Motivated Voters Shatter Monetary Delusions

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It was an interesting contrast last week when the Bank of Japan added to its already massive QQE program. Part of that stemmed from the fact that Bank of Japan officials began QQE in April 2013 with unshakable faith in theory and expectations for smooth execution. Listening to Governor Kuroda speak about it then was to be convinced that at least he was convinced, so the rhetoric now is a sharp departure from those days.

As is typical in this age, the Nikkei 225 responded last Friday to the bump in what is really QE10 in Japan by rallying 1,000 points in the early going before settling back for a closing gain of "only" about 750. As we are told from an early age now, stocks are supposed to be fundamentally grounded in the economy so it was quite jarring to see so much celebration over what has turned into an embarrassing disaster.

The coincidence of the Bank of Japan's "surprise" is not lost on anyone paying close attention to Japan outside of the Nikkei. That very same evening the Japanese Ministry of Internal Affairs and Communications, Statistics Bureau, released shocking and alarming statistics on the state of Japanese households: household spending fell 5.6% Y/Y in September as household income declined by a very similar 6.0%. While monthly volatility may be expected in the aftermath of the recent tax increase, these figures have become typical.

Just when the "recovery" in Japan was proclaimed to be firmly entrenched, enough in perceptions so that the government went ahead with the same sort of tax increase that drowned the economy in 1997, the aftermath of the change has been nothing like expectations. Orthodox economists were aware that the initial stage after the tax change would be rough, but very confident that "growth" would resume in short order. Instead, real household spending has fallen by an average of 5.4% each month (-5.8% average for real household income) with no signs of abatement in what is really depression (especially when added to the devastation in Japan's trade position).

In gaining the "inflation" they have been seeking, they created a collapse they never saw coming. It is so bad right now that income in even nominal terms has been negative for seven months running, predating the tax hike to demonstrate the poison of "inflation" as proximate cause rather than allow misdirecting blame to the tax change. In that context the "surprise" QQE boost is not. In other words, the Bank of Japan panicked and stock "markets" celebrated it.

"Inflation" policy is a tricky thing especially for central banks that have little appreciation of it apart from some notion as a variable in a regression equation. Just recently, Ben Bernanke told Schwab's IMPACT conference in Denver how those expecting inflation as a result of QE were practicing "bad economics." That was a curious retort to severe criticism given the entire premise of QE in America was the same as QQE in Japan - inflation. Maybe he was qualifying his assertions about "runaway" inflation, but that doesn't fit even his 2010 paradigm. The whole point of monetary measures already at the zero lower bound is to generate "some" positive inflation as it is believed to be an economic catalyst (the Keynesian notion of "pump priming" relayed to monetarism).

For all that theoretical notioning all that has happened is that stocks in the US surpass record highs. That "market" is supposed to be a marker about economic affairs and thus some take high stock prices as a signal for economic recovery, yet its much larger, more sophisticated and ultimately more closely situated to actual finance cousin, the global "dollar" "market", is saying the exact opposite about the economy. Stocks continue to be bullish on everything while bonds and the "dollar" (the global dollar "short") are bearish on just as much.

Given that the best performing stock markets of late, including Japan, continue to be situated in places where economies are mostly wrecked by redistribution that is not a great correlation upon which to place much hope. And while this dissatisfaction in finance seems limited to other places, Tuesday's election here in the US more than suggests the opposite conclusion.

In almost every poll leading up to November the economy was, by far, the biggest concern of voters in almost every classification and bisection. Since the business end of QE is really psychology, as is the "wealth effect", that is a damning indictment on its effectiveness - if record stock prices cannot keep people happy enough to form a recovery then the whole of the theory is in jeopardy (again, as in Japan).

Even erstwhile left-leaning publications received that message. Greg Sargent writes in the Washington Post:

"The exit polls show that candidates like Mark Pryor, Kay Hagan, Bruce Braley and Mark Udall lost by anywhere from large to truly massive margins among non-college whites and older voters. That's also true of the overall national electorate. You should treat these exit polls with a grain of salt, but the pollsters I spoke to agree that this gets at a fundamental problem Democrats face....

"'We have a huge problem: People do not think the recovery has affected them, and this is particularly true of blue collar white voters,' [Democratic pollster Celinda] Lake said. ‘What is the Democratic economic platform for guaranteeing a chance at prosperity for everyone? Voters can't articulate it. In the absence of that, you vote for change.'

"'Our number one imperative for 2016,' Lake concluded, ‘is to articulate a clear economic vision to get this country going again.'"

