Plans Galore
As the Bernanke era is
winding down, a number of articles have appeared at Bloomberg and elsewhere in
the mainstream press with authors opining on the things his successor Janet
Yellen must do. That's the problem when you have a job as a central
planner: everybody else thinks only their plan is the right one, and
they are trying to get you to implement it. Apparently it hasn't yet occurred to
anyone that central planning simply does not work. People seem to believe that
the power to manipulate interest rates and the money supply somehow means one
can do whatever needs doing, if only one puts one's mind to it (and preferably
follows their advice).
This time we don't want to
discuss far-out ideas such as the one that the Fed should use credit dirigisme to stop 'climate
change' (which has to be one of the most hare-brained proposals
yet).
There is of course the
by now often repeated assertion that 'Yellen
needs to cope with too low inflation'. A headline of this sort
generally indicates that the author knows zilch about monetary theory and
doesn't realize what has actually happened over the past five or six years as a
result of the Fed's ultra-loose monetary policy. There is no other explanation
that is viable. The broad US money supply has increased by about 90% since 2008,
and there are still people clamoring for more inflation. It simply leaves one
flabbergasted. What's even more astonishing is that several Fed board members
have likewise broached this idea on a number of occasions over the past year or
so. It is probably an example of the Peter principle at work.
How else can we explain this? The guys actually operating the levers are just as
clueless as their countless armchair advisers.
Admittedly, we are armchair
advisers of sorts as well, but we have only one very consistent advice and that
basically is: abolish the whole enchilada and replace it with free banking and a
money freely chosen by the market. We are not trying to 'make plans' for anyone,
we want the planning to end.
There is no need to discuss
again what the flaws of this '2% inflation targeting' policy are. Anyone who
hasn't realized yet what this policy produces has likely been asleep for the
past two decades or so. Let us just note here that 1. the policy has created
booms and busts of rarely seen amplitude and 2. it may end up creating even
worse consequences down the road. We say this because we can quite easily
envisage a future situation when even this targeting of a modest rate of change
in CPI is ditched because 'more urgent problems' demand to be addressed by the
printing press.
And let's be clear about one
thing, all the extensive blather about the 'monetary policy tool box' is just
so much smoke and mirrors. In the end it always comes down to the printing
press, or its 'electronic equivalent' these days (i.e., the whole thing is far
less complicated than it is made to look).
This is a good
opportunity to show the most important chart in the world again, namely that of
the true money supply:
During Bernanke's chairmanship,
the broad US money supply has roughly doubled, with the bulk of the growth spurt
occurring from 2008 onward. Because Bernanke doesn't understand money, he was
surprised by the bust. During his first three years on the job the annualized
growth rate of TMS slowed down to less than 3% annualized from a peak of more
than 20% annualized in 2001/2. It was this slowdown in monetary inflation that
revealed the wealth destruction of Greenspans's echo boom/housing bubble
implemented after the tech bubble went belly-up.
Note the important
distinction: real wealth is actually not destroyed by the bust. The wealth
destruction happens during the boom – that is when scarce capital is
misallocated and consumed. When the bust begins one has arrived at the moment
when perceptions change: illusory phantom wealth is no longer mistaken for the
real thing. It suddenly becomes clear that economic calculation was falsified
during the boom, and that what looked like profits was really an accounting
chimera – click to enlarge.
Anyway, we have just
come across an article discussing yet another problem that Janet Yellen is
supposed to tackle, which struck us as quite amusing, especially in view of the
above chart (which has in a way almost crystal-ball like qualities: it
cannot tell us when it will happen, but it does tell us with apodictic
certainty that a denouement of major proportions is coming).
'Easing Bubbles'
The author starts out by naming
Yellen's task, and by stating something that should be blindingly obvious, but
apparently it isn't to everyone, so he
feels compelled to mention it:
“Janet Yellen probably will confront a test during her tenure as Federal Reserve chairman that both of her predecessors flunked: defusing asset bubbles without doing damage to the economy.The central bank’s easy money policies already have led to pockets of frothiness in corporate debt and emerging markets. The danger is that unwinding such speculative excesses will end up shaking the financial system and hurting growth.Yellen is “going to be trying to do something that no one has ever done,” said Stephen Cecchetti, former economic adviser for the Bank for International Settlements, the Basel, Switzerland-based central bank for monetary authorities. She needs “to ensure that accommodative monetary policy doesn’t create significant financial stability risks,” he said in an interview.”
