A shocking disease about which we know very little even though it has been running rampant for seemingly a long time already. Not COVID. As sad as it may be, there’s more documented about SARS-cov-2 than the timid investigations into how the global monetary system really functions. In less than a year, we’ve come to know quite a lot about how the coronavirus gets transmitted, yet know shockingly little about how dollars are transmitted globally.
Or that they aren’t really dollars at all.
First, however, gigantic GDP positive during Q3 for the United States. So far as real GDP might be concerned, this thing’s over – hooray!! - back to even again after just two quarters when most models from the start showed it would take until the end of next year at the earliest.
Reaction to this, however, has been muted. For one, it’s been expected for several months; estimates were continuously raised throughout Q3 so that we knew what the number was going to look like well before this week. It’s the one for Q4, and then those for 2021, which contain all the mystery and gravity.
The same lacking weight holds for Q3 as it had for Q2. I wrote three months ago, “You know something’s truly amiss when the government reports the economy has just experienced its worst quarter maybe ever and hardly anyone cares.” The minus-thirty has now been canceled out by a plus-thirty.
“Big whoop [the -32%]. The question on everyone’s mind, the only one that truly matters, is what comes next. That’s been the whole thing from the very beginning. For whatever reasons, right or wrong, they turned the economy off. Can it be turned right back on again?”
Q3’s number seems to suggest that, yes, it can be turned right back on. Underlying the headline gain, the answer you find is very different. Those details are located, if you’re interested, on the other side from GDP, the expenditure approach’s necessary twin called GDI.
In the latter, buried amidst the arcana of economic accounting is a line for US government subsidies. Not only that, this is one of those numbers which gets netted turning it upside down; in this case subtracted from indirect taxes paid on production and imports. In other words, it’s highly confusing in that subsidies are deducted from taxes that are added together with other sources of income to come up with GDI.
The reason for doing it this way is that the government has sources of income for its spending, too, and they need to be added into GDI. Except subsidies paid out are, essentially, a transfer payment. GDI doesn’t do transfers; that’d be double counting since they are received and show up somewhere else.
Elsewhere in this case is what’s called the net operating surplus. Business profits and such.
The Bureau of Economic Analysis (BEA) doesn’t yet have the quarterly estimate for Q3’s GDI available. Other lines, corporate profit data, in particular, hasn’t been sufficiently collected to this point to fill in all the component estimates. But the BEA does have those for indirect taxes and the subsidies deducted from their aggregate balance.
Prior to Q2 2020, the latter had never been more than $82 billion (at a seasonally-adjusted annual rate). Not an insignificant sum, yet hardly more than a rounding error in the federal leviathan’s total contributions to GDP. This year’s second quarter, though, the estimate moved up “a little” to a little less than $1.1 trillion.
In this latest quarter, Q3, subsidies were apparently larger still; more than $1.2 trillion. And while these vast thirteen-figure sums have been or will be subtracted from GDI, they represent the shocking level of “stimulus” which has been added into the domestic economy (net surplus) in other parts so that it might have first been limited to “only” minus-thirty in Q2 before then boosted to plus-thirty in Q3.
These two numbers otherwise buried deep within the mind-numbing minutiae actually explain far more about what’s taking place right now than either of the headline thirties. The subsidies certainly tell us a lot about why GDP and the labor market appear to have so drastically diverged.
It's called the permanent income hypothesis, and it applies to business (the recipient of the government’s loans-turning-into-grants project) as well as consumers. Companies react to a regular stream of customers very differently than they do should a huge percentage of their customers disappear. Even when in the aftermath of that disappearance Uncle Sam shows up to make up much or even all of the cash difference.
A steady stream of customers indicates something about the future that isn’t written anywhere on the government’s digital checks. And everyone knows, as has been reinforced repeatedly over the last month or so, those checks are subject to partisan bickering and political forces including colored interpretations about how things might be going from the point of view of the top down.
A windfall is treated as a windfall, not a substitute for prior levels of revenue and activity.
