks and assets higher, and the rest of it would be storybook/Hollywood. Yet, here we are, three and a half years later, almost six and a half years after the Great Recession started, wondering whether a recovery has actually taken place.

In April 2013, Haruhiko Kuroda, Governor of the Bank of Japan, announced that they too had done what was necessary, in their own form of QE, to pull Japan out of its twenty-five year economic hell. That it was the ninth or tenth iteration of that monetary program did not matter, this time was supposed to be different as the switch had finally been flipped. Like Bernanke, he left no margin in his statement, asserting as much in his pronouncements:

"We took all available steps we can think of. I'm confident that all necessary measures to achieve 2 percent inflation in two years were taken today."

In the interim, inflation has moved toward his stated goal, and still the economy in Japan careens toward the precipice of disaster. Given the export orientation of the Japanese economy, it was a foregone conclusion that Japanese QE would devalue the yen, thus unleashing a forceful competitive advantage that would close the virtuous circle on the inflation program. Japanese would be forced to pay more internally for goods and services, but that was alright because they would be receiving more income as export activity boomed and corporate profits rose enough to be "shared" as wage growth.

None of that happened, as the government now is resorting to the threat of publicly shaming Japanese companies that do not increase wages "enough." Perhaps they should import some protestors from the US, if they can get them out of McDonald's. Indeed, importation has been the only factor on the rise in Japan's trade balance, as exports have not grown enough even to the pace of the yen's devaluation - which means Japanese businesses obtain more "money" for selling goods overseas, but actually sell fewer to do so. The trade deficit in January and February 2014 combined was ¥3.6 trillion, or 50% higher (worse) than January and February 2013, a level that was unimaginable before all of this began. The Bank of Japan must have flipped the impoverishment switch rather than the growth one.

Now, after almost eleven months of such QE surety, Kuroda now openly talks about the possibility of needing even more. Apparently all the measures necessary to create and cajole economic utopia were not taken back in April 2013.

Benefitting from this backwards growth plan has been the rest of Asia, once considered, admittedly a long time ago, the sole dominion of Japan Inc. In the year and a half since Abenomics first threatened devaluation, Japanese businesses have relocated production from inside Japan to other Asian nations, devoting themselves to labor cost control instead of internal growth. Yen instability has driven these companies to remove the yen from consideration as much as possible, thus explaining much of the trade deterioration for Japan. Where Japan once sold massive amounts of goods into Asia, they now import components, parts and even finished goods from them.

And as much as Asia has been on the leading edge of taking trade share from Japan, the Chinese have seen a surge in their economic expansion in Japanese trade. In the eleven months since Kuroda's declaration of evidently brittle certainty, Chinese exports to Japan (denominated in yen) have jumped an average of 20% Y/Y. Japanese exports to China have only increased an average of 16% Y/Y (denominated in yen). With such a heavy yen devaluation, Japan's trade deficit of ¥1 trillion in January 2014 alone should have been (in orthodox calculations) impossible.

But the Chinese themselves are not celebrating their good "fortune." Rather, the financial system that is believed to be a solid extension of the PBOC (China's central bank) is undergoing historic shifts in financial function and capacity. Credit growth surged beyond anything ever seen in the past five years, and now we are seeing the potential downside to such deliberate paper. In more recent weeks, as defaults and rumors of defaults persist and multiply, the yuan's appreciation, another assumed rule of orthodox economics, suddenly and abruptly changed to devaluation. That has left observers scrambling to find explanations that do not destroy the carefully crafted idea of the sagacious PBOC.

In many outlets, that has meant framing the yuan's move as a purposeful punishment for "hot money" speculators. The revealing signal, in this telling, is the widening of the daily currency band, meaning the PBOC is on top of this imbalance, directing liquidity from its centralized position. As the Wall Street Journal this week put it:

"The band-widening announcement came as China's central bank in recent weeks has engineered a decline in the yuan's value to drive out speculators betting on the yuan's continued rise and to introduce greater two-way volatility into its trading, in a bid to pave the way for expanding the band. The PBOC has done so by guiding the parity rate lower and by instructing big state-owned Chinese banks to aggressively purchase dollars."

That makes a nice and tidy package; the problem with it is copper. Copper forms the basis of a large proportion of dollar debt collateral. As much as the PBOC and China in general project a certain economic independence befitting such a rising power, the bulk of the raw materials the country needs to create its economic and central planning "miracle" would be totally off limits without the US dollar. Chinese material importers have to obtain dollars in order to purchase foreign resources.

As much as the PBOC is sitting atop a multi-trillion dollar "reserve" excess, meaning that it seemingly should be easy for Chinese companies to obtain US dollars, there are enormous obstacles to mobilization, not the least of which is the daily currency band. Thinking about this in terms of eurodollars and global wholesale finance, the Journal's theory about punishing speculators does not explain enough to be compelling, amounting to more of a latent PR backstory. Instead, Chinese banks "aggressively" purchasing dollars, in quantities sufficient to cause notice, might rather be indicative of a dollar shortage among Chinese companies (and banks that lend those dollars to the corporate sector).