(emphasis
added)
Sometimes we're no
longer sure if we're reading Bloomberg or the Onion. Say what?
Clearly, it is true that Greenspan and Bernanke have 'flunked the test' as the
author avers. It is interesting that there is an almost grudging admission that
there may be 'pockets of frothiness' out there, although they sure aren't in
emerging markets anymore. Perhaps the author doesn't look at charts much (many
EMs are looking rather frayed and have done so for some time now). The biggest
bubbles seem to be in a number of developed market stock and bond markets
(especially junk bonds). The admission is still remarkable because the
mainstream media and central bankers alike have spent months trying to convince
us that there are no bubbles in sight anywhere. Ben Bernanke himself has only recently said so
again.
Other than that, what can one
do aside from having a good laugh? Poor Janet Yellen! She is supposed to
accomplish what simply cannot be done, namely 'unmake' the mistakes she and her
predecessor have jointly committed (let us not forget, she was vice chair and
never once dissented with the decision to implement an extremely loose policy).
We mentioned above that it is important to keep in mind that capital
consumption and wealth destruction occur during the boom, not during the bust.
It is already too late in short. Someone would need to give Ms. Yellen a time
machine. But even if it were possible for her to travel back into the past, why
would she change anything? The current bubble has not yet burst after all and
once it does, it is absolutely certain that she will be just as clueless as
Bernanke was when Greenspan's bubble burst in 2007/8.
Mr. Cecchetti from the BIS
mentions en passant that “Yellen is going to be trying to do
something that no one has ever done”. Well, there is a reason why 'no-one
has ever done it': it can't be done. The air cannot be 'let out slowly'
from a bubble. Once a bubble is underway, it keeps expanding until it doesn't
anymore – and thereafter it collapses, with all the attendant unpleasantness.
The idea that the central planners who have lit the fire under the bubble with
their inflationary policy will somehow be able to 'fine tune' its eventual
demise strikes us as utterly ludicrous.
The only question is really for
how much longer and to what extent it will expand before it bursts. This is not
knowable in advance. Recall our recent
discussion of the 1998 to 2000 period – even a short term crash in asset
prices (such as in 1998) would not necessarily constitute firm evidence that the
bubble is over. It may merely be the prelude to an
acceleration.
We can only make a few
educated guesses regarding this point. For instance, we know that the
'tapering' of 'QE' is currently underway and that therefore the probability is
very high that the recent slowdown in US money supply growth will continue (in
spite of the impressive chart above, the annual rate of growth of TMS has
actually slowed down even before 'tapering' began). We know for a fact that this
will eventually create a major problem for currently extant bubbles. What we do
not know is what lead and lag times will be involved, and what threshold the
growth rate must cross before things become dicey (we regard the recent
correction still only as a 'warning shot' so far, but obviously that will
possibly have to be reassessed depending on developments).
We also cannot be
certain yet how quickly and with what measures the Yellen Fed will react to any
untoward developments in asset prices. Whether or not the bubble can be
extended similar to what happened after 1998 may well depend on these factors.
Once again, an educated guess partly based on experience is all we can go by
(our current assumption is that they will be slow to react). None of this
invalidates our central point though: there is no way for the bubble to end
painlessly, regardless of when precisely it ends. All that can be said in
addition regarding the timing is 'the later it happens, the worse it will
be'.
The Bloomberg article provides
a bit more detail and color on the monumental task awaiting Yellen
(snicker):
“Yellen faces two challenges in dealing with bubbles: she has to identify and deflate them before they get too big and dangerous; and she has to manage monetary policy without causing them to burst in a way that causes havoc in financial markets and undercuts the expansion.”
