Markets See the Gathering Downside That Powell Does Not

Markets See the Gathering Downside That Powell Does Not
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“At least Iowa is going to hell slower than everywhere else.” That was Charles Evan’s joke to try and lighten the mood. As President of the Chicago branch of the Federal Reserve, it was his job to summarize business prospects throughout the Seventh District which includes the Hawkeye state. There was nothing good to be said by anyone.

Evan’s jest was actually preceded by another from, surprisingly, Janet Yellen. There must be something about the depths of crisis to bring out the lighter side, even for those when it might not match their public persona. These are Economists, after all, so they aren’t expected to be professional comedians. Still, there is something telling about the level and content of the dry humor.

“MS. YELLEN. An accounting joke concerning the balance sheets of many financial institutions is now making the rounds, and it summarizes the situation as follows: On the left-hand side, nothing is right; and on the right-hand side, nothing is left. [Laughter]”

This was December 15, 2008, ten years ago. The FOMC would gather starting on that date ostensibly for its regular policy meeting. This was no ordinary session, however. The levity interspersed throughout was befitting a funeral of sorts, the tension and deep disappointment leaping out from the dead pages of transcribed text.

It was, in many ways, the end and policymakers seemed keenly aware of the possibility for the first time.

The FOMC’s Chairman Ben Bernanke would get in on it, too. In times like these, it can be perversely comforting to notice and note the foibles of some other outfit performing as bad or worse than you.

“CHAIRMAN BERNANKE. I will just note for the record here that the NBER has finally recognized that a recession began in December 2007. I said in the Christmas tree lighting ceremony that they also recognized that Christmas was on December 25 last year. [Laughter]”

It took the NBER a whole year to recognize what became obvious to recognize, sure, but it wasn’t their job to prevent it. In his introduction to the marathon session, Bernanke’s words would herald the arrival of the lost decade:

“CHAIRMAN BERNANKE.  As you know, we are at a historic juncture—both for the U.S. economy and for the Federal Reserve. The financial and economic crisis is severe despite extraordinary efforts not only by the Federal Reserve but also by other policymakers here and around the world. With respect to monetary policy, we are at this point moving away from the standard interest rate targeting approach and, of necessity, moving toward new approaches.”

Though no one would ever state it outright, at that meeting or any other, the Federal Reserve had utterly failed at every single thing it had tried. This conclusion cannot be in doubt, it wasn’t then, simply because they had led us all to this “historic juncture.”

But if ZIRP and QE were the genius response, how come things continued to go wrong? You never hear much about that nowadays, as much of a blackout as it was contemporarily.

Two weeks into the New Year, on January 16, 2009, the Committee Members were once more rousted and summoned to another emergency conference call of the kind they had sadly become accustomed to. One of their prior “solution” schemes was already at risk of unraveling.

Merrill Lynch had been in as almost as dire straits as Lehman the prior September. The former “investment bank” was arguably forced into the arms of an unsure Bank of America during the heat of the panic. It was supposed to mark the end of the matter for both ML and BofA; and yet, as the transaction legally closed on January 1 all it had done was threaten to bring the bigger, presumably more stable depository bank closer to the brink. Google the joke about dog poo and ice cream.

ML was still losing money, a ton of it, on illiquid, badly priced markets. The FOMC’s General Council Scott Alvarez stunned (I imagine) call participants in mid-January by disclosing Merrill’s now Bank of America’s hit as “in the mid-20’s pretax.” What he meant was a loss of around $25 billion for Q4, up from estimates of “only” $10 to $15 billion the company had privately communicated just weeks earlier. Only Citibank, already bailed out, had managed to lose that much.

BofA along with the Federal Reserve and the Treasury Department had by then agreed to a rescue the rescuer by January 16. But why? ZIRP, QE, TARP, etc., Bernanke’s “new approaches” had already been launched. Surely the markets were reasonably assured by them so that they would absorb even bad news. That was their purpose, after all.

Except, though some markets did get better after December 15 and 16, 2008, it wasn’t where it was needed so that they all would flush all over again after January 7. That particular date stands out for the reasons cited above; it was when the minutes for the mid-December policy congregation had been published. These are not transcripts, instead a highly sanitized and condensed version of the discussion (omitting all the dark comedy).

