Only Socialists Know the Downside to Socialist Money
You have to hand it to the Europeans, as when they go big they do so in style. Most attention was focused on the young lady who decided to rush Mario Draghi as he sat trying to explain why cash isn't really acceptable in the securities lending business. While she provided the flair, it was Draghi's strange notions of QE's primary importance that should have set the agenda. There can be no doubt, however, that the absurdity of the whole spectacle was as much a poignant reminder of the times we inhabit.
Far too often the idea of QE remains one about the "money supply", as indeed the first word of the acronym is quantitative. That stretches not just from the ECB's public organs but infests the commentary that accompanies all of it. Even economists will get in on the misdirection, often saying or cheerleading for more "loose" policy without so much as a thought about how you define and carry out "loose" to begin with. There is a plethora of bank "reserves" all denominated in "dollars" and yet strangely very little of anything that "should" follow from that.
The context of the European version of QE is already fraught with difficulty right from the very start. European banks were adamant about not parting with government bonds for various reasons, raising doubts about the operational means by which all this "expansion" would take place. As it was, the March end did finally meet its €60 billion quota, but only just barely and for who knows what premiums in between. The entire process has left a third of Europe's government bonds trading with negative yields, further pressuring QE, again in only its second month, as any security with a yield less than the deposit rate (currently -20 bps) becomes ineligible.
What a world that would be where the ECB is left buying only Greek and Spanish bonds on renewed rampage of Greek default and a return to PIIGS references. In some ways, it would be quite fitting as that would apply the very essence of these monetary principles in their most direct fashion - to not just subsidize the prices of various asset classes but to totally and completely direct and overtake them. There is no "lender of last resort" anymore in the traditional, Bagehot arrangement, QE is the enactment of "market of last resort" to which the ECB is intent on proving beyond all doubt.
In and of themselves, asset prices aren't even all that important to monetary policy as much as they are a means to fooling and cajoling you and me into doing things we might not do of our own mind. The whole of QE in any continent, and it has spread everywhere, which is significant, is emotion.
Again, the "money supply" misconception feeds further and expanded versions where QE is akin to better and more wholesome liquidity. Discrete episodes just in the US and just recently strongly beg to differ on that account, as does the repo market in Europe. There is more than enough evidence to strongly suggest, if not totally prove, that QE has the opposite effect on effective systemic liquidity. Repo rates in Europe have collapsed, signaling not "loose" policy but a lack of available collateral for placement. If the preponderance and persistence of negative yields on sovereigns did not tell you that, then surely the rules governing the ECB's securities "lending" program will.
Just like the Federal Reserve's reverse repo program exists ostensibly as a means for the wholesale money markets to gain access to the Fed's vast SOMA holdings as collateral, the ECB created its workaround under the framework of the overriding Public Sector Purchase Program (the official name for QE). Unlike the Fed's reverse repo, the PSPP version is security for security or simply a swap. The reason for that parallels what the Fed intends (actually intended, as they have all but given up after badly misconceiving this effort) for it, as a means for exiting "extraordinary" monetary programs.
In the reverse repo version, counterparties "deposit" cash in the account and receive SOMA-owned UST securities as collateral for the "loan." From the perspective of the cash owner, the private financial institutions, this is nothing more than engaging in a repo transaction except the other side is the Open Market Desk of FRBNY rather than JP Morgan or whomever in private repo. The Fed can pay whatever rate it wishes on the transaction, which is a reverse repo by virtue of it "borrowing" the cash, and thus acting as a means to "soak up" excess liquidity when and how it wants (in only theory).
Testing under the program was largely a failure, as there was little to suggest it had any impact on systemic liquidity at all, even and especially the ability of the program to deliver collateral into the repo market where shortages actually existed (as a collateral shortage is definitely a disruption to avoid in trying to exit ZIRP). The ECB is keenly aware of this version and is doing everything it can to avoid being seen as "draining" liquidity at the very start of its own QE. In other words, if you want to engage the PSPP securities lending because you are short of collateral on your own end then the ECB is telling you to bring something other than cash as they will not accept it.
In that press conference, Draghi downplayed the idea of a shortage, but that is exactly what you would expect. In April 2011, when yields on t-bills went negative for that very reason the Federal Reserve did the same. In fact, the entire time QE was operable at high rates the FOMC and all its members did their best to make sure the words "collateral" and "shortage" were never uttered even in the same paragraph (only slight hyperbole). Now, years later, it is pretty much accepted throughout even official channels that QE does, in fact, remove a significant chunk of collateral and thus can have a negative effect on systemic liquidity.
In having its PSPP being "cash neutral" with respect to securities lending, the ECB has prioritized the emotion of not being seen "draining" "reserves" over actual function and liquidity availability. If you parse that arrangement properly, you see that QE reduces liquidity in the expectation good feelings about QE (which most definitely include those mistaken assumptions about "money supply") are enough to overcome that physical reality in order to increase financial function to the point the economy moves forward. This is not even convolution, as it is downright Rube Goldberg-ian.
