The Global Dollar System Screams for Better Monetary Management

The Global Dollar System Screams for Better Monetary Management
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It’s a weird sort of thing when you change perspectives. From the one side, Jay Powell’s biggest enemy right now is, of all things, T-bills. You wouldn’t normally think of the most boring of instruments in that way. Maybe such an idea would never otherwise occur. These are the safest of securities, highly liquid and prized to the point that they are conceived as money alternatives. Just the sort of thing any central banker would count on.

This week and last, bill yields have plummeted. Plummeted. On May 22, the equivalent interest for the 52-week was 2.37%. As of this writing, it is 2.03%. The shortest tenor, the 4-week bill, it had a rate of 2.44% on May 7 and 2.40% as recently as May 16. Right now, it’s less than 2.28%.

Twelve almost thirteen basis points may not sound like plummeting, but in the world of money equivalents and short run T-bills this is an enormous move (for comparisons sake, the Panic of 2008 was kicked off on August 9, 2007, by a 12 bps change in 3-month LIBOR). And it signals big trouble.

Taking it, then, from the T-bill’s perspective what this drastic shift really means is that our biggest enemy today is Jay Powell. Government debt doesn’t have its own viewpoint, of course, which says what we are really talking about are the big banks and financial institutions who are the primary owners, lenders, holders, and seekers of these sorts of things. The money dealers.

Rate cuts are imminent, folks.

You can choose to view them however you wish. Having resisted any such notion for an entire year, ever since the eurodollar futures curve first inverted in early June 2018, Federal Reserve officials just this week almost uniformly, curiously uniformly hinted that, yes, rate cuts are on the table if not already a foregone conclusion. Calling the bond market mispriced last year, it would seem as though the bond market, including eurodollar futures, had it exactly right.

James Bullard, President of the Fed’s St. Louis branch, says there is nothing to worry about since a reduction in the federal funds range should “provide some insurance in case of a sharper-than-expected slowdown.” At a monetary policy conference in Chicago, Chairman Powell was less forthright but repeated much the same message. Mr. Powell reassured the world “we will act as appropriate to sustain the expansion.”

Over the past several months, several policymakers and other Economists have begun thinking about 1998 and a possible parallel to their own growing predicament. Faced with an Asian flu, which was really the first systemic eurodollar issue, Alan Greenspan’s Fed skillfully shepherded the US economy through the rough patch by reducing the federal funds target (it was just a target back then) three times in three months during that one year.

That’s the narrative, anyway.

Interestingly enough, however, Jay Powell’s remarks in Chicago came during a speech which ostensibly was about some very big potential problems with monetary policy in the current day. They used to call it the zero lower bound (ZLB) which, apparently, has been renamed the effective lower bound (ELB). It’s never a good sign when you feel a very important concept needs to be rebranded.

In monetary policy terms, what has been bothering Chairman Powell is how the central bank is constrained by nominal reality; the basis for renaming that limit the “effective” lower bound. It is a hard line monetary officials cannot cross, at least not directly. And because they can only get around it with tricks and workarounds, it makes monetary policy less effective when the ELB is in play.

That’s the narrative, anyway.

The major difference between 1998’s rate cuts and whenever and however there may be some in 2019 is that ELB. Alan Greenspan began his “fine tuning” with a federal funds target at 5.50%. Jay Powell would begin with the target range “floor”, the reverse repo rate (RRP), at just 2.25%.

In mainstream conception, this is a huge, huge difference. What Economists conceive of as monetary stimulus is how much a central bank can reduce interest rates; altitude matters in their models. As Powell mentioned in his Chicago speech, two decades ago his predecessor had space for 20 or so quarter-point rate cuts in his toolkit. Room for a few 50s if needed.

The current FOMC has nine – at most.

This is how central bankers think about money and monetary policy; how many times can the Fed Chairman go on TV and tell the public he is “stimulating.” And if he can do that a lot and has room every once in a while to say FIFTY, then that’s supposed to be very powerful stuff.

If he can only do nine before the ELB forces more esoteric and funky workarounds, the public is apt to get distracted by them and therefore respond with more variation.

I’m not making this up! This is just how these people think monetary policy works. Here’s Powell’s description:

“Suppose that a spell with interest rates near the ELB leads to a persistent shortfall of inflation relative to the central bank's goal. But what if the central bank promised credibly that it would deliberately make up for any lost inflation by stimulating the economy and temporarily pushing inflation modestly above the target?”

The “promised credibly that it would deliberately make up for any lost inflation” are those things we now call unconventional policies. Using that very word, authorities are worried those programs lose potency because everyday folks aren’t used to them. QE sounds straightforward sometimes, as might negative rates, but they are new and scary, humans having evolved with deep skepticism when presented with the unfamiliar particularly in big things.

This matters because, as Powell continued:

“For makeup strategies to work, households and businesses must go out on a limb, so to speak, raising spending in the midst of a downturn. In theory, they would do this based on their confidence that the central bank will deliver the makeup stimulus at some point—perhaps years in the future. In models, great confidence in central bankers is achieved by assumption.”

During the Great Recession, the worst contraction since the Great Depression, faced with the ELB (reached in December 2008) the Fed was left with only monetary policy ideas with which the American public was entirely unfamiliar. So, in asking people to spend more, to go out on Bernanke’s thin and shaky limb, Americans’ collective confidence in the central bank to deliver a recovery may not have been as solid as was required.

