Bernanke's QE In No Way Boosted Employment
It is inquiringly odd that a purported hero would necessarily seek rehabilitation, but such are the times in which we live. Ben Bernanke, it seems, is determined at doing so for his reputation, embarking upon on a PR tour in support of his upcoming memoir. The cavity between the deed and the myth is only due to the stratification wherein his popularity rests solely within the elite; the establishment, as it were. In the rest of America, his work is viewed far differently, with cold and almost totally impassioned resentment at what is perceived an arbitrary divide opened most by "quantitative" "easing."
According to Bernanke's perception, this is entirely unfounded; dare impossible. From his self-reckoning, QE's greatest impact has been to "create jobs", the very sort of influence that "Main Street" has been steadily clamoring for all these recovery years. But therein, too, lies the staggering incongruity - QE has "surely" been creating jobs though, somehow, Main Street claims to not find them.
The numbers are all-too-familiar, but worth emphasizing and recounting. Since October 2012, which was both the operational beginning of QE3 and the start of a very conspicuous and apparently durable downtrend in many labor indications, the element of economic progress (or decay) depends highly on which part you highlight. Again, already, that is a setback since recoveries, historically, haven't been up for argument; they are of such power and fury as to be immediately and unquestionably accepted by all rational argument and temperament. Here, there is mush.
From October 2012 until the universally-assailed September 2015 payroll report, the Bureau of Labor Statistics reports an increase in "potential" labor (the civilian non-institutional population) of just more than 7.3 million people. The BLS Establishment Survey (measuring labor from the employer perspective) proclaims payroll growth of 7.74 million, but the Household Survey (measuring employment from the employee perspective) reports only 5.45 million more people reporting employment. The latter is certainly trickier, but in either case leaves a serious deficiency. Since even the best case for employment and labor only covers population expansion and just a bit more, that still leaves those left out from the Great Recession uncovered by a return to work (to say nothing about what jobs may have been produced as compared to what was lost).
While there were either 7.7 million payroll gains or an increase of just 5.45 million people working, the total official labor force enlarged by but 1.2 million. Worse, of those, 1.05 million was reported on January 2015 alone, which raises continuity doubts (especially since the only other months that have recorded +1 million labor force gains in the past twenty-five years were January 2000 and January 1990). This obvious disparity, where the "best job expansion in decades" produces almost no movement in the official labor force despite a still-overflowing "slack" left over from the Great Recession, has been noted not just by critics but the QE practitioners themselves. Janet Yellen in July offered unusual (for a central banker) clarity on the matter:
"I think a significant number of individuals still are not seeking work because they perceive a lack of good job opportunities and that a stronger economy would draw some of them back into the labor force."
She didn't say it, but her words were cutting in validating the concerns presented by America's ridiculously lingering participation problem. It has, of course, grown only steadily worse in 2015 just when the economic "boom" was predicted to put all such concerns to merciful rest. The numbers themselves are bad enough in the surface headlines, but far poorer than are perceived in terms of this disturbing trend of labor incongruity. Since January, the usual setup is given by the Establishment Survey just keeping up with potential labor (Est. Survey +1.58 million; civ. Non-inst. Pop. +1.6 million). But the disparity with the official labor force and the Household Survey has simply exploded; the HH Survey reports a gain of just 599,000 new persons working, for an immodest difference of about 1 million fewer. The labor force has shrunk once again, decreasing by 465,000 over those eight months.
That leaves the economy, and Bernanke's legacy by extension, perched precariously on now two very stark problems; the first is the multi-year difference between what economists say about the economy and what the rest of the country experiences, and now a second whereby that problem is magnified with a recent, local (and global) turn toward unrest. In terms of QE, its positive effects are at best arguable in a situation where all prior recoveries had been inarguable (not exactly a good best case), and at worst beyond suspect and dubious heading toward completely ineffective and into exploring the realm of potentially harmful and deleterious.
With such an utter mess, it makes sense to examine QE as to what it actually is rather than leaving it unspecified and generic. After all, the word "quantitative" isn't attached by accident. Most people still have only a vague notion of how it was supposed to work, leaning more so toward theoretical and bland generalities about "printing money." The term "easing", after all, is connotative of exactly that (by design). Thus, "quantitative easing" suggests controlled and specified money printing; leading one to believe there is an IF X, Y RESULTS kind of process to it all.
And if you actually analyze QE's direct and operational effects on global banking, that is really all that remains - perception about what it is supposed to do rather than what it actually can. There are, of course, any number of claimed monetary channels whereby QE is believed to manifest economic progress, notably "inflation" which has instead, like employment, diverged from theory having remained below the Fed's 2% target for three and a quarter years now, and counting. In fact, as of the latest FOMC predictions for "transitory", the PCE Deflator (the Fed's preferred price gauge) is not expected to reach that 2% target until 2018. Incorporating not that lengthy failure (a five-year deviation from a set target qualifies as only that) as a factor in still more highly optimistic forecasts, economists project their version of the QE-economy as if still that mechanical relationship.
