Unsound Money Stands In the Way of a Real Recovery

Unsound Money Stands In the Way of a Real Recovery
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I think it absolutely clear that the American people, as well as so many other groups of concerned citizens around the world, have been incredibly patient. Over the last decade, in particular, they have been told to let things work themselves out, to not worry about the great consequences that were unfolding before their very eyes because the best and the brightest minds were on the case.  Momentous though these considerations were, their considerable intellectual capacity and combined acumen were pledged as an antidote to any general wariness.  

For the most part, that was how all these “emergency” programs were treated.  There was the occasional backlash, but these didn’t define the overall reaction to the official response, more so disagreement with the form of it rather than the whole thing.  Maybe that was at least at the start a function of the haze which the severity of the crisis created, the general population being stunned sufficiently such that deference was the natural instinct.  Human history is replete with examples of where crisis breeds almost herd-like submissiveness.

But in many ways, too, there was almost a Christian forgiveness in it, as a good many people saw and heard Ben Bernanke assure us that subprime was contained, and many, many more words to that effect in almost a constant stream. Yet, by late 2008 it was clear subprime was not contained and more so that subprime wasn’t really the overriding problem, a fact that most people intuitively understood by then that the chief monetary officer, so to speak, of the United States should have known.  Still, when he announced ZIRP and especially a first round of quantitative easing (it was only supposed to be one), he was given the benefit of the doubt anyway, a benefit that would last through a second, a third, and a fourth.  Central bankers in other places acted similarly, handed uncritically similar discretion.

Patience, like money, is not infinite.  The Japanese being the exception, four QE’s are, in fact, a stark admission of failure for at least the first three (leaving the fourth to be at least similarly suspect).  Populist revolt is not something that sprang up overnight, a sudden rush to torches and pitchforks, in the ballot box sense, born of irrational emotion.  Yet, that is exactly how it is being portrayed by those who have been given chance after chance after chance to succeed. 

Klaus Schwab, the man behind the World Economic Forum, the organization behind the annual Davos retreat, warned recently that globalization is “a very easy scapegoat.”  He suggested instead that “emotional turmoil” has gripped so much of the world because, among other things, things are changing and new technology is threatening jobs.

Bank of England Governor Mark Carney recently made a similar assessment.  Somehow maintaining a straight face, he said that “monetary policy has been highly effective” before going on to recognize, as the Financial Times quotes, “anxiety about the future has increased, because productivity hasn’t recovered and, as a consequence of the latter, because real wages are below where they were a decade ago — something that no one alive has experienced before.” Forgive us, then, if we don’t arrive at the same conclusion about monetary or any other policy.  A major negative result “that no one alive has experienced before” is legitimate cause for some kind of legitimate uprising, no? 

And this is where economists get overly excited, claiming that we aren’t astute enough to understand how Carney can be right about both ends; effective monetary policy that effectively delivers nothing.  The difference is the familiar fallacy of “jobs saved.”  Says the BoE chief, “Monetary policy has been keeping the patient alive, creating the possibility of a lasting cure through fiscal and structural operations.” That’s not what central bank chiefs declared as a successful and effective outcome when they started experimenting with QE. Populists and those growing numbers amenable to their ideas have noticed the downgrade. Economists started out promising full recovery and are now saying “at least it wasn’t worse.”  For a minor recession and several years of stagnation that might follow it, that would be a big deal.  For the level of contraction in 2008 and 2009, where it spread all over the world, is a disaster beyond these childish qualifications.

Most people are quite aware that there was no recovery after the Great “Recession”, a global fact that bears repeating, so unbelievable would it have been to someone living in 2007.  What drives this rejection of globalization is not globalization per se, rather it is a realization after more than enough time that if economists were so completely wrong about the Great “Recession” and then its aftermath they might be wrong about a great many things, if not even everything.  If these so-called experts are what they claim to be, then why the hell didn’t they say first that a great calamity was coming and that it would lead to a total economic break?  You are not an expert if something so monumental catches you by the same surprise as the laypeople you now decry.

