John Hussman had an interesting post this week on a The
Decade of Zero and its Chaotic Unwinding.
Hussman proposes that stocks and bonds are so ridiculously priced that
expected returns in every time frame shorter than 10 years is likely to be
negative. He believes stocks will not be flat for 10 years, rather there will
be a drawdown of 40% or more at some point.
Hussman also discussed central bank policy and whether or not there was
any evidence it works. Let’s continue with the bank policy discussion.
No Evidence QE Increased Industrial Output or Reduced Unemployment
I imagine that Ben Bernanke, Mario Draghi and Haruhiko Kuroda all stay
awake at night imagining ways to force negative rates on savers. But the
larger question, beyond a sociopathic desire to control others in service of
one’s own intellectual dogma, is why anyone would advocate such policies. I
can’t emphasize strongly enough that there is no economic evidence that
activist monetary intervention has materially improved economic performance
in recent years.
Specifically, the trajectory of the economy in recent years has followed a
largely mean-reverting course that one could have anticipated simply on the
basis of lagged economic data, and there is no economically meaningful
difference in the projected trajectories of GDP, industrial production, and
employment using purely non-monetary variables, compared with projections
that include measures of recent extraordinary monetary policy.
Even allowing for a negative “shadow” Federal Funds rate, as Wu and Xia have
done, results in the conclusion that extraordinary monetary policy boosted
U.S. industrial production by less than 1%, and lowered the unemployment rate
by just over one-tenth of 1% beyond what would have been expected from
conventional monetary policy (as defined by the Taylor Rule).
Damn the Lack of Evidence, Full QE Ahead
Yesterday I wrote Spirit of Abenomics: Bold New Plan in September?
Etsuro Honda, an advisor to Japanese prime minister Shinzo Abe made this
statement: The effects of quantitative easing may be diminishing compared
with a few years ago, but “what we should say is, ‘Effects are diminishing,
so let’s do more.’ This is the spirit of Abenomics.”
Spirit of Abenomics
Honda said that it was odds on that Abe would start a “bold new plan” in
September.
I commented … Not only does Honda summarize the “Spirit of Abenomics” rather
well, he summarizes the “Spirit of Central Banking” in general.
We can boil this down to the phrase “If it doesn’t work, keep doing it
until it does work.”
ECB Hints at More QE
The Financial Times reports ECB Hints at Taking Further Monetary Policy Action in
September.
The European Central Bank has hinted at taking further action next month
should economic conditions in the eurozone fail to improve, with its top
policymakers saying the impact of the latest wave of uncertainty to hit the
global economy needed “very close monitoring”.
The latest edition of the central bank’s monetary policy deliberations —
for the meeting on July 21 when it decided to keep rates on hold — indicated
the governing council may well act according to analysts’ expectations and
keep its ultra-loose monetary policy in place for longer when it next meets
on September 8.
The tone of the remarks will raise hopes of an extension of the central
bank’s €80bn-a-month quantitative easing programme beyond the current spring
of 2017 deadline.
Some central bank watchers think the ECB will also ease the rules
governing which bonds can be bought under the flagship QE programme.
Abenomics Flashback
Let’s take a look at a QE discussion from October 31, 2014, nearly two
years ago: Japan’s central bank shocks markets with more easing as
inflation slows.
“We decided to expand the quantitative and qualitative easing to ensure
the early achievement of our price target,” Bank of Japan Governor Kuroda
told a news conference, reaffirming the BOJ’s goal of pushing consumer price
inflation to 2 percent next year.
“Now is a critical moment for Japan to emerge from deflation. Today’s step
shows our unwavering determination to end deflation.”
Physics Lesson for Central Bankers
Bloomberg columnist Mark Gilbert offers this Physics Lesson for Central Bankers.
Quantitative easing’s failure to quash the threat of deflation is
finance’s equivalent of the bump in the data that alerted physicists to the
possibility of a new boson. The mismatch between economic theory and the
real-world outcome of zero interest rates poses a direct challenge to the
current orthodoxy that puts a 2 percent inflation target at the heart of
monetary policy in most of the developed world.
Years of pumping trillions of dollars, euros, yen and pounds into the
economy by buying government debt and other securities hasn’t produced the
rebound in inflation that economics textbooks predicted. Record low borrowing
costs haven’t led to a surge in investment and spending that would lead to
higher prices.
That’s the kind of empirical evidence that should produce a
reconsideration of what Rothschild Investment Trust Chairman Jacob Rothschild
this week called “the greatest experiment in monetary policy in the history of
the world.”
Neil Grossman, director of Florida-based bank C1 Financial and former
chief investment officer at TKNG Capital Partners, likens the need to abandon
the current economic orthodoxy with the impact of quantum physics on science
in the last century.
If Einstein Ran the Fed, Rates Would Rise
About a year ago, Gilbert wrote If Einstein Ran the Fed, Rates Would Rise
Try this thought experiment. Instead of leaving borrowing costs on hold at
0.25 percent when it met Thursday, suppose the Federal Reserve had instead
raised its key interest rate to 3.25 percent. That, after all, was the
average from 2004 to 2008, back when the economy was deemed to be normal. So
if monetary policy normalization is the goal, maybe the U.S. central bank
should get it over with in a single move and see what happens.
I’ve had a bunch of e-mails in recent weeks on this topic from readers who
disagreed with
my articles that said the Fed should stay on hold because there’s still a
non-negligible risk of deflation. Neil Grossman, who’s a director of
Florida-based bank C1 Financial and was formerly the chief investment officer
at TKNG Capital Partners, is a particularly eloquent correspondent on the
topic.