Oh well, if that's all there is
to it…
After reminding us again that
both Greenspan and Bernanke have not proved to be exactly proficient in the
bubble spotting department, the article also repeats the credulity-straining
story about Ms. Yellen's alleged above average abilities in this regard. A
statement by president Obama is quoted in support of the idea:
“President Barack Obama spoke repeatedly last year about the need to avoid what he called “artificial bubbles.” He praised Yellen for “sounding the alarm early about the housing bubble” when he announced her nomination for the job of Fed chairman on Oct. 9. “She doesn’t have a crystal ball, but what she does have is a keen understanding about how markets and the economy work,” he said.”
If she is such a maven in this
respect, then surely we can all breathe easier. This is because right now, she
sees no bubbles anywhere, just like her soon departing predecessor.
Unfortunately we think that she not only lacks a crystal ball, but several of
the other attributes listed by the president as well.
“The Fed is devoting “a good deal of time and attention to monitoring asset prices in different sectors” to see if bubbles are forming, Yellen, currently Fed vice chairman, told the Senate Banking Committee on Nov. 14.“By and large,” she said, “I don’t see evidence at this point in major sectors of asset-price misalignments, at least of a level that would threaten financial instability.”
(emphasis
added)
The fact that she is in fact
unable to recognize bubbles or evolving threats to financial stability was
revealed in her refreshingly
honest testimony to the Financial Crisis Inquiry Commission in 2010 (a recording
of it may still be online).
“For my own part,” Ms. Yellen said, “I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s — I didn’t see any of that coming until it happened.” Her startled interviewers noted that almost none of the officials who testified had offered a similar acknowledgment of an almost universal failure.”
(emphasis
added)
We don't believe
that she has acquired new bubble and stability risk recognition powers since
then. We are rather inclined to agree
with Mr. Stockman's assessment of the ways in which she is different from
Bernanke (in no way that actually matters, that is). Stockman incidentally makes
the not unimportant point that the gaggle of central planners she belongs to are
all bureaucrats with not the faintest conception of capitalism and free
markets.
Total credit market debt in the
US economy: it is the size of this debtberg – the result of unfettered money and
credit creation since the early 1970s – that has made deflation into the big
bogeyman. This ensures that the vicious cycle of intervention heaped upon
intervention will continue to the bitter end -
click to enlarge.
Bernanke's Parting Error
We do get some insight into the
current thinking about bubbles at the Fed, when Ben Bernanke reveals what its
'bubble prevention policy' currently consists of. In essence he simply repeats
his flawed analysis of what caused the housing bubble and this analysis is what
the new policy is based on (basically, bubbles have nothing to do with interest
rates according to Bernanke – all we need is more regulation and especially
alert, super-human regulators):
“The Fed’s zero-interest-rate policy is prompting investors to take greater risks with their money. The extra yield that buyers demand to own older, smaller junk bonds that trade infrequently shrank to an average 0.25 percentage point in the first half of this month from more than 1 percentage point a year ago, according to Barclays Plc data.Bernanke, 60, has set out a two-stage process for identifying potentially dangerous buildups in speculation. First, officials try to pinpoint asset markets where prices are grossly misaligned. Then they consider whether a sudden drop in those prices would be amplified throughout the financial system, as happened during the housing bust. Such intensification could occur if the investors holding those assets were highly leveraged, illiquid or interconnected with others.The Fed’s “first, second and third lines of defense” for dealing with such imbalances is to rely on supervision, regulation and so-called macro-prudential policies, such as mortgage loan-to-value restrictions, Bernanke told the Brookings Institution in Washington on Jan. 16. Only as a last resort would it consider raising interest rates.”
(emphasis
added)
So let's get this straight: the
zero interest rate policy is “prompting investors to take greater risks with
their money” – not according to Bernanke to be sure, but according to the
data and common sense. But raising interest rates is only deemed a 'last
resort' if the Fed happens to spot emerging financial system risks – which we
can already guarantee it won't.
The paragraph in the
middle which we highlighted is ludicrous from beginning to end:
“First, officials try to pinpoint asset markets where prices are grossly
misaligned.” These guys have proved over and over again that they are
utterly incapable of recognizing bubbles that are staring them right in the
face. It is in fact ridiculous that the same people who are responsible
for the misalignment of prices are expected to 'pinpoint' said misalignment. The
economy's entire structure of prices is distorted when interest rates are
artificially suppressed below the natural rate dictated by society-wide time
preferences. All prices are thus 'misaligned' as a result of the policy. There
is no need to go out and try to 'pinpoint' anything.