Basic competence would have required at least a moderate warning about this as a possibility.  Those who did provide that warning were summarily dismissed, but what they warned about is almost a decade later now the admitted (but hushed) truth.  Again, the people see this and appreciate exactly what it means, expressing it right now in voter revolt all across the developed world (again, Japan the notable and constant exception).  With votes still to come in France and Italy, the stakes are enormous.

As such, the rush to defend globalization is itself a logical fallacy, a distraction for the status quo.  Who can be against free trade?  If you declare opposition to the last twenty years, then you aren’t to be taken seriously about anything.  Populists are against free trade, therefore populism is dangerous.  The real question, however, is who gets to decide what is and is not “free trade?” It should be an uncontroversial topic.  Obviously, economists and central bankers and all those who gather at Davos are saying that is what globalization has been and will continue to be.  The vast global population isn’t so sure anymore.

The leading edge of the elite defense has been to offer a very small and qualified apology.  Economists are now saying they erred, not on matters of policy but not in being explicit enough about the consequences of “free trade.”  Mark Carney referenced this in his speech, as well as Klaus Schwab when he spoke.  At the annual American Economics Association gathering in Chicago this past weekend, the Wall Street Journal reports a great deal of “angst” because of “public scorn” and even “disdain for initiatives they championed.”  Joseph Stiglitz said the problem was economists who “overpromised”, though the “science” of economics remains rock solid.

The vast changes of which all these economists speak does appear quite similar to those experienced by past generations at similar moments of great change. To the elite like Carney and Stiglitz, populism of the early 21st century is no different than populism of the early 20th.  When William Jennings Bryan spoke out against gold as if an enormous burden, he did so on behalf of all the dispossessed, primarily farmers and farmworkers, unable to compete with capitalistic progress, forced to migrate in huge numbers to the cities in order to find work in industry rather than agriculture.  It sounds just that simple in writing about it, but in reality it was an enormous social disruption with, for many, an uncertain future. Though we are all so much the better for it, I wouldn’t want to be in their shoes, either. 

The technological revolution of the past few decades makes the comparison sound plausible.  There is and has been an enormous transformation in many economies away from industry; and yet, it is industrialization of foreign nations, particular in so-called emerging markets, that have brought them (the appearance of) prosperity seemingly at our expense. Economists have argued that the US factory worker who loses his job to Mexico or China is being given an opportunity to do better; that factory job is being replaced by a job as a software engineer or some other such that if the factory worker takes advantage of the opportunity will leave him far better off, not just financially, in the long run.  The plight of that factory worker is thus established as a personal choice, the policy already proved.

But is that really the case?  What if instead the factory worker loses his job and his opportunity is not a cushy office job of intellectual capacity and fulfillment but rather pouring coffee at Starbucks or greeting shoppers at WalMart?  Such anecdotes are not data, but all the data bears out this deficiency – especially after the Great “Recession.”  Every single labor statistic not just here but elsewhere shows that the economic dislocation at that time was in the truest sense of that word.  There is far less labor being utilized today than a decade ago.  And what labor is being utilized today is far more like, as David Stockman calls it, of the “waiters and bartender” economy that doesn’t include “breadwinner” employment.

That’s not the lack of comprehensive distribution of globalization benefits that officials like Carney are trying to say is the downside, so easily dismissed as the complaints of the “losers” in the otherwise long run increase in living standards.  It is instead the very real evidence that social progress in economic terms is no longer progressing.  The rise of populism is nothing like that which propelled W J Bryan to almost the Presidency, it is a cumulative act of recognition that very, very little is as it should be.  In the Industrial Revolution, farm workers had industrial jobs to transition to; in the current era people realize there may not be any jobs at all if they are so unfortunate, a desperately bleak outlook that demands serious consideration no matter how irrational it appears to “rational” variables in statistic models and functions that have gotten everything wrong for all this time. 