Powell is saying people weren’t willing to risk their own situations on Fed stuff they’d never seen the Fed do before. Therefore, the answer is to make “unconventional” policies into everyday policies.

Voila, problem solved.

Are you starting to see how naked this emperor is? These are unserious people.

Let’s start with the fact that Ben Bernanke had nearly as much altitude with fed funds as Alan Greenspan did in the late nineties. When the FOMC first voted for that first rate cut in September 2007, a fifty, by the way, the target was 5.25%.

By this current line of thinking, in order for Bernanke’s “stimulus” to have been effective he would’ve needed even more room before reaching the ELB. Why? Going back to Powell in Chicago, the alternate tools required once hitting nominal zero “should not be thought of as a perfect substitute for our traditional interest rate tool.” In other words, the most powerful stimulus is the straightforward notion an interest rate cut signals to the public.

When the Fed cuts the benchmark money rate, everyone already knows what the central bank is saying. When the same Fed begins buying up long-term mortgage bonds, it sounds like they are being consistent, but it’s more open to interpretation. Far muddier. In expectations policy, interpretation is bad.

Laypeople understand immediately what a rate cut (supposedly) means and what it is supposed to imply. And that might just be central bankers’ problem.

Thus, we are being asked to believe that if Ben Bernanke had, what, room for ten more rate cuts before reaching the ELB that would’ve been enough? Twenty more?

It is absolutely impossible to overstate this point. All monetary policy is based on the assumption, yes assumption, that what amounts to stimulus is only the central bank saying it is stimulating. It ultimately doesn’t matter what is done, only that the central bank says it is stimulus and the public understands it the same way in a straightforward manner.

Monetary policy, therefore, is essentially: trust us.

The ELB gets in the way of trust. It forces central banks to do the other stuff. Jay Powell doesn’t want you to question the other stuff and he believes you might only be doing so because it is still relatively new and called “unconventional.”

This is madness. What the public might’ve taken away from 2008 is how for years and decades these same policymakers had called these same rate cuts we are all very familiar with stimulus. Ben Bernanke started in 2007 with potentially 21 in his pocket. He had room for several fifties, even a seventy-five plus a fifty in one ten-day stretch in January 2008.

And you know what? None of them seemed to make a damn bit of difference. The whole system came down anyway, millions upon millions of Americans were thrown out of work and the whole world fell into chaos. Maybe people weren’t really questioning the other unconventional stuff, maybe people had come to see very good reasons to question the entire premise starting with rate cuts.

What do you central bankers actually do?

It is, admittedly, a stretch to claim everyday folks have been wondering about monetary policy in this way. Realistically, Powell is right: most people don’t give it all that much thought. They are perfectly willing, most times, to believe in the central banker. If Bernanke or Yellen or now Powell says stimulus, who am I to disagree? The more straightforward the policy, the more familiar, the better.

The closer you are to the nuts and bolts, the details of design and operation, this view doesn’t hold. In other words, if you are operating within close proximity to the sausage making in money and economy, then you haven’t been able to ignore the ineffectiveness of rate cuts before the ineffectiveness of everything else. There is no “trust us” basis down here in the trenches.

Bear Stearns taught that lesson, one reinforced by Lehman and AIG. Everyone inside was reminded again in 2011, many the last time they would need to be.

Monetary policy is something to manage the expectations of consumers and workers. It isn’t actually meant for money dealers. The contradiction is as profound as it is ridiculous.

This is exactly why T-bills are Jay Powell’s biggest enemy today. And why the financial agents behind these moves in bill yields view Jay Powell with so much growing suspicion and doubt. Do you bet your survival on the Fed being able to fool workers and consumers into spending out on their limb? Not your survival, but you might be willing to bet just a little – at times.

At other times, however, none of it factors. Whether or not Powell can make his unconventional into everyone’s conventional doesn’t stop the collateral call from BONY, a potential kill shot whose probability rises when there isn’t the effective flow of monetary resources.

When that flow is visibly disturbed, like right now, at those moments do you want to bet your survival on the Fed being able to fool workers and consumers into spending out on their limb?

The lower nominal yields fall, the higher eurodollar futures prices rise, the greater swap spreads compress even to the point of negatives, the more the insiders dealing in effective modern money are saying: absolutely not.

Modern monetary policy no longer deals in money. And it quite purposefully excludes money dealers from its thoughts and designs.

Right now, the global dollar system is screaming for more effective monetary management. Also right now, central bankers have gathered in various conclaves, seeing the dissatisfying product of all their work and have thought heavily about responding with better ways to fool workers and consumers who are only out on these limbs because this is all just so absurd.

It is also very simple. Long ago, as I’ve noted on so many occasions, Economists and central bankers realized they were having very serious trouble keeping track even defining modern money. Rather than redoubling their efforts to those ends, they decided that by managing expectations they wouldn’t ever have to. It was a gigantic gamble made upon a huge assumption without much evidence.

The Global Financial Crisis and Great “Recession” were the costs of losing the bet. In very broad terms, it was tested, experimental evidence for re-centering the official viewpoint away from purely expectations management back in the direction of technical monetary competence.

Unconventional policies didn’t work, even Powell had to concede “views differ on the effectiveness of these policies.” Coming from the Fed Chair, that’s a strong indictment. And it wasn’t because everyday people were frightened and uneasy about the big new stuff, it was simply because the monetary system needed some money.

The 4-week bill today says, money soon or else.

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

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