That is more than a little confusing given the nature of stock prices in the US. From those and mainstream economic commentary, there should be no need to "get this country going again" because they say it has been going for the better part of five years, if especially the past two. On the campaign trail recently the figures 10 million jobs in 55 months have served as the basis for covering economic "going again." Yet, basic math already suggests the problem there as an average of 182k is actually insufficient and quite lackluster.

But reality is actually much worse than even that, as full-time jobs in the US remain 2.6 million below November 2007's cycle peak. What voters actually feel is something closer to that than anything of stock prices or recovery, especially since the true deficit is not just 2.6 million, but more like 9 or 10 million (the pace of full-time jobs in a recovery that conformed to even the lousy cycles in 1991-4 and 2001-04). If this period of "recovery" had followed the prior two, full-time jobs would have been restored to the prior peak in about 42 or 43 months, rather than the 82 months and counting right now, meaning that by now the total of full-time jobs would be about 9 or 10 million more than there are estimated right now. That would certainly be enough to rile the electorate dead set against stock prices and the mainstream narrative.

This is about awakening from the idea that "inflation" is some kind of solution, and maybe even a little inclination that "inflation" is not some kind of solution for problems derived from past "inflation solutions." Every central bank on the planet, including the Fed that may have ended QE but is still entrenched at ZIRP, is actively courting "inflation" and getting the opposite, including badly managed economic expectations.

These dim prospects for full-time employment are hitting hardest at the weakest points in the economic structure. For example, the National Association of Realtors last week said that first-time home buyers were the lowest proportion of transactions of the past 30 years. The NAR cited too much "competition" from "investors" that push prices up too fast (inflation) coupled with lending standards that remain "too tight." That is a big reason why the GSE's are "working" on dismantling much prudence in lending, because what we "learn" from bubble collapses does not stay learned when the economy doesn't perform up to policy direction.

In the end, however, anything the GSE's do toward lower mortgage hurdles isn't likely to help first-time buyers short of full abandonment of any prudent standard. By and large, these people are already saddled with large debts and, as noted above, likely in a job far less than the ability to service them. That duality of youthful reality is why household formation remains stuck; from October 2012 until June 2014 the total number of households in the US actually shrank by 19,000 despite population growth (the civilian non-institutional population) of 3.8 million during the same period. What would the housing "market" look like without all those institutional investors primed with direct leverage from QE3?

However, it is actually worse than all that since rampant debt and reduced incomes are actually quite linked. Try as any central bank might, these two factors are inseparable and certainly nothing of what can be accomplished via "inflation" will change that.

Anyone familiar with the "law school scam" can see the outlines of this in actual behavior far outside of orthodox theory. A Google search of that topic yields endless anecdotes and accounts of what is largely an economic tale of decay and manipulation. In one example, relayed in The Atlantic, the author makes plain disdain for for-profit law schools as misleading students in search of nothing but cash.

"There are only a small number of for-profit law schools nationwide. But a close look at them reveals that the perverse financial incentives under which they operate are merely extreme versions of those that afflict contemporary American higher education in general. And these broader systemic dysfunctions have potentially devastating consequences for a vast number of young people-and for higher education as a whole."

I urge anyone interested to read this story as it is a cautionary tale about more than higher education, as the magazine states specifically. And while their ire is rightfully directed at these for-profit schools, this is an imbalance that is far broader in its reach owing to the means for its very existence in the first place.

"These investments were made around the same time that a set of changes in federal loan programs for financing graduate and professional education made for-profit law schools tempting opportunities. Perhaps the most important such change was an extension, in 2006, of the Federal DirectPLUS Loan program, which allowed any graduate student admitted to an accredited program to borrow the full cost of attendance-tuition plus living expenses, less any other aid-directly from the federal government. The most striking feature of the Direct PLUS Loan program is that it limits neither the amount that a school can charge for attendance nor the amount that can be borrowed in federal loans. Moreover, there is little oversight on the part of the lender-in effect, federal taxpayers-regarding whether the students taking out these loans have any reasonable prospect of ever paying them back."

What that makes plain is that causation of all these imbalanced negative factors is as much about the intrusion of "free money", as orthodox Keynesians and monetarists are found of referring about "inflation" policy, as it is about "market" agents that intercept it. The entire system reorients itself toward the disruptive influence and away from objective balance through actual market profit. These schools have an active and ultimately artificial incentive to "make" law students when there is no organic reason to do so in such quantities. As long as outcomes are divorced from payment (as in healthcare) prices will spiral upward and the infusion of debt reinforces that.