Indeed, it is even worse than all that as one of the more prominent disassociations especially since 2012 is that those nations who had been industrialized before, experiencing the “miracles” of what looked like globalization benefits, are no longer so prosperous.  Emerging markets have been thrown into a constant state of turmoil from which they cannot actually emerge no matter what they do.  The Chinese have been first in that unfortunate line, given the prominence of the Chinese economy, but the damage has been more extensive elsewhere. 

In Brazil, for example, industrial production collapsed by more than 21% in just the last six months of 2008.  That isn’t surprising. As of the latest figures for November 2016, industrial production is down once again by more than 21%, this time from the prior peak in June 2013 forty-one months ago.  At least there was an upturn in 2009 and 2010, to where sixteen months after the bottom IP had recovered the prior peak.  This time, there is no upturn. Prosperity disappeared and doesn’t look set to return. 

This pattern of economic behavior is not unique to Brazil; stack Brazilian IP against Chinese and the outlines are exactly the same, only the ultimate levels of the patterns being so different (in Brazil, output is collapsing; in China, merely decelerating).  For both countries, the difference of absolute levels is no difference at all, for if their economies are not growing as they once were they are in mortal danger. 

Chinese President Xi Jinping will be the first such Chinese official ever to attend Davos, and his message will be a familiar one to this discussion. He is expected to push the same canard, where populism is the path to “war and poverty”, while the same type of globalization is the only way forward to salvation.  He doesn’t appear set to address, nor do I expect him to, how we already have the poverty and are merely missing (to this point) the war that typically throughout history has followed extensive malaise.  It is incongruous for him, and the rest, to claim that doing the same things that have led to that poverty will correct that very problem. 

What he clearly means is quite simple; the Chinese want to go back to 2007 again.  As the primary beneficiaries of “free trade”, it is in their interests to rekindle that romance.  Prior to 2008, Chinese exports would average 20% to 30% growth, and industrial production, fixed asset investment, and all the rest of the primary economic functions were at similar speed. Over the past few years of the “rising dollar”, Chinese exports have contracted and the whole Chinese economy grinding to nearly a full stop.

Attaining such growth, however, was never a miracle.  One need only examine the balance sheet of the People’s Bank of China for the answers.  In September 2011, the PBOC records total assets of RMB 28.5 trillion, of which 84.7%, or RMB 24.1 trillion, were “Foreign Assets.”  Up to that month, both total assets and foreign assets had been almost steady in their growth, accounting for why the Chinese experience during the Great “Recession” was relatively brief, if still sharp.  From September 2011 until December 2012, the foreign asset basis of China’s entire monetary regime ceased expansion.  It was during these months that the Chinese economy first began to slow in a way very different than its experience during early 2009.

September 2011 is notable, of course, for the plethora of wholesale banking problems that reignited crisis in much of the developed world. For a brief time after 2012, the official balance of forex increased again but only until May 2014.  Topping out at RMB 28.1 billion, and 85.4% of the total balance sheet at that time, the balance of foreign assets has declined by an enormous RMB 4.8 trillion, or an unthinkable 17% since.  The PBOC has responded by initiating several internal liquidity procedures to cushion such a huge monetary blow, but China’s economy has behaved as if being dragged down by persistent monetary instability. As of November 2016, forex assets were only 68.5% of the PBOC structure, meaning enormous RMB infusions that rather than fix the problem create further redistribution feedbacks that are often as big a problem (in reality) as the imbalance they aim to solve (in theory). 

This has been a near-constant feature of the global economy during this entire period, for what we have to realize is that globalization in this context is really just eurodollar expansion and then contraction (or decay).  During its growth period, especially the first part of the 2000’s, most were happy to accept “free trade” because it seemed to work; some places far more than others.  After the eurodollar break in 2007, suddenly globalization is no longer popular and nothing seems to work anywhere, least of all monetary policies.  That assessment clearly includes the Chinese and their central bank who are, for all intents and purposes, closer to actually having been printing money than any other central bank.  And it still isn’t nearly enough.