So many people, especially those in various offices of policymaking bodies, still fail to realize that there isn't any money in monetary policy and that the direct effect of that has been to disperse so many of the functions of actual currency. It is too difficult, apparently, to realize that there are times, and it seems the proportion of these periods are greater now than even in the panic period, when cash isn't and that other financial factors are. Collateral is just one element that is perhaps most visible in that respect, as there are clearly times when collateral is more "money-like" and preferential than cash.
This deficiency in understanding, or at least prioritizing of emotion and feelings over function, isn't universal. In fact, you can go back as far as March 2009 to find insightful counterexamples. When every other central banker in the world was being refuted daily by "market" prices that never did what these liquidity "experts" intended and expected, Dr. Zhou Xiaochuan found the central axis of the basic problem rather easily:
"The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability."
That quoted passage is taken from an essay Zhou, the Governor of the People's Bank of China, published through the BIS. Most commentary focused on what they assumed were the nationalistic undertones of the second part without much appreciation for the first. I don't have any special knowledge about exactly that intent or suggestion, replacing the dollar with the yuan, but in everything that has happened since, the words "credit-based national currencies" have struck to the very heart of persistent failure and economic discontinuity.
In that essay, it is clear that Zhou holds no favor for debt-based currencies precisely because of what they allow; namely (other) central banks to prefer political ends via the cover of economic policy. In that basic sense, the Chinese understand the greatest weakness of this "reserve" currency is its pliability. I am not naïve enough to suggest that there is or was no nationalistic intentions from the Chinese side, nor do I bear any comfort in that the communist head of the Communist means for communist monetary expression understands the implications of the dissolution of market-based money far better than Alan Greenspan, Ben Bernanke (both of whom continue to embarrass their former offices with this "global savings glut" lunacy) and Janet Yellen. You can throw Mario Draghi and Haruhiko Kuroda in that too, as they are all the perfect chartalists that really believe money has no inherent properties that they aren't obliged to give it - and take away.
Of course, for his part, Zhou followed exactly the same script as provided in the orthodox textbook in 2009 and thereafter, nurturing perhaps the largest bubble in human history that may, in the end, dwarf even our own housing debacle. We may never know whether that was his choice as PBOC head or if that was the government priorities as they existed during the last "administration." For a long time, the Communist party championed economic growth above everything else, which put the PBOC in the same box as the Federal Reserve, the ECB and the dreams at least of the Bank of Japan.
With the change in party leadership in 2013, there was a shift in priorities including those of the monetary end. I personally wonder if Zhou's own views were "allowed" to be more fully cultivated, as the ideas of monetary "reform" are almost nothing like what existed at the PBOC during the "growth era" but are suspiciously consistent with that 2009 elucidation. There are, of course, the usual platitudes included about allowing market forces greater leeway, and to "normalize" some banking functions including the deposit system. Those, however, are merely the superficial as the real change lies beneath and unappreciated still.
To that end, it is little wonder almost nobody has heard of this because the mainstream certainly outside of China remains the dominion of orthodox economics. In these minds, growth is synonymous with monetary policy, and thus policy must "do everything" to champion growth without much attention to accountability. If you actually examine what the PBOC is conducting now and for the past year and a half, it is almost the anti-growth set of policies, closely helmed by Zhou.
Ever since the "reform" agenda was presented, it has been curious as to how many stories have appeared in Western media outlets about his imminent replacement - going back to 2013 and even the comical rumors of his having defected in 2009. Again, that may be as much China being China as anything, but there has been a regularity to it that seems to border almost upon cheerleading for it. The Wall Street Journal, in particular, as a mainstream monetarist outlet, has publicly and individually produced two such stories just in the past seven months. There was the "rumors" that Zhou was being considered for replacement in a story run on September 24, and then a similar piece on February 28 that used almost the exact same language of Chinese leaders discussing his fate amid "disagreements in policy."
At issue, apparently, is the new "reform" agenda that is dissimilar to the prior regime of "growth" through bubbles. Zhou has engaged the PBOC on a "targeted" approach to policy, which means that the central bank is preparing for a kind of managed decline. They seek, through these targeted measures, to bolster only those financial elements deemed necessary and proper to more easily weather this new intended trajectory; conspicuously leaving out all the rest, most especially bubbly types of wealth management products and the conduits that fed them.
The net result has been a slowing of Chinese growth to levels before thought unthinkable if not impossible; the Chinese leadership in 2009 would have proclaimed 7% GDP and sub-6% industrial production the equivalent of suicide. We know this precisely because those were the trough of what China was forced to endure during the Great Recession, to which was ordered these huge asset bubbles to countermand - grow at all costs, including desperate financial imbalance. To do the opposite now is confounding to everyone who expects central banks to act according to the dominant ideology.
I think that is the problem the Wall Street Journal is having, as the economists there are continually confused about the assumed "absence" of the PBOC during this deep and deepening economic slide. The fact that China is still slowing and the PBOC appears little interested to revoke it this time suggests that there may not be as much divide among Zhou and the rest of the government as this side of the Pacific would make it seem; raising the issue about just who is having the most trouble with all of this and exactly who would be more comfortable with Zhou put out to pasture. The Chinese economy is now, as of the latest figures, passing through that assumed economic "floor" once thought un-crossable and still he is there at the head.
