Adam Smith was sufficiently brilliant to simply call it the invisible hand and leave it alone. How does individual business make the miraculous seem ordinary enough to be taken for granted? On a microscale, that’s for them to know and macroanalysis to forever be frustrated.
Booms or busts, those are a different matter. While we can never know down to the specific economic equivalent of the Planck scale, there are any number of Big Picture factors which are repeatedly associated with either one. And this goes back before the days of Mr. Smith.
To his 21st century successor, however, what must determine growth against contraction is how we’re all feeling. It is as if the New Age of the sixties somehow infected every last bit of discourse surrounding small “e” economy.
And in one sense, that’s true. The utter humiliating travails of mainstream dogma during the seventies Great Inflation disaster caused a widespread rethinking of, well, dogma. The catastrophe didn’t produce sound advances in economic science, the sort of trial and error (emphasis on error) we might associate with legitimate progress.
Moving away from the tangible world of work, companies, and money, econometrics lurched into psychology, egged on by any number of competing inquiries (like behavior economics) but mostly due to complete ignorance about most of reality (not heeding the simple wisdom of Ronald Coase).
Following Smith, though not his advice, Economists found it much easier to play the role of psychoanalyst rather than dive deeper into the hard questions. The result is the whole thing riddled with pop psychobabble in place of useful knowledge.
But one recent example:
“Indicators like G.D.P. are important, but much of the time, the root of economic problems lies with expectations. When we think about things like inflation, financial conditions and monetary policy, it’s best to frame them through people. And people are, of course, silly and messy.”
Some fringe document produced in an off off-Broadway academic journal? No, this was published in The New York Times (opinion, but still), building off a recent mainstream study and celebrated as serious scholarly critique. “The vibes in the economy are … weird. That weirdness has real effects.”
Such nonsense is in no way out of character for what’s believed – down to the core – inside central banks or taught at every one of the Big E Institutions worldwide. Recession, they say, is little more than when enough of us feel bad.
This explains much of the weird behavior and vibes particularly this year from authorities. Jay Powell’s (utterly embarrassing) press conference from a few months ago where he made a spectacle of, paraphrasing, making sure Americans knew he felt their pain – by speaking directly to them. He then repeated the spectacle.
If you feel better that Chairman Powell gets your suffering, then Chairman Powell expects you feeling better will produce optimal economic outcomes in fact and not just by this surreal presumption. His policy is nothing more than happy placebos.
That’s not monetary policy, obviously, since there’s nothing in it but what Haruhiko Kuroda admitted (out loud) was pixie dust (his infamous yet spot-on Peter Pan analogy).
Why bring all this up in The New York Times and elsewhere? Recession, bust, contraction and worse. Stop being so glum, chum, don’t drag us down into your emotional gutter and it will all just work out fine.
This was once (long ago) a serious discipline, and not for lacking opportunities to reform itself and rediscover useful ground. So many recent episodes to deduce hard truths from out of such slobbering laziness.
What was it that put Europe into recession by 2011?
Not just recession, of course, re-recession, a second devastating contraction following so close to the preceding one (this earlier episode was even called “Great” as if by superstition merely naming it in that way would be the end of it). We are to suppose it was just Europe’s multitudes failing to become adequately optimistic after they’d survived the worst economic climate since the Great Depression without anyone really explaining what had just happened.
Stepping away from the psychospeak, there were far more pressing issues in the real world. On May 3, 2010, not even a year after the end of the “Great Recession”, the European Central Bank’s Governing Council voted to suspend “the application of the minimum credit rating threshold in the collateral eligibility requirements for the purposes of the Eurosystem’s credit operations” at least for Greek bonds (the suspension would be widened).
Three days later, Thursday May 6, at about 2:32 pm EST, American stocks began a truly frightening plummet.
If it sounds like there are a few steps missing in between those things, from ECB eligibility over Greek bonds to the 2010 flash crash on Wall Street, there are but none having much to do with how anyone was feeling.
The middle monetary ground is populated almost always by some form of repo funding. Sovereign bonds had been the bedrock collateral issue behind nearly all of it from the very beginning (and I mean the decade of the teens, as in 1910s). Non-sovereign issues had become mixed up in collateral streams from the early nineties, in particular the middle aughts.
This was, in a nutshell, that whole Global Financial Crisis thing-y which had produced the world’s not-so-Great “Recession.” How anyone felt about subprime mortgages had been immaterial. There was suddenly not enough collateral, meaning there would be no money, bam, panic and depression just like always in history.
Repo participants having just gone through the exercise of far more closely examining collateral types and the values placed on them, even before 2010 they began to apply the same exercise to instruments issued by questionable obligors even if those borrowers happened to be sovereign governments.
The key lesson everyone (outside of Economists and central bankers, obviously) had just learned was that it wouldn’t be credit risk which doomed anyone’s ability to stay in business. Weaker credits had meant vanishing liquidity even if the assets were money-good (as nearly all of them ended up being).
Disappearing liquidity for a set of instruments, indeed an entire category of them is lights out in repo. And if you’re shut out of repo, you are the next Bear Stearns or Lehman Brothers.
By the time Europe’s central bankers (those who play them for the TV, this is all for emotional effect, after all) realized there was something wrong by May 2010, it was already too late. Illiquidity had spread like an unstoppable cancer, eating away the internals of the global monetary body, not just its European appendage.
Repo isn’t only euros, or dollars, in isolation, it is eurodollars meaning the banking system which operates in and out of all those. Trouble in euros is trouble for banks in euros therefore trouble will spread far outside of Europe. A collateral shortage due from a sudden rejection of lesser (market view) European sovereign issues is as much an issue for monetary sufficiency in America, Japan, or emerging markets as it is for the Greek government.
