Donald Trump Is the Result of the Fed's 'Next Year' Recovery

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Stocks have always had a complicated relationship with the economy, which is why bubbles are the way they are. That paradigm has perhaps been stretched now more than at any point since even the FOMC, masters of four QE's, aren't much enthralled with their own handiwork. After proclaiming for years that stocks were a full part of the monetary channel, the "wealth effect" and all that, we are left to wonder just who has benefited from all this as the real economy cannot take much more. Thus the asset inflation is transformed in part from an active channel to instead a singular signal of what might be to come.

That was the enormity of this week's stock mini-crash, though it has been since forgotten mostly in the space of a few days. But for a brief moment the bottom fell out and finally those onshore of the dollar's reach glimpsed the terror already being meted out by the eurodollar across the globe. Again, stock prices in that brief moment might be described as suddenly awakened to the idea that their rise all these years was in anticipation of exactly nothing.

Monetary policy has always been mostly the promise, but this "cycle" has been uniquely devoid of everything else. It is always "next year" for the recovery, but at some point that would be a calendar too far. The "dollar's" rise beginning last year was a stark warning that the clock was winding down; irregularity of imbalance was always within a condition set for expiration. The issuance of a third QE, then quickly a fourth, brought renewed hope that the stock (and corporate bubble) inflation reckoning would be pushed back on both sides - that stocks could "afford" to be more patient while perception about the awaited recovery received yet another boost.

That was always the problem in the disparity, as stocks have been waiting for ultimate deliverance yet they have only received more means for that supposed end; if the economy needed additional QE's what might that mean about the economy's true underlying condition (not to mention a damning commentary on the past QE's)?

The stock crash was preceded quite closely by a yuan crisis, though it continues to be declared an intentional devaluation as if a central bank openly entangled in all manner of wholesale desperation could fairly be classified along those lines. The common theme is, as it has been, eurodollar decay acutely amplifying into a full "dollar" run. Despite whatever about China's economy, the truth is that every single eurodollar indication was in or near full flight in the weeks leading up to China's public break. It isn't much mentioned anywhere, but LIBOR, conjuring unwanted but still-lucid memories of the not-so-distant-past, surged at the outset of August well beyond its already-troubling rise from last December. Repo rates, too, were spiking upward at the same time the yuan had suspiciously deadened.

Such currency devoid of any variation is always a surefire signal of someone doing something, and in this case it was clearly the PBOC "supplying" "dollars" that the private offshore "market" would no longer. The din of China selling its treasury hoard has grown only in recent days, but the evidence has been there going all the way back to March. That means the only notable exception about China's participation in the "dollar" decay has been the openness with which it struck on August 11; the PBOC fell victim to the "dollar" much as the SNB, Banco do Brasil and central banks elsewhere had done before it.

The Chinese descent along that trodden path only demonstrated how far and deep the disorder had sprung; as we, of course, know full well this week. The rift in wholesale liquidity reached pretty deep, as, again, onshore dollar markets were in steep disorder alongside their more engaged foreign partners. That the PBOC would be so disastrously overwhelmed marked a significant shift that the "dollar" might not be so studiously ignored much longer as it may mean that the wait for global salvation is finally near or even at its end.

I have written far more than I care to recall about August 9, 2007, and still we are seeing the proceeds from that paradigm shift. Such transitions are always violent and scary, but it really stretches the boundaries of faith that it might happen twice. The events of 2008 were supposed to have definitively marked the final liquidations but for all their supposed might central banks around the world only tried vainly to rebuild the world as it was prior to August 9. Everything that has transpired since flows from those two central points; that the "dollar" is systemically unworkable in sustainable fashion and central banks would at some point meet that inevitability no matter their intentions and efforts otherwise.

This is surely as much a political discussion as economic, since the clogged nature of the financial "plumbing" is in many respects just a representation of government arrangements. It won't be banks shaping the realignment so much as they might lobby in favor of certain positions, as they have always done (Dodd-Frank, five years later, is still largely unwritten and unspecified on the main accounts). The people should have their say, but likely won't without major effort; since money is no longer money there is no direct popular challenge to the socialist framework of elite economic (attempted) control.