They do have to be somewhat realistic, though, while being succinct which meant these minutes contained the following attention-snatching statement:

“Even with the additional use of nontraditional policies, the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial.”

It was an ominous confession. Previously, Bernanke’s Fed had been committed to making sure something like this didn’t happen and all communications were formed from that approach (we are doing X so as to prevent the worst economic outcome). From mid-that point forward, it was a huge shift toward managing the fallout because it did happen (we are doing Y so as to make sure the worst economic outcome is less worse). A lot of very wary people, formerly maestro believers, got the message.

The Fed “put” was on very shaky ground by then; after January 7 it didn’t exist. It couldn’t exist.

For policymakers, this wasn’t a big deal; they easily switched gears because they have no skin in the game. Everyone else saw it for what it was – “despite extraordinary efforts not only by the Federal Reserve but also by other policymakers here and around the world” this was the world’s unescapable fate.

The Bureau of Labor Statistics estimates that the US economy had shed an astonishing 1.9 million payrolls during Q4. In Q1 2009, after ZIRP and QE, it lost another 2.3 million. The quarter following that, 1.5 million more. The worst nine months in generations.

It’s also when the Fed’s real, and only, talent kicked in. It was in early January, that third wave of liquidation and crisis coming long after all the non-standard approaches had been launched, the narrative changed to “jobs saved.” It would also studiously omit “around the world.”

As in, how could this be a global issue? There was panic pretty much everywhere always beyond the grasp of central bankers who had declared for decades this thing wouldn’t, couldn’t happen. Why were German and Japanese banks failing for a US housing bubble? Nobody really asked that question (despite what had been hundreds of billions of dollar swaps with overseas central banks).

Policymakers had all studied two things strenuously which they believed would give them enough ammunition in the modern financial world; the Great Depression, no one more than Bernanke, and Volcker. If the former was about what not to do, the latter was about what to do.

It had become legend that in 1979 Paul Volcker stood his ground amidst the opposite monetary imbalance, the Great Inflation, and therefore established the modern communications doctrine. All any central banker had to do was declare himself undeterred, that he would do whatever it took to achieve his goal. So long as he is willing, markets would bend to his will. This would eventually become the Fed put.

And it was Janet Yellen in December 2008 who had ultimately summoned the myth.

“MS. YELLEN. In sum, I think we are moving to a Japanese-style deflationary, zero nominal interest rate, situation at an alarming pace. To stay in the game and control expectations, we need a Volcker-like transformation, something like—although the situation is different—the ’79 announcement, which knocked private-sector priors off the idea that they should trigger all reactions to announcements on nominal interest rates. You need a dramatic move that emphasizes this new reality.”

What “new reality”, you ask? They failed. Time for something else. She was championing bold, and the rest of them figured QE and ZIRP was just the ticket.

To see it all fall apart within weeks was a blow from which they never, ever recovered. This is why they did QE twice, then three times, and then for ridiculous measure a fourth time in December 2012 – and nothing else. Lower for longer, as the slogan became in money markets once economic lethargy stretched year after year, had itself become a joke.

It was Charles Plosser of the Philadelphia branch who before the vote on ZIRP recognized the real risk, echoing Yellen:

“MR. PLOSSER. First, I believe we need to publicly convey that we have entered a new regime. Otherwise, it may look as though we have lost control of monetary policy…”

As Bank of America would signal, it was already too late. It wasn’t they had “lost control” more appropriately they never had it to begin with. Going back to Yellen, this was why:

MS. YELLEN. A third factor that worries me is that, in contrast to many past recessions, this one is global in nature, and the fact that it’s a worldwide slowdown—while lowering commodity prices, which is good—is also going to make it harder for us to pull out.

Much harder in more ways than she would ever realize. Recall that it was Yellen who took over for Ben Bernanke in February 2014 just as another (the third) worldwide slowdown struck. And she struck much the same tone in 2015 as she had in 2008, worrying while trying first to suggest especially the oil crash would be a good thing in the end.