No wonder weekly jobless claims near to the end of October, seven months into this thing, remain substantially worse than at any other time in history before March. The government, not a rebound in the private economy, is what’s keeping things afloat, a truly precarious aggregate position to which businesses are, right now, acting upon. Without this “stimulus”, it’s unbelievably ugly right now – as the rest of the GDI, and some GDP figures, will attest.
Of the former, wages and salaries paid during Q3 remain less than Q1 to a degree far worse than the Great “Recession’s” worst deficit. Yes, in labor market terms it’s beyond 2008 (and that’s comparing Q3, not Q2). That’s how far the gap between private and earned economy is though GDP suggests everything’s back to normal.
This, too, comes as no surprise. Reacting to the lesser private economy rebound, markets (including stocks!) have been pricing in more serious doubts about what comes next beyond the thirties. And they’ve been doing so, in stages, going back to early June. Not COVID resurgence, rather growing unease over how this lack of legitimate recovery seems more and more the baseline stripped away from its “stimulus” artificiality.
At the forefront, oil. Crude is the leader simply because it measures physical reality against monetary and economic conditions closer to the ground. There’s actual stuff to be produced, transported, and, if necessary, stored. The more the last of those three, the more that’s not good.
Oil markets have displayed a stunning lack of faith in this “stimulus” rebound because despite GDI’s propensity to subtract subsidies, those haven’t been necessarily used to get overall demand back in the game. About one-fifth of domestic oil production has been shuttered since March, and yet the WTI futures curve remains in serious contango (incentivizing more future storage even with inventories, despite that 20% production cut, at record levels for this time of year).
The real danger, therefore, is that businesses use their “stimulus” receipts to have done and keep doing other things than hire back, or pay more to, their workers. That’s just what they’re not doing right now. Without a natural rebound in the private economy, there’s no point in hiring back workers since there’s no work for them to do.
Dating back to August 27, markets (yes, including stocks) have shifted negatively for a second time. Where first there was unbridled optimism over reopening and the potential for legitimate recovery (free from longer run demand destruction), it had been tempered in early June before doubts being taken more serious again just before September.
And September brought with it a return of unwelcome “market volatility” first in crude then in other places (including, you’ve no doubt noticed, stocks). The dollar, too.
What was supposed to have been a crash or rout in the US currency consistent with all the things one is told to identify with growth and successful “stimulus”, monetary as well as fiscal, the currency’s downfall has instead been put on hold for now two months and counting. Even DXY, the dollar exchange value index most susceptible to these kinds of amplified downward moves (thanks to its huge weight assigned to the misleading euro), it’s not going down anymore.
Other broader dollar indices have been far less crash-y all along. Suspiciously, so, particularly those currencies tied to EM economies where dollar funding remains paramount. Where has Jay Powell’s flood of dollar liquidity been? It has certainly been reported as fact in all the mainstream press, yet in dollar terms there’s been absolutely nothing to it (inflation expectations, too).
What are we missing here?
If you go by the people at the BIS, for example, even they will admit you’re missing pretty much everything which matters when it comes to the global US dollar system. Starting with the fact, yes, fact, it is a global US dollar system. As I wrote at the outset, we know more about a COVID virus less than a year old than we do about a monetary regime which has been in place for more than half a century.
How little do we know? Here’s what the BIS wrote in June 2020 for its international monetary working group (chaired by someone who works for the Federal Reserve Board):
“The complexity of global US dollar funding markets as well as certain data gaps prevent the construction of an accurate and complete map of activity. International banking data provide a view into the activities of internationally active banks, but they often lack information on maturity and counterparty type. Data for transactions occurring between non-banks (financial or non-financial), in particular those transactions occurring outside the United States, are among the most opaque.”
“Most opaque” is what you’d reasonably call downplaying these limitations. In truth, the BIS, therefore the Fed, has very little idea about the conditions across the multiple dimensions of this global monetary system. No one has really bothered to look, not seriously. Even something like this report is shockingly (to me) haphazard and half-assed.
Another example, and one very pertinent to the year and events of 2020:
“Although repo markets are more transparent now than before the GFC, data gaps leave them relatively opaque. This is particularly true for activity among non-US entities that takes place outside the United States and activity outside the tri-party repo market in the United States.”