So Donald Trump ascends toward the majority on the one side because those that have claimed the mantle of free markets seem so set against actually doing something (anything) in that direction. Despite the fact that this recovery has been revised downward at every turn, and that market discontinuity has become startlingly regular (so much for abnormalities that are conspicuously normal), Republicans remain haunted and afraid of orthodox economists. In 2012, they were more likely to address, indirectly, broad and deep economic dissatisfaction but all that has seemingly faded with last year's GDP pronouncements (even though they prove yet again the actual aberration is where GDP is high); even in last year's Congressional elections, despite the economy still being polled as the single topic of priority, nobody wanted to discuss it, leaving it only in Janet Yellen's hands.

And what hands, those mighty instruments of dithering. Not even Yellen will take up the topic, as the Fed itself can't bring its own policies to confirm that which they know is false. Early last year, at Yellen's start, it was convention that the "exit" from ZIRP would be March 2015, if not as soon as January. Yet with each "anomaly" the date of reckoning (which, by every public proclamation was supposed to be recognition of that final achievement) was pushed back - again and again and again. There was no way that the Fed would wait past June, the labor market was "white hot" to an intensity only the 1990's could appreciate and yet now September is increasingly in doubt even though second quarter GDP was revised up to 3.6% (maybe that has to do with the less-subjective GDI being less than three quarters of a percent for the second consecutive quarter?).

Trump's gains may not be so monolithic, but if there is a core to them it is just this dissatisfaction. Immigration is just the proxy, the one that has lit the light of popular impatience. The people have long known what Janet Yellen is just finding out, and which Ben Bernanke is arguing still largely against himself. This is not just a problem on the "right", not at all, as Bernie Sanders' similar position is the same expression worn upward on the "other" side of the assumed aisle. There aren't many takers anymore for "voodoo" economics; economists are just the last, as always, to find out.

Bringing up that particular word risks setting this discussion in starkly branded political terms, which is not the point here. George HW Bush uttered the phrase in the 1980 Republican primary against Ronald Reagan, to which popular myth has assigned a particular meaning. In reality, Bush was only criticizing Reagan to the extent that his tax cut plan actually included anything more than business taxes; Bush was actually trying to argue that he was the only "supply-sider" in the whole field. That Reagan might add tax cuts for individuals placed him, as Bush told it, into the past where even Democrats no longer resided.

It is totally forgotten now, but as economic history professor Brian Domitrovic reminded in December 2010, it was the Democrat majority in Congress that authored, through Congress's Joint Economic Committee (JEC), its annual report in 1980 titled Plugging in the Supply Side; it was unanimously adopted. Its introduction, written by Senator Lloyd Bentsen of Texas, said:

"The 1980 annual report signals the start of a new era of economic thinking. The past has been dominated by economists who focused almost exclusively on the demand side of the economy and who, as a result, were trapped into believing that there is an inevitable trade-off between unemployment and inflation...The Committee's 1980 report says that steady economic growth, created by productivity gains and accompanied by a stable fiscal policy and a gradual reduction in the growth of the money supply over a period of years, can reduce inflation significantly during the 1980's without increasing unemployment. To achieve this goal, the Committee recommends a comprehensive set of policies designed to enhance the productive side, the supply side of the economy."

Again, that was authored by Democrats and voted in favor by liberal icons Ted Kennedy and signed by the likes of George McGovern. As Domitrovic noted, the Bush tactic was actually intent on tying Reagan's tax cuts to the demand-driven inflation policies of the past.

"This reasoning is essential to grasp in seeing why Bush called Reagan's plan ‘voodoo.' Reagan wanted everything the JEC report wanted and then some on the income-tax side. Whereas the JEC Democrats were thinking of something on the order of a 10% cut in income-tax rates, Reagan wanted the ‘Kemp-Roth' cut of 30% - along with all the business provisions. Bush argued that the business tax cuts were sufficient to solve the two sides of the unemployment/inflation problem, and that the only thing Kemp-Roth would spur was inflation. ‘Voodoo' referred exclusively to Bush's dubiousness about Reagan's claim that his plan would combat inflation."