Given the behavior in copper, and the foreign distance from default rumors, the dollar shortage actually makes more sense, and more complete sense. This liquidity shortage is bad enough that the PBOC has been forced to widen its currency band enough so that banks can rollover sufficient quantities to avoid dollar insolvency. Thus, the Chinese banks are not being directed to bid "aggressively" for dollars, but rather their own survival, and really the survival of China's economically planned "miracle", is driving them to desperation. It is wilful confusion of causation here.

The Journal's formulation is one of calm and control, where the evidence continues to point to something else. That is the theme persistent throughout all these examples of government economic control flowing through central banks. The projections fail to match the abilities, and thus what is left is imbalance and crisis management.

While we may think that is only applicable to these far flung locales (and I have not mentioned Europe here, but only for space constraints) there is no shortage of it domestically. Last week, and in other places, I noted how it is highly and evidently incongruous that a relatively minor 1% increase in average mortgage rates utterly decimated mortgage finance - to the point that mortgage issuance and mortgage repo collateral are down by more than two-thirds in a matter of months. Also, US Treasury prices are far lower today than before the word taper was first given mainstream reference.

Yet, despite those, US stock prices are at or near new highs. High yield debt is trading close to the same, where junk bond yields are at unbelievable lows approaching rates once consistent with money market funds and short-term US treasuries. Leveraged loan prices, the new subprime of corporate lending and syndication, were wholly undisturbed last year despite every other credit class selling off in near-historic fashion. In other words, the pricing regime of credit assets here in the US has totally inverted.

The riskiest pieces have become the lowest "beta", including stocks. Is that truly market capitalism? None of this can be called capitalism, or even markets. These are all attempts to create "demand" where none exists, to conjure an economy from nothing. To do so requires, even demands, this risk inversion.

The telltale sign of government interference is exactly that. Take the Soviet Union, for example. The Soviets designed, crafted and built some of the most magnificent industrial creations in history (Magnitogorsk, for example), and where did it get them? In 1974, Leonid Brezhnev addressed the Seventeenth Komsomol Congress, introducing his dazzling plan to build the Baikal-Amur Railway. His intent was to transform Siberia into a communist paradise, an economic center at the center of ultimate Soviet triumph - fulfilling Khrushchev's promise to achieve full communism by 1980.

The Soviets spared no effort to achieve it. Estimates are not fully reliable, but most show that from 1974-1982, the Russian government dedicated 1% of total GDP, annually, on railway construction. There were upwards of 500,000 laborers toiling in the worst imaginable and inhospitable wilderness (to build a railroad anyway). It was a stimulus plan that would make Paul Krugman blush with envy. And still, the Soviet Union fell apart right as the railway was finally moving toward completion.

In a present-day New York Times article that described taking a ride on the completed Baikal-Amur line, the author notices, "For the last three hours, we hadn't seen a single road, village or human in this forest wilderness. Looking out, I couldn't imagine another place in the world that could be more pristine, and devoid of human habitation, all within sight of a transcontinental rail line." The author's companion, Mila Kozlova, summed it up best, "Brezhnev built more of BAM to make a pioneer utopia, and that never happened."

The Soviets built a magnificent railway (or at least most of it by 1989) into the wilderness with the idea it would create a route for resources to flow to the hot growth of Asia. It would provide the means to generate industry in the vast interior, strengthening the Soviet economy as a basis for generations to come. Rather than that bountiful future, it now serves as a reminder that there is more to a sustainable economy than a determined governmental effort to create demand from nothing. Allocating resources in abundance is simply not enough; they must be allocated in the correct amounts at the correct time, a woven web of information so complex and so indecipherable as to be useless in an aggregated format.

There is a deeper fundamental basis at work in all of this, a governing dynamic that is so out of favor as to be all but extinct in contemporary thought. Everything in economics is about redistribution, even the truest of free markets is redistribution on the basis of merit. Inflation is itself a symptom of redistribution, often from the real economy to the financial, but modern practitioners of monetary influence believe that "a little" redistribution is ultimately harmless, the concept of neutrality. Fiscal proponents and the neo-Marxists that have sprung up in the wake of repeated economic failure seek redistribution along the lines of "fairness", as in being an underclass designated by government, with government as the distributive axis.

No centralized body can incorporate and understand efficiency in a manner consistent with long-term sustainable expansion. It cannot be done, as if there needs to be more evidence of that than shown here. Centralized redistribution schemes, all of them, amount to the same outcome - inefficiency. In any economic system where inefficiency is introduced in such broad measure, risk as a guiding principle is overturned to the point of inversion. The Baikal-Amur railway was a massively risky proposition, but those economic risks were disregarded in political considerations of economic naivety and ignorance. That we see such disruptions in risk here and abroad today is simply the acknowledgement of the same ultimate inefficiency. Given that, economic underperformance should be expected as a full part.



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

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