Taken under less ideological bias, that means there is actually no "if X, result Y" relationship with inflation at all. Really, there isn't even anything of money printing as Ben Bernanke himself noted back in his November 2010 op-ed in the Washington Post introducing QE2.
"This approach [purchasing financial assets] eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth."
But it wasn't "easing" as might be understood conventionally as "money printing":
"Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.
"Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation."
The Fed itself isn't even quite sure it had any effect on long-term interest rates, either. Instead, the most they can come up with are regression studies on the academic concept of "term premiums." Even here, the claims are specious and unconvincing. They are the latter because even within those studies the most they can "find" of only "term premium" effects are upper bounds of 50 bps to 100 bps despite a cumulative balance sheet expansion of $4 trillion! Some studies have modeled as little as 11 bps. These "term premium" conceptions are specious because, as Ben Bernanke himself described in a blog post from April:
The dark blue line shows the estimated term premium. The difference between the yield and the term premium is the risk-neutral yield, plotted in light blue in Figure 4. The risk-neutral yield, an estimate of what the 10-year Treasury yield would be if investors were indifferent to risk, actually rose through 2014, implying that the recent decline in yields is entirely due to a falling term premium.
That naturally raises the question of why the term premium has recently fallen by so much. The answer is not obvious. Fed policy doesn't seem to explain the decline, as purchases of Treasuries under the quantitative easing program wound down last year.
Past all that gloss of academic economism, what Bernanke is saying is that term premiums actually fell (more than a little) during the period of first threats of taper, then actual taper and finally a full stop to QE. In other words, the bond market did the exact opposite of what the Fed's theory expects and these economists have absolutely no idea why. In fact, it's worse than that as, taken blandly as a whole here, term premiums reacted far more blatantly without QE than with it.
If it didn't act through "inflation", expectations or not (more "not" since market-based expectations are back down to 2009 lows recently, especially after the relevant September payroll report), and the effects on the bond market are once more arguable, to be kind, then what has QE actually accomplished?
In that regard, we are left with but correlations with asset prices. While immediately bringing to mind equities, the other channel for QE interference is suspected "portfolio effects." This is a banking matter whereby bank portfolios are forced to extend further down risk curves (in either maturity or class transformation) as the Open Market Desk removes more "risk-free" securities from secondary (and primary, with its own set of collateral mania) circulation. So what QE actually does is this kind of risk coercion, whereby almost completely inert bank "reserves" (no money printing) are created in order to push banks into buying and fostering more risk assets and their prices; the reserves themselves are just one form of concentrated (from the system's perspective) liability that has no direct bearing on much of anything (except the withering of money dealing itself).
When discussing this "reach for yield", typically thoughts occur in relation to "dumb money" and retail; grandmothers and fixed income savers recoiling at the grotesque financial environment and holding their noses while buying a junk bond ETF yielding the same as a medium-dated US treasury bond did before Bernanke's financial heroics. This certainly accounts for some of the animosity from "Main Street" who feels the direct oppression, but "reach for yield" actually isn't as retail as it is institutional.
The numbers are mammoth, but in perspective it is perhaps unsurprising that financial institutions are the leading purveyors and ultimate buyers of the junk bond bubble. While companies have issued about $1.2 trillion, gross, in high yield bonds since the start of 2012, gross issuance of leveraged loans is nearly $2 trillion. While retail investors only account for some of the junk bonds, institutional investors, including bank portfolios, account for nearly all the leveraged loans.
In May 2014, Deutsche Bank had recently concluded a greatly oversubscribed "capital" floatation (estimated bids to placement was 20 to 1), though the exact circumstances and nature of that €8 billion is still unclear today. In its accompanying press material expounding on its turnaround strategy, the bank made obvious at least the nature of what it was trying to accomplish. In rebuilding after the panic in 2008, Deutsche had been anticipating and expecting internal profitability to drive much if not all of its "capital restoration" project. This was due, of course, to gained sensitivity to such mathematical ratios after the panic as well as the anticipated impacts of Basel III following a similar theoretical line.
And all was proceeding swimmingly at one point, where its CET1 capital ratio once stood at less than 6% in Q2 2012 (note: just before QE3 and Draghi's "whatever it takes") had risen to 10% a year later. But from that point onward, the CET1 ratio started to decline as leverage kept rising (and RWA's) but performance no longer bested it, or even kept up. That inflection was, of course, the dramatic taper selloff starting in May 2013 and meeting a climax that August or September (depending on the particular market, currency, or asset class). By the end of Q1 2014, Deutsche Bank's CET1 was down to just 9.5% again and predicted to fall further; thus, at least one reason for the capital campaign that May.