The point itself was beside sound economic reasoning, as Domitrovic further wrote, "A 30% tax cut would mean 30% inflation. The idea was that with inflation running at about 20%, when voters heard Reagan stumping for 30% (in a tax cut), they would associate that with a jump in the already fearsome inflation rate." The political tactic obviously did not work, though "voodoo" has stuck around for decades as if it applied exclusively to the Laffer Curve. It was unequivocal in 1980 where economics had gone wrong, and it was there that debate remained about any positive impact through broad "demand side" tax cuts as the nature of economics was turned. In 1981, with Reagan now in the White House, Rep. Henry Reuss, a quite open "liberal" from Wisconsin, took over the chair of the JEC and proclaimed, "We've given up blind pursuit of Keynesian demand acceleration."

That declaration was with good reason, as the Great Inflation itself proved without doubt. Yet, here we are more than thirty years later in almost exactly the same spot, with somehow vast differences in what passes for reasoning and orthodox acceptance; that "inflation" is much more difficult for economists to conceive, money isn't money or even a "dollar", and no economist is anywhere close to renouncing the same tactics and philosophies that so clearly failed already at least once around the world.

In 1988, Democratic nominee Michael Dukakis picked Senator Bentsen as his running mate, to which Paul Craig Roberts, Reagan's Assistant Secretary to the Treasury in 1981 and 1982, wrote in the New York Times in July 1988 that Democrats were in "danger" of being the only supply-siders left.

"Unless proud Senator Bentsen has agreed to be a fig leaf for a covert left-wing subversion of the American economy, Reaganomics now has more to fear from Peter Peterson, the Republican economic strategist; Martin Feldstein, the former chairman of President Reagan's Council of Economic Advisors, and Senator Bob Dole than it does from a Dukakis-Bentsen administration. On their respective records, it's a lot easier to have confidence in Lloyd Bentsen than in many of the Republican regulars who have been running the Reagan Administration into the ground."

What happened? The answer is almost easy in two parts: Paul Volcker and Wall Street. Volcker's participation might be more accidental, though the exact nature of the Federal Reserve in the early 1980's remains shrouded also in myth. It was Volcker who has been lauded as the great slayer of inflation, rising to the dollar's challenge by slamming the US into recession - twice. But there was much, much more than that, especially since he did not leave the Chair until 1987 and the period between his greatest "achievement" and Alan Greenspan's tenure wasn't exactly much of a change; in other words, Volcker started the 1980's as supposedly the market champion but little was upset when notorious monetary commander Greenspan took over and was soon "directing" economic inputs anywhere he could (only slight hyperbole).

In May 1982, for instance, the FOMC met to discuss an unusual irregularity in the "market." Some Wall Street firm, a "fringe operator" as Volcker termed it, operating some "rinky-dink [scheme]" that sounded very much like nascent rehypothecation got itself in trouble. The position size was somewhere between $2.5 billion and $4.5 billion which was potentially market-moving in those days.

"VOLCKER So, we have a potentially large amount of securities overhanging in the market in a distressed situation, and we're trying to figure out what to do about it. Chase Manhattan is in the middle of this as the middleman in the shorted securities. The people they borrowed the securities from claim that Chase is liable and Chase claims it is not, so we have a [mess] there. Losses are well in excess of $100 million just on that set of transactions, and we don't know what else is involved; we're trying to find out. I'm told that the bond market was off a little last night and off a little more this morning."

