It Is Always Everything Else But the One Thing That's Wrong

It Is Always Everything Else But the One Thing That's Wrong
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The world doesn’t seem to realize it yet, but Japan has crept ever closer even on the islands. Last year at this time, Bank of Japan officials were openly talking about finally exiting from QQE and maybe even ZIRP. Inflation was on the rise, they believed, and it wouldn’t be stopped this time.

Their December CPI rose just 0.3% year-over-year. Inflation was indeed stopped. The key question for Japan’s economy before it even gets into 2019 is not where the policy exit begins but in how many quarters it actually contracted last year. Somebody somewhere needs to make Japanese central bankers explain why anyone should ever listen to them. The whole world should demand the same answer from each of theirs.

Over in Europe, the ECB was on track for much the same scenario. Mario Draghi couldn’t stop talking about Europe’s booming economy, leaving him little room other than ending QE and beginning the rate hike process. It’s never what you say, it’s what you do voluntarily or not. Backed into a corner, Europe’s central central banker had up until very recently remained steadfast.

Like Japan, Europe’s policy trajectory has recently been shelved. QE was terminated, sure, which only means the Continent’s participating National Central Banks are still buying all sorts of financial assets. They just aren’t buying more of them.

Interest rate hikes in 2019 were a foregone conclusion. Now they are just gone. As one article published by Bloomberg put it this week, “Despite the best efforts of central bankers, investors are betting the next phase of European monetary policy will look a lot like the last one.”

In other words, Japan. New policy; everyone gets excited; it fails; new policy that looks suspiciously like the old. Rinse, repeat.

The United States has proven just as susceptible. Until recently, the only thing the President and the Federal Reserve could agree on was the booming economy. Depending upon which was talking at any given moment, the US system was either awesomely strong or the best in so long people couldn’t fully appreciate just how awesome.

In a matter of months, that has instead devolved into public arguments about who will be to blame for it going wrong. The best economy in forever was so strong it couldn’t withstand effective federal funds at 240 bps? I don’t think so.

For all its posturing about the unemployment rate, even the FOMC has been led to abandon it. Chairman Powell in December justified that last “rate hike” by committing to wage inflation which should show up any day now. The minutes from the very same meeting but published after all the market chaos (for this round) instead put inflation pressures as “muted.” Big difference.

This latter contradictory view was repeated this week as the FOMC gathered again. US officials are now questioning everything from those “rate hikes” to balance sheet normalization. So-called quantitative tightening, or QT, apparently has become a questionable element, too. On the whole, it really seems like US monetary authorities are struggling badly at the moment.


The issue of looming recession isn’t really about a looming recession. The big picture problem is not how there might be one, it is that there might be another one. The world hasn’t yet recovered from the last contraction (or several, in the case of Europe) and the years piled up in between mean more than officials will allow.

In fact, that was the big fuss about “globally synchronized growth.” The slight worldwide economic improvement during 2017 was quite purposefully declared the start of global recovery. Finally, after a decade of malaise, this was the big moment, the successful conclusion of so many individually heroic central bank efforts.

One country already back into recession is Italy. For two straight quarters, the entire second half of 2018, Italian GDP shrunk. These were not huge minuses, however their mere existence the biggest setback yet. Globally synchronized growth can’t have been synchronized with Europe’s third largest economy already in recession.

Now we must ask who gets to decide if it was ever even growth.

How Japan became Japan wasn’t zombie banks. They did exist just as they do now in Europe and the United States. Instead, the way Japanification creeps up is what sure seems like an intent never to learn. Excuses play a more central role at the central bank than anything else it will do.

The Economist magazine, as its name implies it will always stick up for Economists especially those who run every central bank. For its February 10-16, 2018 edition, the cover art was President Trump sitting in a hotrod under the title Running Hot. What will be plastered on the front for any issues published in February 2019? Bold-faced lettering declaring “WE WERE WRONG” won’t be on any of them.

In its most recent publication, speaking up on behalf of Economists’ current predicament, the Economist informs us how Italy’s latest recession is mostly on Italy. Populists, you see.