While that capital view of the bank was likely in close proximity to the expected effects of QE in asset markets (though the taper issue seems to have been a total surprise, perhaps because Bernanke more than hinted in September 2012 of "open ended" QE being semi-permanent?), what Deutsche did next was undoubtedly "portfolio effects" and "reach for yield." Where all the rest of the eurodollar system peers, save Credit Suisse and a few smaller holdouts, took the 2013 taper issue as a signal to get out of the business, dramatically scaling back all across FICC, Deutsche for some reason took it as opportunity. As spelled out in that May 2014 press/investor packet, the bank intended to use that new "capital" as a foundation for expanding much further into US junk bonds, leveraged loans and even emerging market debt - and all the wholesale money dealing financialism to support it. It wasn't exactly the top, which would come with the "dollar" turn in later June 2014, but it was close. Who is the "dumb money"?
The effects have been entirely predictable. Not only were the bank's co-CEO's forced into resignations this past June, as incessant reversals in those riskiest asset classes ("transitory" wasn't transitory enough, apparently) only built and accumulated, the bank was downgraded on what amounted to counterparty concerns over its CB&S portfolios - essentially its derivative (dark leverage) and fixed income books, now brimming with both extended in 2014 into those asset classes noted above. Wednesday, the bank "unexpectedly" announced a predicted €6 billion loss on what it claims are "impaired goodwill" due to leverage capital effects on franchise and book values, but there aren't really that many dots to connect here.
QE promised a lot, vaguely, and banks took a lot on those promises. Unfortunately for the economy, junk bonds and leveraged loans are highly inefficient conduits to economic activity (as noted in a prior column), and neither was money dealing for any of it. And so by virtue of Deutsche's still-unfolding foibles we begin to see what Bernanke refuses. The eurodollar banking system was perfectly willing to provide some partial restoration but only under the presumed cover of QE in asset prices. The turn in 2013 was really a betrayal to those presumptions, and thus most banks have been removing themselves from QE's path ever since. Several of those that sought opportunity in that drain were only fooling themselves, as the eurodollar reversal has proved far more dramatic than QE even in myth ever truly was.
Thus, 2015 has been amplification, of sorts, in that eurodollar/wholesale reversal as the last of the holdouts are bludgeoned by that raw financial reality rather than the maybe/maybe not term premiums economists conjured solely to find something that conformed to their smoothed and flat financial worldview. The message from Deutsche (and Credit Suisse) this year has been deleverage, deleverage, deleverage, which is quite contrary to what "should" be taking place in the boom they all spoke of as late as this past winter. The related events of this year, and you have to consider the junk bubble swoon especially since July (not long after, coincidence or not, Deutsche's ratings downgrade), have only impressed greater urgency in getting the bank to where all the former eurodollar practitioners already are.
Without such necessary internal financial support for the whole "dollar" system, it is no wonder "term premiums" are collapsing more without QE than with it. It is entirely perverse, where QE created these very conditions by thoroughly misaligning its mystique with what it could actually influence or deliver (which, again, is only a choice between very little and somewhat harmful). Some of this wholesale reversal was, admittedly, inevitable owing to the circumstances of the buildup to 2007 and how it was forced, by the market, to unwind in 2008 and early 2009, but Deutsche Bank's story within it represents the antithesis of even the idea of "quantitative" and "easing."
By such comprehensive count, then, the full weight of the attempt has been entirely upside down; the risks asymmetrical. In other words, there was very little actual gain from the monetarism, and what has been brought up as recovery is conspicuously lacking unlike all prior recoveries (save the relevance of the dot-com recovery and the housing mania). The downside risks, however, were already great owing to those structural "dollar" deficiencies but enhanced now (another in the serial line of asset bubbles, this time without much by way of actual financial support and systemic liquidity) by what little can actually be traced to QE.
Relatedly, Rice University's Baker Institute for Public Policy recently celebrated the 30th anniversary of the Plaza Accord. The think tank being named for the former Secretary of State who initiated the gathering, you can appreciate why the event was geared toward discussing, "a uniquely successful example of currency policy coordination." Including an interview with former Fed Chair Paul Volcker, all that purported "success" left an apparently ineffaceable puzzle:
"Why has the Plaza coordination of 1985 never been successfully repeated? How do currency markets, major players and coordination possibilities work today? Do we need to manage a dollar depreciation today? Is there an alternative to currency manipulation and currency wars?
"These questions have puzzled economists for three decades."
All but five of the eighteen presenters were PhD's in economics, including former Secretary Baker and Mr. Volcker. I don't know if they got around to discussing term premiums or inflation expectations, but I seriously doubt any of them incorporated or appreciated the condition of Deutsche Bank's balance sheet in moving the actual "dollar" where it has. Maybe there hasn't been another such Accord because congregating politicians in some ballroom of the highest end hotel no longer carries any balance; economists just haven't gotten the memo though they have been warned at various points along the way (yes, that Greenspan 1996 quote again). It's not even enough to say the dollar isn't what it used to be, though that is literally true in every sense of monetary evolution, actual economic and financial recovery demands recognition, contra Bernanke's attempts, of why these economists continue devoutly dutiful toward proving over and over they don't know what they are doing. The cost is rising by the day, and Bernanke only seeks, still, now out of office, to add to the inevitable bill.