Some of this fungible financing "stuff" was very new to the institution and nobody on the committee was quite sure what its role should or would be. Lawrence Roos, President of the St. Louis branch but only an alternate member of the FOMC at the time, wondered, "What is our responsibility in a situation like this - just to keep order? Is that our concern, rather than letting it take its normal course?" To which Volcker had already surmised:

"VOLCKER Ultimately, if there's no other solution, we might just have to stabilize this market for a period of time. At least I can see that as a possible scenario. So, I just took this very preliminary step of keeping in touch with the market if it really goes off. I think the next step, if the market comes under more pressure, is that we'll just have to go in openly and buy some bonds. That is very insufficient knowledge, but it about summarizes what I know, frankly. The other lenders involved in this particular short-selling operation are apparently major security houses in New York. There is a group of 7 or 8 of them; they're all well-known firms. They should be able to withstand the loss if things ever settle, so far as we know about the loss. But that doesn't mean it won't send ripples of very deep concern all through the market."

This was just a minor episode of primitive "too big to fail" in its view of "market stability" as a primary function of policy - which opens up the entire so-called market to a central bank determining wholly on its own what counts as "stability" and even where that applies to which "market." At that time, the Fed was already in play as the Latin Debt Crisis had sunk many Wall Street firms into a serious mass of bad loans (it isn't clear whether or not the "rinky-dink" firm was involved in the LDC, but by inference it seems that it was in the first stages), but no losses would get recognized on any balance sheet until Citigroup in 1987 (even though the FDIC in the 1990's would estimate that Citi, Manufacturer's Hannover and Bank of America were rendered insolvent by the "event").

That crisis was really the first disruption of the Bretton Woods replacement, as credit-based reserve currency, the "dollar" not the floating dollar, almost immediately found banking going just insane upon any volume once freed from hard limitation. The Fed was, by the early 1980's, making plain where its priorities were taking policy and why. Almost at the same moment the "supply side" of economics removed the Keynesian destructiveness from the mainstream the "demand side" had already re-entered the back door of the open Fed.

That is what this eventual unbridled monetarism consists of, going back to "aggregate demand" because, in theory only, it seems much easier to control and much more conducive to monetary command. Wall Street was only all for it because they realized very early on that they were to be its primary tool - DC and NYC back together ruling the economy. Volcker made it all possible because of the reputation he had "earned" as a responsible central banker; making the idea of monetary "markets" under watchful paternity somewhat plausible as soft central planning as if some kind of Platonic enlightenment.

What that really meant, in political terms, was the birth, or rebirth actually, of the seemingly dead technocratic ideal. It was Samuelson and Solow that first brought the idea of the economic technocracy to the Kennedy Administration to disastrous results. That was why even Democrats had so universally moved against it by 1980 (only two decades after its "invention" in the exploitable Philips Curve). An "enlightened" Fed represented the same ideals in simply a different format, this time favored by the so-called Republican Establishment. Over the rest of the Great "Moderation" it had become totally bipartisan, as Keynes was once more dominant in economics everywhere - all "demand" all the time to unhealthy obsession (see: Japan).

Technocracy abhors actual markets almost as a tautology; markets chart a much different course than mathematically determined "optimal outcomes." With "both" political sides favoring the technocratic approach, continued politically strangling of the issue was only viable so long as there was light at the end of the very, very long "recovery" tunnel. Nobody wants to say it, but technocracy has failed now in the very same manner as that which led up to 1980. Apparently, however, 2008 wasn't enough of a failure as to unload the witchy enchantments of economists into the political class. Therefore, it is not efficacy they seek but, as technocratic power devolves into, just maintaining control. That is, after all, why every central bank sought to rebuild the economic and financial world exactly as it had been prior to August 2007 even though it was clear to almost everyone then not within the orthodox bubble the impossibility of the attempt; and why they still claim that is the only way forward.

The point about George HW Bush and "voodoo" is well taken not as even "supply" or "demand" but rather that the whole attempt at economic control is that. It is almost amazing by comparison that thirty-five years ago the economy mattered more than actual power, though even if by which whichever side offered the fix or participated in it would claim the democratic mantle and mandate for it. Maybe economists learned their own lesson from that, namely that if they ever reclaimed the technocratic throne they would do whatever they could, no matter the economy and people's lives, to hold it against all outcomes - they never offer anything but the same command approach to the obvious exception of everything else that used to be easily and conventionally embraced. The willingness of political figures across the spectrum to allow it and even strengthen it defies democracy. Thus, Donald Trump.


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

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