“Such intensification could
occur if the investors holding those assets were highly leveraged, illiquid or
interconnected with others.” – So where exactly in the current bubble era
are investors who are not 'highly leveraged' or 'interconnected with
others'? That must be a group of investors stranded on a remote island without
access to telecommunication (and presumably speculating in coconut milk futures
priced in cowry shells). Even though the banking system is
superficially better able to deal with bank runs than prior to 2008 because 'QE'
has increased the amount of covered relative to uncovered money substitutes
outstanding, there are far more deposit liabilities in existence
now. Moreover, there are countless ways in which risk has been
shunted into other, even more opaque corners of the financial markets. It is not
even necessary to mention the endless rehypothecation chains employed by the
shadow banking system or the one quadrillion dollars in outstanding derivatives
notionals (in spite of netting out reducing this exposure considerably, these
will in extremis depend on the ability of links in the chain to
actually perform. We saw what can happen when a big link threatens to break when
AIG suddenly realized that the CDS contracts it had written were bankrupting it
practically overnight). Just
look at this example that concerns one of the biggest currently raging
bubbles (one of those neither Bernanke nor Yellen profess to be able to
see):
“A U.S. bank regulator is warning about the dangers of banks and alternative asset managers working together to do risky deals and get around rules amid concerns about a possible bubble in junk-rated loans to companies.The Office of the Comptroller of the Currency has already told banks to avoid some of the riskiest junk loans to companies, but is alarmed that banks may still do such deals by sharing some of the risk with asset managers."We do not see any benefit to banks working with alternative asset managers or shadow banks to skirt the regulation and continue to have weak deals flooding markets," said Martin Pfinsgraff, senior deputy comptroller for large bank supervision at the OCC, in a statement in response to questions from Reuters. Among the investors in alternative asset managers are pension funds that have funding issues of their own, he said."Transferring future losses from banks to pension funds does not aid long-term financial stability for the U.S. economy," he added.The breadth of the statement from the OCC is unusual because it technically oversees banks and not asset managers. Regulators are eying a number of risks to the financial system as they aim to prevent a repeat of the mortgage bubble that spurred the 2008-2009 financial crisis. They are not comfortable with different players sharing risk if the total level of risk in the system is getting dangerously high.That may be happening with leveraged loan issuance, which hit a record $1.14 trillion in the U.S. in 2013, up 72 percent from the year before, according to Thomson Reuters Loan Pricing Corp. A measure of the riskiness of these loans has also been rising – the average size of the debt for companies taking these loans in 2013 was 6.21 times a form of cash flow known as EBITDA or earnings before interest, tax, depreciation and amortization, up from 5.86 times in 2012 and the highest since 2007, LPC said.”
(emphasis added)
Mind that this is
just one example of how Bernanke's echo bubble has once again increased
systemic risk. We would be willing to bet that no-one at the Fed
has ever raised this particular issue. It is also worth pointing out that the
main reason why regulators have become cognizant of this risk at all is
because it is already too late to do anything about it. The fact that
they have even noticed that something is possibly amiss proves ipso
facto that the bubble in this corner of the financial universe has become
so gargantuan that all that is left to do is to wait until it bursts and maybe
say a few prayers.
Conclusion:
There is no point in trying to
avert or prevent bubbles caused by monetary pumping by regulatory means. If one
avenue for bubble formation is cut off, the newly created money will simply flow
into another area. In fact, new bubbles almost always become
concentrated in new sectors. If there were a genuine desire to keep the
formation of bubbles in check, adopting sound money would be a sine qua
non precondition. However, no-one who has any say in today's system has a
desire to adopt sound money and give up on the failed centrally planned monetary
system in favor of a genuine free market system. Our guess is that the
booms and busts the current system inevitably produces will simply continue to
grow larger and larger until there comes a denouement that can no longer be
'fixed'.
Janet Yellen: I swear there's
no bubble in sight anywhere!
http://www.zerohedge.com/news/2014-01-30/guest-post-janet-yellens-impossible-task
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