While ostensibly this is an educational problem that reaches almost every corner of college life today (see the trend in the number of college students and its correlation with the availability of federally-intruded debt), it is exactly the same process as to which debt and "inflation" redistribute negatively in any other part of the economy. An orthodox economist will claim monetary neutrality as a get-out-of-jail-free card in any erosion of the economic foundation, but common sense and intuition shows that such thinking is irreducibly false - as the "law school scam" rests plainly and unambiguously. The intrusion of non-productive credit renders organic and profit-based market signals moot, and the result of that is waste and inefficiency that reduces the potential of the economy to create growth and compounding wealth and income.

The longer those gain the worse the economic foundation erodes. The Japanese experience suggests a concurrent attrition via amplitude as well; the more intense these artificial intrusions in the name of redistributed "inflation" the worse it gets much faster (a lesson apparently lost from the Great Inflation). That all of that would end up with a divergence with stock prices is unsurprising given the actual pathways in modern finance that make up the modern "dollar" supply.

In basic economic terms, orthodox economists have, tracing back to Irving Fisher's debt "paradox", viewed "deflation" under severely harsh terms for what amounts to no good reason. The fact of consumers being able to buy more for less "money" is really unqualified success of capitalism, a fact that we enjoy in every piece of technology at our wide disposal. But an economist sees "deflation" in financial terms as it relates to, somehow in unspecified and generic pathology, debt - falling prices supposedly makes existing debt more unsuitable. Thus, Fisher's paradox was where deflation becomes an inescapable feedback loop where as prices fall borrowers rush to pay off debt, making prices fall further and so on.

The mark of the modern central bank is to try to interrupt that process, which is exactly what Bernanke was getting at in his Denver remarks. But that gets a whole lot of what actually transpires in the real world away from theory totally backwards. As we see from deficient housing and an over-saddled youthful generation, it is "free money" in the first place that yields deficiency in economic function.

On those terms, in seeking to avoid Fisher's depression description, the central bank endeavors to create the opposite condition whereby borrowers do not rush to pay off debt at all because they can't. The more they can't pay debts, the less actual beneficial economic activity they can engage upon, meaning the economy, even seen through national income and spending accounts, falls under even worse circulation depressing incomes and job opportunities still further. And the preferred solution to that condition is more and more of the very redistribution agent that is the cause of the malaise, distortion and attrition in the first place; and not just with students but everything under the sun.

The current orthodox position in just this case, as we see now all over the world, is that any activity is better than no activity. Paul Krugman has expressed this idea on numerous occasions, that it is better to have unproductive economic activity rather than let resources remain "idle." This is clearly false, as the "law school scam" shows too well where unproductive activity feeds on itsself, nurtured by the twin impulse of "inflationary" credit and debt. In other words, this is not a neutral proposition at all, in that artificial activity of this nature is increasingly harmful to the point of its own economic "paradox."

The election has been, again, a reminder that awareness of it may have reached a critical point. The Fed and every other central bank keeps talking about doing more and maintaining "stimulus" after seven years of "emergency" measures - and to what gain outside of stocks? Where are the jobs? The fact that some economic accounts show positive numbers is not the same thing as economic growth, as these positive numbers without jobs and income (true wealth creation) simply suggest more artificial, and thus reversible, activity. What has become apparent from all of it is deficiency awakening a heightened distrust in economic authority (to go along with other forms of anti-establishment fervor) as the majority of the disaffected can so very easily tell the difference.

Unfortunately, this is a bipartisan problem that I don't think is appreciated by either form of political outlet. The policies of Ben Bernanke and Janet Yellen have been welcomed and practiced under every political alignment, accepted easily without question or comment (aside from minor disruptions that are put down as "fringe" and "crank"). Both the Bush and Obama administrations viewed Bernanke-ism (as indistinct from Greenspan-ism or now Yellen-ism) as the "best" that could be attained, as if the central bank was some kind of sagacious economic oracle. The crisis in 2008 and everything that has happened since has proved that they were neither prescient nor much of a practitioner of actual economics - instead captured and enamored with nothing but statistical intrigues and theory.

That is the commonality that is on full display now, broken monetary promises, sky high asset prices and economies that aren't anything close to actual recoveries and sustainable function. Japan is but the first to feel the pain of "inflation", which is not all that surprising since this is either the 10th or 11th (depending on your definition) version of QE to take place there. The most charitable description of these kinds of policies and results is that they do create a temporary disruption that looks like growth and recovery in some narrow respects. That is, of course, in keeping with Keynes' doctrine which is focused solely on the shortest of terms (we really are dead in the long run, but that is no excuse to make life miserable all the way there), but waste and distortion pushing apart activity from profitability can never last. That is as true here as it is in Japan and Europe, with at least a sufficiently large, wary and motivated voting bloc shattering the monetary delusions with some great force and emphasis.


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

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