If you can’t use Greek or Italian bonds today in repo at the same terms as you could yesterday, the knock-on effects knock financial markets down one after another crossing every boundary, while producing a mad dash for what’s left in collateral availability which might feature dependable liquidity characteristics. US Treasuries even JGBs if you are that desperate. German 10-year bunds though especially the 2-year schätz.
Over the next several years from early 2010, repo collateral would get pared back even more (in euros) than it had during the GFC, with sovereign issues from Ireland, Portugal, or Spain getting the same liquidity cold-shoulder as Greece and Italy. Un-affectionately dubbed Club Med, it would be the whole European economy clubbed into re-recession by a gross monetary shortage.
The European economy has never come closer to recovering from it, thus extensive and extremely negative psychology were the results from this, not its cause. Economics has put the carrello before the pferd.
Time heals all liquidity wounds, right? Especially with QE, we’re manipulated to feel better by being led to believe this stuff is no more relevant than ancient history. Thus, the idea that any recession this year perhaps next (at the latest) must be emotion because it certainly can’t be repeating these same stupid mistakes.
Right?
On June 15, this year, the European Central Bank announced…something. Unsure what to call it, the media seems to have settled on “anti-fragmentation” or some such, a term which had apparently been adopted for at least common usage. The name doesn’t really matter, nor does its substance except by implication of what that means – again.
European authorities have grown worried – emotionally taxed, you could say – some sovereign issues are “unduly” suffering from “unexpected” selloffs. The primary focus is nowadays Italy, and for good reason (as I’ll get to in a minute), though there have to have been more than a few bad memories drudged up sounding Spanish and Greek, too.
The yield spread of Italians over Germans, basically the Club Med 10-year over the best quality 10-year collateral, had blown out to 250 bps. Alarmed, the ECB conjured up enough rule-breaking maneuvers which would “legally” allow them to buy the afflicted paper while selling what wasn’t (bid for Italy, sell German).
Ostensibly, any criticism over “anti-fragmentation” has been limited to the emotions of national politics. The verboten word “bailout” thrown around. That’s not the problem, repo is.
Again.
You see, the Germans don’t issue a lot of debt. While a wise course of action, this has led to unintentional and severe consequences (not because of Germany). This is not an argument for turning German finances into Italian, merely acknowledging how the world and its money truly works – in reality rather than blind application of central bank happy talk.
The demand for collateralized interbank money didn’t disappear after the 2010-12 debacle. On the contrary, the use of securities financing transactions has only scaled up that much further (and not just behind repo trades, derivatives that get used as money are more often collateralized, too).
Since Germany doesn’t create a lot of debt, it leaves a vacuum. One that has been partly filled by re-use among (global) dealers operating in the system, more so by other kinds of sovereigns which aren’t so fiscally prudent.
Yes sir, Italy.
According to ICMA’s April 2022 European repo market survey, “Italian government securities expanded from 21.3% of ATS trading in December 2005 to 42.6% in December 2021 via a peak of 44.5% in December 2015.” In other words, Italian instruments were backing nearly half of all automatic trading systems (ATS) in repo, therefore a decent proxy for what’s going on euro-wide.
Over the same timeframe, German bonds had been 44.6% of ATS repo back in ’05, but were just 13.8% by June last year.
With so much of the secured euro markets depending upon Italian sovereigns (again!!), what happens when, say, spreads on Italian sovereigns blow out to 250 bps above their German counterparts?
We don’t have to imagine, nor should we search our feelings for an answer. June 15, you might remember, that was the day which triggered a monumental selloff across just about every global market there is. If you look at a chart of practically any financial instrument, you can pretty much bet the middle of June sticks right out on it.
While this had also been the day when the Fed announced its first 75 bps rate hike in nearly three decades, and that sucked up all the world’s mainstream attention, the true effects of that date had been more meaningfully uncovered by Treasury bills (and J-bills, too, meaning short-term Japanese).
And it wasn’t rate hike; rather suspiciously, ridiculously low yields; anti-rate hike rates. Four-week T-bill equivalents had been below the Fed’s RRP “floor” at several prior intervals, but once the RRP was set to 1.55% for Thursday, June 16, the 4w bill priced so high it produced a rate an enormous 36 bps below. The gap would only widen over the coming days, into the following week reaching a frightening 57 bps by June 22 with the whole world’s markets in utter disorder – kind of reminiscent of May 2010.
As I’ve written far too many times to recall, these results mean one thing and one thing only: severe and destructive collateral shortage. There is no reason whatsoever to purchase a T-bill, especially one becoming more expensive by the day, by the hour, that will return to you so much less than you could otherwise get at the Fed’s completely risk-free RRP. Such value must be in a different utility than its investment characteristics, its usability as collateral.
The same would show up for Germany's 2s.
That’s the thing about these central bank programs. Like May 10, 2010, when the ECB announced their grand Greek “fix”, the OMP, rather than fix the problem central banks simply publicize how big of one there must already be. If a central bank is adequately alarmed by gross illiquidity and monetary ailment so as to get involved with whatever scheme, the situation already must be beyond the pale.
While European and global recession risks (reality) hinge upon actual monetary working order, what the ECB today offers in its anti-fragmentation policy is intended to do little more than make everyone feel better. Just like the 2010 OMP, or the later SMP, the eventual LTRO and all the rest of the abused alphabet, particularly the letters Q and E, these do nothing for liquidity because their purpose is psychology.
Do you feel better that the ECB is watching Italian bonds closely? This is the policy in a nutshell, and also an accurate description of why it won’t ever work.
Final thoughts back to Adam Smith:
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
What of the central banker and Economist? In whose interest does their gross and ugly degradation of reality serve? Facing down global recession risks, those same familiar ones, the interests are certainly not our own, un fatto too easily established by a whole bunch of interest rates.
