Ten Years Later, There's Still No Economic Recovery
As has become typical, the Federal Reserve Chairman’s semi-annual Congressional update on all things banking and economy was overshadowed by events. This time for Humphrey Hawkins its Jerome Powell’s turn, taking his place where Janet Yellen and Ben Bernanke had been before him. He says all the same things they did, as they mostly do. The economy is doing great, thanks to him.
This week marks one of those ten-year anniversaries that has gotten lost in the noise of aftermath. That there was an aftermath should have been an important clue, but the status quo is gifted tremendous inertia.
On July 15, 2008, then-Chairman Bernanke was before the Senate attempting to be cautiously optimistic. Sure, there had been a lot of nasty surprises, he said, but there was a growing sense the worst was behind. For the policymakers at the FOMC, they had already let themselves believe Bear Stearns might have been the end of it.
While that was his main message, it was completely overwhelmed by Fannie. And Freddie. The GSE’s were in trouble again, not that anyone in any position of authority agreed with the assessment. Markets were wrong, they claimed. One who made exactly that remark was Senate Committee Chairman Christopher Dodd, of Dodd-Frank fame, who opened Bernanke’s Humphrey Hawkins examination with the following absurdity:
“In considering the state of our economy and, in particular, the turmoil in recent days, it is important to distinguish between fear and facts. In our markets today, far too many actions are being driven by fear and ignoring crucial facts. One such fact is that Fannie Mae and Freddie Mac have core strengths that are helping them weather the stormy seas of today's financial markets. They are adequately capitalized. They are able to access the debt markets. They have solid portfolios with relatively few risky subprime mortgages.”
What were those “crucial facts” markets were unable to figure, caught as they supposedly were in the irrational grips of fear? As it turned out less than two months later, the GSE’s didn’t survive unable to access any debt markets anywhere. They were turned over to federal government conservatorship the week before Lehman. Then all hell broke loose everywhere.
In order to scold the stock market for daring to question “crucial facts”, joining Ben Bernanke at his Congressional appearance on July 15 was Treasury Secretary Hank Paulson and SEC Chairman Christopher Cox. Mr. Cox’s presence was even more noteworthy than Secretary Paulson’s. Just that same day the agency imposed a ban on naked short selling, not just for shares belonging to the GSE’s but also those of primary dealer commercial banks.
It was the proximate cause of all that came next. Oil prices, importantly, peaked on July 14, 2008, falling sharply with pretty much everything when news of the short selling ban was released to the public. The crucial facts that the global markets began contemplating July 15 and after was that authorities, especially Ben Bernanke, had no idea what they were doing.
Overseas economies which were thought able to “decouple” from US and European subprime problems after July would instead get sucked into the devastating monetary whirlwind, too.
In policy terms, however, everything was simply rearranged starting with the whole financial frame of reference. If July 2008 was about how Bernanke believed the Federal Reserve had prevented some truly bad stuff from happening, by July 2009 it was purposefully switched to how the Fed had prevented some truly bad stuff from becoming truly truly bad stuff.
Speaking before Congress in the summer of 2009 again because of Humphrey Hawkins, Bernanke claimed the government including the Federal Reserve “may well have averted the collapse of the global financial system.” As Congressman Barney Frank, of Dodd-Frank fame, noted on the same day, “no one has ever gotten re-elected with the bumper sticker that says, 'It would have been worse without me.'”
As a staunch defender of the central bank, he actually meant that as a compliment to Bernanke. Criticism, supposedly, was lacking crucial facts and people were starting to get the sense that maybe a global monetary panic maybe should not have happened to maybe any degree at all (thus, Barack Obama). In the years since, Frank’s words have attained more literal truth than figurative defense. Nobody wants to believe the central bank is little more than a monetary passenger, yet the nagging feeling persists.
After all, how in the world could subprime have done all that? Bear Stearns failed, and it wasn’t, as I wrote on the 10th anniversary of its demise, some obscure subprime peddler like Countrywide. It wasWall Street. Likewise, Senator Dodd was right about one thing and one thing only in July 2008. Neither Fannie nor Freddie had much to do with subprime, either.
Using subprime as an excuse meant making a monetary event seem like something else, an exogenous factor beyond the scope of monetary policy. Irresponsible lending practices sounds just plausible enough to keep anyone from seeking the right answers, and maintaining Economists in the business of political authority. Inertia.