“Italy’s recession is also partly home-grown. In September 2018 its populist government unveiled budget plans for 2019 that defied the European Union’s fiscal rules. As the row with Brussels worsened, government borrowing costs rose sharply.”

A higher risk-free rate regime, allegedly, meant that banks pulled back from offering credit to the real economy; the standard theoretical transmission. “A survey of lenders by the European Central Bank found that in the fourth quarter of 2018 Italian banks became more fussy about whom they lent to, even as credit standards in other large euro-zone countries eased.”

If we are talking about fussy Italian banks, why limit ourselves to just Q4? Not for nothing, despite this populism excuse, Italian GDP contracted in Q3, too. That couldn’t have been the issue for the first quarterly negative.

Neither was it any new fussiness on the part of Italian banks. The stuff that never gets reported in the press is how unflinchingly ineffective monetary policy is and has been right where it is supposed to be most primal and technical. Italian banks have been pernickety since, unsurprisingly, October 2008.

The Economics-born theory is always very simple and therefore attractive and alluring. The central bank floods the system with liquidity. That liquidity in the form of lower or even zero interest rates plus in the case of any large scale asset purchase (LSAP) such as quantitative easing (QE) becoming the addition of bank reserves reassures the banking system that another liquidity crisis is impossible. Since what happened ten years ago was just that, financial institutions no longer have to worry about liquidity and can get back to the business of being a financial institution.

That means credit growth and loan expansion leading to economic expansion. The emphasis in QE is on the “E.”

The ECB has tried several ways to carry out this theory over the course of the last decade. These various experiments were not by its own choice, which tells us a lot about the theory. There was ZIRP all along behind OMP’s, SMP’s, LTRO’s, T-LTRO’s, covered bond purchases, corporate bond purchases, and finally public sector purchase program (PSPP, otherwise known as Europe’s QE).

The level of bank reserves in Europe as in America has exploded as a byproduct. The amount of lending has not. It seems that what central bankers declare as easing, this liquidity, it instead only fits their definition rather than what is practiced with banks. We don’t need to guess which one matters more, there is a mountain of evidence.

In Italy, the aggregate balance of loans is actually less in December 2018 than it was in April 2015 when QE began; and much less than October 2008. The total of Italian bank loans outstanding was at its best only slightly higher, up 4% total, at the peak of this “boom” back in November 2017.

Yes, Italian banks had been fussy for nearly a year before the populist budget battle even took place. Since last November, lending has retreated by more than 5% as Italy slides back into recession. Maybe the Economist(s) just hates populists and is too eager to pin the latest setback on them lest anyone look more closely? Perhaps QE just isn’t E?

The funny thing is, you see November or December 2017 show up almost everywhere as an inflection point. From Japan to EM’s, that’s when trouble shows up. Which only means throughout 2018 while Powell, Draghi, or Kuroda were gloating about strong economies the reverse had already taken hold in these very crucial places. No one ever seems to think about the credentials, who it is that gets to decide on the public’s behalf strong versus weak.

Industrial production for Italy would peak in December 2017, as it did for Spain as well as France. German industry actually topped out the month before, November 2017. IP in Brazil, for one non-European entry, registered its best recent production level also in December 2017. These are all among the globe’s largest economies.

While economic weakness crept into the mix more and more, officials claimed there was no economic weakness at all. It was left to the work of the world’s bond markets instead to piece together a more accurate assessment. Yields rose but only slightly during a time when every “expert” and monetary authority claimed the bond market was a very dangerous place to be.

There was no massacre. Curves instead flattened, further Japanification on the horizon with the global economy far closer to souring than soaring.

Central bank actions and statements in 2019 merely offer the final proof on that point. Monetary officials in every corner are now waving the white flag. Policy surrender is the most obvious theme of 2019 so far.

In US Treasuries as eurodollar futures, each curve had declared all throughout 2017 there was almost no chance the Fed was going to make it to 3% before the usual setback showed up. This week’s FOMC dovish debacle basically admitted that was true; even though just weeks ago the Chairman was talking like he was heading for the moon Powell’s been stopped three “hikes” short of the minimum.