We have arrived all over again at 1944, the year of Bretton Woods, though so far, fortunately, without the war conditions that enveloped the whole process.  What I mean by that is years before WWII, economists including John Maynard Keynes in the UK and Harry Dexter White in the US realized the Great Depression was “great” because of monetary instability.  These men were no great admirers of unfettered free markets (White was actually a Soviet spy, high up in the US Treasury Dept) and still saw that without a stable monetary system there would be no economic rebirth let alone sustainable growth.  White argued, as retold in Benn Steil’s book The Battle of Bretton Woods, “the lesson of the 1930’s was that exchange rate instability was politically disastrous.”  From the position of the time and setting, that was a powerful indictment.

In reviewing Steil’s book and commenting for himself on those lessons learned the hard way, Forbes editor John Tamny writes in 2013:

 “To monetarists the Fed is never ‘printing’ enough money (they point out that today’s QE dollars are mostly at the Fed), and that’s of course true given the tautological reality that producers will never demand that which lacks credibility for it being unstable, and often falling in value.”

The problem of the eurodollar, indeed just money in the most stripped down terms, is not one to be solved by “quantity.”  If there is a “dollar” shortage in the world, as I believe there is, it isn’t to be eradicated by some central bank somewhere creating more of something.  The answers are not to be found in the public sector, they are to be made by a private sector where money is put back on honest terms.  The great problem of the eurodollar is that we can’t even define it, so how would the Federal Reserve meet its various and multi-dimensional deficits?  The short answer, which should be perfectly clear by now, is that they can’t and never will. 

The very idea of honest money is to make it simple and universally accepted without further definition or qualifications.  The eurodollar is perhaps the logical end of “floating” currencies, where in this case it has floated in all sorts of ways we still don’t understand.  I have spent the better part of two decades trying to figure out all this stuff, and I am still more concerned today about what I don’t know than what I have actually been able to catalogue. That’s an enormous problem not as a personal shortcoming but as the relevant systemic issue.

Thus, the monetary answer is not a QE for eurodollars or moving monetary targets to eurodollar-related monetary numbers, it is to establish a system that no longer contains eurodollars at all. I would not argue that Bretton Woods was the perfect solution, I am more a critic than a fan, but at least they got the concept right if “off” on the execution (why it only lasted until 1960 and the establishment of the London Gold Pool).  It is fashionable to attribute the explosive economic growth in the years and decades immediately following the new monetary order to the war, but the contributions of monetary stability were far more important in sustaining that growth all the way into the 1960’s (when the eurodollar really started to intrude). Ironically, the very seeds of globalization and actual free trade were planted in this fertile, stable ground.

Ben Bernanke, Mark Carney, or any other in the endless litany of confused economists were all expecting the Great “Recession” to be a recession and nothing more.  Implicit in their changing narratives is that the Great “Recession” really wasn’t a recession at all.  And if it wasn’t, then it must have been a monetary event.  Because of that, central bankers are going to say that monetary policy was terrific even though the best they can claim of it is couched in dubious “jobs saved” rhetoric.  The sudden defense of globalization and “free trade” is, again, a distraction though not unrelated.  Since “free trade” has itself been monetarily-driven, its failure is likewise in the same category.

Populism in this age is therefore inverted to its earlier incarnation.  Bryan was wrong and was therefore almost an impediment to rising living standards.  Sound money prevailed, and the Industrial Revolution strolled ever onward, if never free of its messiness and personal disruptions.  It is orthodox monetary theory that now stands in the way, predicated on unsound money to the point of raw ignorance on the subject, a recognition that is for the first time more than politically acceptable and getting more so by the election.

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

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