They never put all these pieces together; worldwide financial anomaly, global economic slowdown, each impervious to central bank interventions; the desperate need to go beyond what had been standard for decades. In other words, they should’ve been listening to Robert Roosa who at a Boston Fed conference (of all places) as late as 1984 warned:

But this combination of improvisations could not cope with, and indeed may have contributed to, the enormous expansion in markets for U.S. dollars offshore, and the new networks of interbank relations that made possible the creation of additional supplies of dollars outside the United States and beyond the control of the Federal Reserve. The ‘offshore’ currency markets soon became securities markets and, spurred by the U.S. effort to maintain control over capital exports from the United States, markets in Eurodollar securities flourished.

Not just beyond the grip and reach of the Federal Reserve but each and every central bank on the planet. Bernanke would lament after his Christmas joke, “But the extent of the global downturn this time is really quite exceptional.” He never asked anyone at the table why that would be.

If it is fair to claim the Lost Decade truly began on December 15, 2008, it’s also no longer fair to call it that. The global economy has been lost, for sure, but it is about to surpass a single ten-year period. Yellen was right to bring up Japan, and then wrong not to take her own advice about it.

While Saturday marks the passage of exactly one decade, on Sunday at the start of a second the world will be looking further and again in the downward direction. The promised recovery of so many promises still as yet to materialize.

In 2017, they all said it was finally over. Globally synchronized growth was supposed to mean something, at least as a first perquisite for recovery aimed squarely at 2018. Those hopes have been blasted apart this year.

In Europe, the ECB was late to QE but has been at it for almost four years now. Germany’s economy like Italy’s contracted in Q3, industry has been stalled for more than a year already across the whole continent, and France is gripped by related social chaos. Populists of several varieties occupy more political space in each individual nation.

In Japan, the Bank of Japan, the original pioneers of both QE and its failure, had added additional letters to it almost six years ago, becoming over time QQE with YCC. It’s economy in 2018 is now contracting, too. Real GDP was negative in Q1 and again in Q3, with revised figures last week showing the minus to have been double the previous estimate. Household spending, income, and real wages are likewise declining suggesting more serious downside still.

In China, PBOC Governor Yi Gang warns this week downside risks to the Chinese economy are accelerating. Global commodity prices have been predicting the stall (and more) and in November China’s contribution to global trade and growth (imports) finally gave in. And China’s automobile market is on track to contract for the first time in almost three decades, with sales dropping by double digits in each of the past three months.

In India, the central bank’s Governor, now former Governor, Urjit Patel took to the pages of the Financial Times in June to plead with Western monetary officials to appreciate global illiquidity (in dollars) and what it was doing. He was ousted to begin this week in a dispute with the government over handling the fallout from the collapse of that country’s largest shadow financier, IL&FS, who had previously been binging on Eurobonds (the very securities market Robert Roosa mentioned in 1984). Fearing economic reprisal, Modi has overdone Trump.

I could go on and on. Instead, I’ll end in the United States. Jay Powell is, or was, supremely confident about globally synchronized growth perhaps more than anyone this side of Mario Draghi. Both eurodollar futures and now US Treasury markets have called his bluff. There is and has been mild inversion in both. Markets see the gathering downside he would rather not admit is exceedingly possible.

The President increasingly positions Jay Powell as scapegoat despite his (noticeably less frequent) claims of a domestic economic boom. The word decoupling has vanished as quickly as it was dusted off and reused.

In other words, it doesn’t matter where or if whichever central bank is conducting “new approaches” or not. Where is Yellen’s Volcker-esque “dramatic move?” The results are still the same regardless, as if central banks don’t count. It’s the only conclusion any sane person would reach, even as far back as December 2008 (and a good deal earlier).

The only question that needs to be asked is why they can’t see it. The word “offshore” looms over everything but it never appears in any discussion. Authorities have cleaned up every space they could conceive of. Paraphrasing Sherlock Holmes, if you eliminate any problems onshore, whatever constant dysfunction remains, no matter how improbable, must be offshore.

December 15, 2008, should not have been the starting point for a lost global decade. Yellen was right, they needed to go big but that would’ve been starting from scratch; rethinking their monetary and therefore economic model from the ground up. They had all the information required to see the problem for what it was. “Jobs saved” was, and, as we are reminded again ten years later, still is a criminal abomination.


It has been no laughing matter. At some funerals, a light-hearted touch just isn’t appropriate. 

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

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