So, ten years later we still wait for recovery having supposedly avoided “the collapse of the global financial system.” In every one of those years the Federal Reserve Chairman appears in front of Congress, twice at each House, and declares how the economy is getting back to normal – only to be overshadowed by more events that equally have nothing to do with subprime mortgages.
Many people now speak of the US economy in particular as if it is booming. They do so, however, from only one piece of evidence: the unemployment rate. The number itself is uncorroborated by any other data, especially wage growth, therefore in the absence of corroboration it is supplemented by a plethora of anecdotes. Most of them either refer to some imagined labor shortage (again easily refuted by wage and income data, income data which declares rather than suggests alarmingly decelerating labor markets to nearly nothing the past three years, including every month so far of 2018) or the idea of globally synchronized growth.
This latter concept is actually based on the belated acknowledgement that something hasn’t been right about the world’s economy since, well, July 2008. In 2017, for the first time all the major systems were positive at the same time. How tiny little subprime managed to keep them from accomplishing this “feat” for a decade is another huge mystery.
No one has yet explained why “synchronized” might actually matter. It is instead a term of art conjured up because just plain “global growth” had already been used – in 2014.
It leaves poor Jerome Powell to testify of a US boom based in most part on a labor shortage no one can identify in fact rather than story plus an additional qualification to an idea that already failed just three years ago.
And now global growth is in jeopardy, synchronized or not.
Germany is the engine of Europe, one crucial fact that even US authorities would agree on. The German economy at its margins is an export-based system that therefore reflects global economic conditions in its own composition.
According to Statistisches Bundesamt, between 1975 and 2014 France was Germany’s largest trading partner. It was a two-way arrangement with a heavy amount of trade flowing in each direction, though, obviously, favoring on balance the Germans over the French. This was in many ways the basis of globalization as a political ideal; trading partners don’t make war on each other and given the history of the first half of the 20th century in these two countries alone, Germany and France as important economic partners was an unqualified success in more than economy.
France is today (as of 2017) Germany’s #4. It has been surpassed by the United States, but only as #3. The second largest trade partner is actually the Netherlands, as a point of redistribution, however, to the rest of the world. Officially now #1 to Germany is the People’s Republic of China.
Year-over-year in May 2018, total exports from Germany fell 1.3%. It was the second contraction over the last three months. More ominously, exports to countries outside of Europe declined by 6.4%. Almost certainly as a related result, German imports were up just 0.8% in May, with imports from countries outside of Europe dropping by nearly 2%.
German exports rose 6.3% in all of 2017 from all of 2016. For the first half of 2018 so far, exports are up just 3%, with, again, more recent indications trending at best uneven. Global trade was supposed to be the key component to globally synchronized growth.
These are not the only signs of growing concern.
The Zentrum für Europäische Wirtschaftsforschung (ZEW) is a think tank of sorts located in Manheim. Since 1991 it has produced a survey of analysts working at important banks, insurance carriers, and industrial firms. The ZEW’s Indicator of Economic Sentiment is drawn from that survey and is widely followed well beyond Germany’s borders. Again, Germany’s economy can say a lot about everywhere else.
Since January 2018, the ZEW has collapsed. To begin with, it wasn’t all that great throughout 2017 even as this globally synchronized boom narrative propagated in place of actual economic growth. It never got above +19.5 last year, noticeably less than prior peaks of +62.0 in December 2013 or +57.7 in September 2009. Last year’s ZEW was instead much too much like early 2011’s shallow high, just +15.7 that particular February.
Also repeating 2011, the ZEW is down sharply in a matter of just a few months. Over the last six since January, including the latest estimate for July 2018, the index has shed 45.1 points, sitting now at -24.7. That’s the lowest level, by far, since August 2012 when Europe was last in “unexpected” recession.
This is Trump’s fault, they’ve already started to claim. Trade wars and threats of more retaliatory activity, some say, are having their predictable effects. Conjuring images of Smoot Hawley, bad US policy is going to be blamed no matter what. Like subprime, it is convenient and for some conveniently obscures the repetition.
The same people making noises about trade wars were seven years ago blaming currency wars. In lots of mainstream convention, there isn’t anything a government can’t do (except, of course, stave off panic and downturn). Throughout late 2010 and early 2011, the newspapers and media outlets were filled with stories about how the US was provoking a currency war via so much “money printing.”
The first foreign official to suggest this was Brazil’s Finance Minister. In September 2010, just after Ben Bernanke spoke at Jackson Hole in Wyoming practically announcing a second QE, Guido Mantega was outraged for what so much “easing” was going to do to his country’s currency, the real. He wanted it weaker, not the dollar.