But there is even deeper meaning here, that will never be uncovered by that shuttered and limited perspective. The leadership at the PBOC, which actually includes more than the singular force of Zhou Xiaochuan, may have realized this all the way back in 2009 when he openly decried "credit-based national currencies." It may have been the change in party leadership that opened the door, as a mere matter of national economic survival, or it may have been the global and unrelenting slowdown that struck in 2012 that convinced him/them that there was no going back, proving rather conclusively that the dominant monetary theory for all global affairs doesn't work and is powerless to reverse the decline. Whatever the case or the ultimate turning point, the PBOC has realized that the global "dollar" system that existed before August 9, 2007, is irreparably broken and that its continued mal-adjustment and instability is doom for China under the textbook arrangements.
No nation ever benefited so much from the "dollar" as China did. Alan Greenspan through his own attempts at managing the US economy did so much better (on the way up, anyway) in the Middle Kingdom than he did of the United States. There can be little doubt, as it is obvious in every single economic measure, that China's rise coincided exactly with the wholesale eurodollar standard, and the global "dollar" short. What Greenspan was feeding, expecting just a domestic process, was the growth of China via Swiss, German and even American banking. This is not to say that eurodollars singularly financed the Chinese expansion, but that it was more comprehensive in that China's growth was uniquely cultivated to best take advantage of that dominant systemic operation.
The same "leakage" that allowed the "money supply" to be so radically altered was the same process that pulled China up from almost nothing. That would seem to be an unalterable good from any perspective, including from the Chinese. But here, too, we see the unshakable illusion of monetarism, as what was built in China was referenced to, and oriented toward, that "dollar" system with little attention toward internal consistency and profitability as it might exist without that financialism. China was built to serve as the economic arm of the eurodollar system, and so the break in eurodollar existence starting in August 2007 and the instability that has wrought has meant the same for Chinese economic reality on this downside - take away the monetary illusion and what is left behind is dry sand.
I think that is the animating element behind the PBOC's shift, as they realized (and, again, I have to believe that the slowdown in 2012 was perhaps the last straw as it proved, conclusively, that there was no going back) that the eurodollar standard, or the current arrangement of "credit-based national currencies" is heading toward an inevitable break. It may be lingering on now almost eight years after the first quake, but it is clearly becoming increasingly unworkable - as Draghi's cash priorities and our current liquidity existence show all too well.
The fact that even economists are now recognizing that the once-vaunted US "boom" of myth and legend from 2014 was only myth and legend, and that the current "slump" is far more concerning than just the wintry snow of winter. That matter of economic instability is not a surprise at all to the Chinese, who are not just situated in the same global supply chain under constant duress of vacated economic promises but also very keenly aware of how the eurodollar operation tells us a lot about economic prospects to begin with.
The "supply" of finance, in all its currency-like expressions, under eurdollar debt traces to bank balance sheet construction and re-allocation. The "rising dollar" thus has nothing to do with the anachronistic "strong dollar" (which was an agent and signal of stability) and anyone who knows the eurodollar system can detect the financial version of coming problems. Chinese reform is essentially trying to extricate China's economy from the fading "dollar" function before it all blows apart, an educated gamble for existential risks. That even means doing very little about economic growth that slows sharply, because the worst case is having enormous asset bubbles in play when there is finally a break.
Actually, that is the second-worst case, as the very bottom and most dangerous is in fact actively injecting further bubbles while the governing dynamic of the eurodollar system lastly fails. In that sense, there is no separation between finance and economy as the lack of recovery is itself closely related to the erosion in function of global monetary efficacy and durability. To those under the orthodox ideology, that looks like China has given up on growth; to those that can appreciate the roll-back and unmistakable decay in the eurodollar system, it actually looks like prudence.
Once that realization has been incorporated, the persistent failure of QE and all the monetary policies tried since 2007 make sense - these central banks are trying to reconstruct a system that cannot be rebuilt. They are trying to prop up a financial arrangement that no longer works simply because that prior existence was most conducive to their ideas about economic control and management - and their control and management of it was the reason for its fatal wounds in the first place. They are still, to this day, trying to go back to 2005, and the ECB is now the latest to wander into extremes of absurdity to achieve it.
I have no particular love or even admiration for the PBOC or Zhou, only that in its current incarnation of reform it is far and away ahead of the curve in relation to all the rest. That is, indeed, a very low bar to set, but it is at least something moving in the right direction toward being freed from the global (Japanese-style) prison of debt, debt and more debt. I have said it numerous times, there is something wrong, even unholy, in how the statist central bank in one of the most overtly statist systems is far more aligned with markets and market processes than all the rest of the "free world" monetary systems. This is not to say they have achieved genuinely free markets, but that is deeply profound as to how messed up "credit-based national currencies" have allowed everything to become; where the people have been utterly deprived of voice and power in finance "for their own good" that seems to have so very little of the "good." The sociopolitical descendants of Mao have deeper and more realistic assessments of the downside to socialism in money than the acolytes of Milton Friedman. We are left hoping that the Communist planners teach ours a little something about humility and the downside of ideology, if only monetary at first.