By what, though? Italian populists in a political fight about EU budget rules? No one ever asks what it was that thwarted Japan’s economy each and every time along the way to today just shy of three decades lost.

What really sticks out about Japan’s experience is not the zombie banks or the so many QE’s (24 of them), it is this stop-go pattern. The economy falls, the Bank of Japan intervenes, the economy appears to get better but then stumbles again before it ever really does. Economists tell the public that the “get better” part was due to their heroic efforts; and then fall silent when it comes to the “unexpected” stumbles.

Sticking just to the reflation, you can see why people not paying close attention would think monetary policy effective. Central bankers are quick to take credit for sheer coincidence, the real legacy of Alan Greenspan’s way of doing it (expectations policy in lieu of monetary competence).

And when there are Italian populists to blame for the inevitable premature setback, as there is always something like Italian populists to blame, the public doesn’t easily discern how monetary policy was actually ineffective the entire time and in every way imaginable. This right here is how we get to so much time passing and nothing changes.

We have again arrived at an odd and uncomfortable crossroads. It’s like September and October 2007 in that risk markets in particular (as opposed to the bond markets) are almost giddy that the Fed or ECB has shifted. In truth, stocks then were soaring unlike the economy and they were actually celebrating the bond market’s complete victory without contemplating much beyond the shallow monetary policy change.

To review, Bernanke declared subprime contained in March 2007 as similar monetary irregularities and economic turns occurred. Then in August 2007, after Bill Dudley said nothing was imminent, things took an obvious turn for the worse. Even stocks fell.

The following month, however, in September 2007, the Fed cut the federal funds target by 50 bps – a purposeful double shot to soothe nerves. (Some) Markets cheered; the S&P 500 would go on to register a new high in early October two months after global panic had already begun. Why? Ben Bernanke had finally been woken up to the dangers and he acted!

This was, after all, what eurodollar futures had been predicting joined later by the UST curve. As things got worse, curves became more and more distorted, signaling in technical terms broad expectations for rate cuts. Economists had mulishly refused to admit these were even on the table. When the rate cuts came, initial risk market reaction was grand relief when instead these markets should’ve paid closer attention to why Fed officials had had their minds changed for them.

That would come a bit later, this other reality.  

We are taught from the very beginning in Economics that monetary policy is itself the object; don’t fight the Fed. It doesn’t take all that much to see monetary policy very differently. When reluctant central bankers have their minds changed, waking up to the danger so that they actually try to do something about it, that’s more about the problem than it is any ability they might possess to fix it.

In 2008, this was all very new. In 2018, not so much.

The Fed, ECB, and Bank of Japan getting it wrong this time leaves almost no doubt about Japanification. Interest rates worldwide like the global economy seem trapped, an inescapable gravity linked to some unknown dark force. Bond markets persist against all expectations otherwise, drawn to the monetary blackness and covered in persistent propaganda excuse-making. The mainstream is misled by Economists into confusing low rates for stimulus when they are actually evidence for what’s been wrong the whole time.

Which means, as it now stands, there will be more ZIRP, more QE’s, and more lost decades. Say it with me, Japan.

This is what the bond market has been saying, for the most part, since 2011. Stocks are, quite perversely, surging (for now) on bonds being right about this bleak long run potential. Without framing it properly in just this way, some markets will reflexively applaud central bankers copping to yet another massive error about the economy and how their policies fit (or don’t) into it. That’s how absurd it has become. It does explain a lot as to how the world could have become so messed up.

In 2014, it was an oil supply glut. In 2011, Portugal and Greece. In 2008, the term subprime mortgage was conspicuous in its ubiquity. In 2019, look out if you are a populist, Italian or otherwise. It is always everything else but the one thing that’s actually wrong. Central bank independence is the whole story, though not in the way everyone thinks. Independence has meant their declarations and explanations are not subject to challenge.

If society defers to you to write the history of some really bad times, are you going to write that these bad times were mostly your fault?  No, you write how the times aren’t so bad - until you can’t. And then you hold fast until it’s time to “save” the world again from the same unknown darkness. Blaming, of course, the darkness on whatever’s handy at the moment. 

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

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