“Relatively opaque” translated means there is no systemic basis for monitoring what really goes on in what had long, long ago already become the central dollar focus of this worldwide dollar system. Most repo never sees the tape anywhere; bilateral, bespoke transactions between financial firms where neither side is American nor touches the US border in any fashion.
But it’s still dollars.
Why do we care? Simple. As the report also specifies, though the US accounts for only about 10% of global trade, around 50% of trade is directly invoiced in the US dollar denomination. And this makes it sound less important than it is.
For one thing, it doesn’t account for financial flows; both to make those dollars accessible to traders in various global locations so that they can engage in trade as well as dollars made available in financial forms to finance that trade along with absolutely necessary investments (“hot money”, if you prefer). According to other BIS data, the US dollar accounts for more than 90% of those kinds of transactions.
The dollar basically intermediates much of the global economy, and at the margins where growth happens the vast majority of all of it. The world needs and demands a constant source of dollars. That is indisputable.
Where does it get them?
Funny thing, from what the BIS has been able to cobble together, the data also shows that it is actually US banks which are the global dollar system’s largest borrowers. Yes, borrowers. “…the United States is the largest receiver of cross-border US dollar bank funding, totalling [sic] $6.1 trillion.” Even US banks and non-banks get much of their funding from outside the US.
The domestic financial system operates in huge part by its relationship with a global dollar system no one knows much about. That seems kind of important, don’t you think?
For one thing, it raises questions about why US banks would be so heavily financed by this offshore eurodollar (the word “eurodollar” only appears three times in this 81-page report; as if it is to be carefully avoided). The current Fed and BIS may not have a good answer, but, as I wrote a few weeks back, a few of those who worked at either decades ago already knew what it was:
“The gross eurodollar size was in 1988 a third greater than the entire M2 stock would be three years afterward, while its net size was closing in on two-thirds of it. And this was three decades ago.”
Why does the US financial sector lean so heavily on the offshore market? Because that’s where the dollars are!
The offshore dollar system is far, far larger, more complex, and more aligned with how a bank-centered system would evolve. Milton Friedman was correct in 1969 about how eurodollar expands the supply, though incomplete as to why. The world outside creates dollars and, since the seventies (Dufey and Giddy), far more “dollars” that aren’t tracked because authorities are apparently incapable of admitting central banks are not central to them even though when honestly studying these practices it becomes clearly evident they aren’t.
Given this background, markets shifting stance on August 27 makes more sense. That was the day Fed Chairman Jay Powell’s floating virtual head showed up for Jackson Hole announcing the unfunny joke that is average inflation targeting. In the wake of GFC2 back in March, balanced against this rather not-opaque stance of determined monetary ignorance, the Fed Chairman basically laid all his losing cards on the table for everyone to see his ridiculous bluff.
There is no flood. These people wouldn’t even know how to begin one. Some working with the BIS, though, do at least know where. It just isn’t the United States.
At a time like the middle of 2018, when the symmetrical inflation target (no different than the “new” average inflation target) was first introduced, this backwards behavior was mere trouble (as it proved to be). In September, October, and soon to be November of 2020, with the private economy propped up only by trillions (annual rate) of federal government infusions, dependent upon QE and bank reserves to keep people (markets) thinking only positively, businesses acting out perfectly the downsides of the permanent income hypothesis in the labor market (Keynes warning about deflation), the contrasts in reality are becoming too much to favor complacency.
Fewer and fewer seem willing to bet that way. Even in stocks. Perceived risks (certainly not inflation expectations) are rising and have been for months because they never really went away. For a time, Jay’s flood fairy tale was fun while it seemed like there was a genuine rebound, but even in the aftermath of a plus-thirty GDP it leaves us with too many unknowns in all the wrong places.
BIS reports like the one cited above would have represented a nice start had any come out sometime during the decades before August 2007 (or March 2020), something to build upon before it ever got of hand. Forty and fifty years later, during a time of serious economic and financial upheaval, what are they waiting for? No need to figure that out when COVID’s around to easily blame (like subprime mortgages). The real disease is the same something else.