Ironically, the dollar’s fall would stop in April 2011, just months after the whole currency war thing became a thing. Like Germany’s ZEW and its export trade, the middle months of 2011 were not swept up in an inflationary wave lifting the global tide and with it all of the national economic boats. Quite the contrary, commodity prices soon plummeted and with them a great many economies, including Germany’s.
Over the years since, Guido Mantega would actually be granted his wish – and then regret it. He wasn’t, however, gifted a “strong dollar” by Ben Bernanke, Treasury Secretary Geithner or either Senator Dodd or Congressman Frank. The real, like so many other currencies, was pummeled by something else entirely.
If we go by just Humphrey Hawkins, then we have to conclude that these looming trade wars will be, just like the former currency wars were, nothing other than the nefarious work of subprime mortgages. Apologies to Mr. Bernanke, but subprime cannot have been contained because now eleven and almost a half years later the same things keep happening in the same ways.
This includes, of course, what’s going on in the People’s Republic of China. Globally synchronized growth may have been a Western idea, but it was written down in Chinese characters. But what the Chinese economy experienced in 2017 wasn’t actually different than the ZEW or any of the other reflationary improvements we found all throughout the world.
In real terms, GDP in China has barely budged since slowing under 7% in 2015. In more important and less fudged nominal terms, GDP accelerated more noticeably.
During the worst of the “rising dollar” period, the accumulated work of the “strong dollar” Guido Mantega once worked for, nominal GDP was less than real GDP. In both Q3 and Q4 2015, China was gripped by deflation. Bank reserves had contracted, sharply, a big shift from how bank reserves were always believed to grow rapidly.
This tightening on money was contrary to the PBOC’s intent, China’s central bank having reduced benchmark interest rates several times before those quarters along with reducing the banking system’s required rate of reserves (RRR). Both measures were supposed to offset the central bank’s involuntary balance sheet contraction.
The simple reason the PBOC was leaving the level of bank reserves to outright fall was because its asset side, the majority of China’s monetary base in forex especially “dollars”, was shrinking. In conventional terms, this is called capital “outflows” but that, too, is wrong. The word outflow implies that money leaves one place and therefore has to show up someplace else.
In the eurodollar world, this money leaves China (or Brazil) and is destroyed, obliterated by the keystroke of a bank accounting system (the technological successor to the bookkeeper’s pen, as Milton Friedman once observed of eurodollar creation). Why “dollars” are destroyed is every bit as important in July 2018 as it was in July 2008.
Not wishing to suffer further miscalculation and the potentially devastating economic effects from it, the Chinese central bank began 2016 “printing RMB.” Reflation eventually took hold and nominal GDP accelerated in China from a low of 6.4% in Q4 2015 to a high of 11.7%. This may sound like a lot but in 2011 on the cusp of that global letdown nominal GDP had sped up to a high of 19.7%.
The bigger problem for the rest of the world this year is that the top in China’s nominal reflation was reached in the first quarter of last year. It’s been slackening for five quarters now, spending the balance of 2017 slowing a little, down to 11.1% by Q4, and then slowing much more in the first half of 2018. In the latest estimates released at the start of this week, nominal GDP grew by just 9.8% in Q2 2018.
Trade wars? Like the conspicuously brief 2010-11 currency wars, there is something else going on here.
Some boom, this globally synchronized growth. You might begin to wonder how markets might interpret such crucial facts different, very different as they are from the narrative and the expectations for global growth produced by that narrative. You might also start to think that if you were a money dealer hoping for the one trend (opportunity) but seeing instead only this other one (risk), it would make sense to pull back on money dealing slowly at first and then at an accelerating rate when everyone else sees the same things, too.
If you were to do that, we would then expect deflationary symptoms to intensify and spread. Commodities like copper and gold would decline sharply, and they would have infected currency translations especially in places like Brazil and China where this “strong dollar” would surely play havoc with them all over again. Guido Mantega didn’t say trade war, he is no longer a Brazilian minister, but his successor might as well do it just to make it official.
Copper and gold are down big recently and going further as I write this. BRL and CNY likewise, with CNY falling to near 6.80 now. One Wall Street Journal headline this week: German Economy Loses Luster as Global Tensions Bite. Which global tensions, exactly? And why are Chinese bank reserves contracting again?
Subprime mortgages. Obviously.