Grossman uses the analogy of physics, where the weird stuff that happens
at the quantum level (including what Albert Einstein called “spooky
action at a distance”) forced theorists to rewrite their textbooks;
The problem with economists is that they fail to understand that
standard economics is not appropriate as one approaches the zero rate bound.
This is similar to what happened in physics over a century ago. In order to
stimulate growth in the U.S., U.K. and globally, interest rates must be
engineered to relatively normal levels.
Economics certainly doesn’t seem to be following its textbooks. The
Fed’s balance sheet has swollen to $4.5 trillion from just $1 trillion
when it introduced quantitative easing; yet consumer prices aren’t going
anywhere. So maybe the advocates of monetary-policy normalization are onto
something.
Sticking With Failure
It’s clear the current policies have not worked. Even Krugman admits that.
Krugman has a hopeless solution though: more fiscal stimulus. Krugman’s
plan of action is precisely what got Japan into trouble in the first place.
For discussion, please see Krugman’s Arrow Theory Misses Target by Light Years.
Central Bankers are Threatening the Engine of the Economy
Bill Gross says Central Bankers are Threatening the Engine of the Economy.
Are near-zero interest rates and a global store of about $13tn worth of
negative-yielding bonds actually good for the real economy? Recent data
suggests they may not be. Productivity growth, perhaps the best indicator of
an economy’s vitality, is abysmal in most developed countries. It has been
declining in the past half-decade or so, not coincidentally tracking the advent
of QE and zero lower bound interest rates.
In the US the year-on-year trend for productivity has turned negative .
Most central bankers dismiss this fact as a short-term aberration. But the
Japanese economy provides an example of what interest rates at or near zero
can do to a large, developed economy. The answer is not much: not much real
growth; not much inflation — and, together, not enough nominal GDP growth to
repay historic debt should yields on sovereign debt ever return to normal.
Corporations are using an increasing amount of cash flow to buy back
shares as opposed to investing for growth. In the US, more than $500bn is
spent annually to boost investors’ incomes rather than future profits. Money
is diverted from the real economy to financial asset holders — where in many
cases it lies fallow, earning little return if invested in government bonds
and money markets.
Historic business models with long-term liabilities — such as insurance
companies and pension funds — are increasingly at risk because they have
assumed higher future returns and will be left holding the short straw if
yields and rates fail to return to more normal levels.
The profits of these businesses will be affected as will the real economy.
Job cuts, higher insurance premiums, reduced pension benefits and increasing
defaults: all have the potential to turn a once virtuous circle into a cycle
of stagnation and decay.
Central bankers are late to this logical conclusion. They, like most
individuals, would prefer to pay later than now. But, by pursuing a policy of
more QE and lower and lower yields, they may find that the global economic
engine will sputter instead of speed up. A change of filters and monetary
policy logic is urgently required.
Pack of Mindless Lemmings Head For Cliff
It’s crystal clear current policies are failing. Yet the central bankers
follow each other like a bunch of mindless lemmings.
Is the ECB the lead lemming now? Or is it the bank of Japan? Who is
following whom?
It’s difficult to say which lemming finds the edge of the cliff first, but
the cliff is there waiting.
Fed Uncertainty Principle Yet Again
Many of you may be asking “Why can’t the central banks see their policies
are counterproductive?”
For that we need to return to quantum physics once again. I explained this
on April 3, 2008, before the crash, in the Fed Uncertainty Principle.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts
the economic picture. I liken this to Heisenberg’s
Uncertainty Principle where observation of a subatomic particle changes
the ability to measure it accurately.
The Fed, by its very existence, alters the economic horizon. Compounding
the problem are all the eyes on the Fed attempting to game the system.
What happened in 2002-2004 was an observer/participant feedback loop that
continued even after the recession had ended. The Fed held rates rates too
low too long. This spawned the biggest housing bubble in history. The
Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the
worst possible moment.
Here is a recap of the Fed Uncertainty Principle and its corollaries
as I wrote them before the crash.
Fed Uncertainty Principle:
The fed, by its very existence, has completely distorted the market via
self reinforcing observer/participant feedback loops. Thus, it is fatally
flawed logic to suggest the Fed is simply following the market, therefore the
market is to blame for the Fed’s actions. There would not be a Fed in a free
market, and by implication there would not be observer/participant feedback
loops either.
Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market
does. The Fed will be disingenuous about what it knows (nothing of use) and
doesn’t know (much more than it wants to admit), particularly in times of
economic stress.
Corollary Number Two:
The government/quasi-government body most responsible for creating this
mess (the Fed), will attempt a big power grab, purportedly to fix whatever
problems it creates. The bigger the mess it creates, the more power it will
attempt to grab. Over time this leads to dangerously concentrated power into
the hands of those who have already proven they do not know what they are
doing.
Corollary Number Three:
Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed
to repeat them with bigger and bigger doses of exactly what created the
initial problem.
Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The
Fed is operating under the principle that it’s easier to get forgiveness than
permission. And forgiveness is just another means to the desired power grab
it is seeking.
If you understand the key principle, its clear where the problem is. Here
are the key sentences.
- There would not be a Fed in a free market, and by
implication there would not be observer/participant feedback loops
either.
- The Fed has no idea where interest rates should be. Only
a free market does. The Fed will be disingenuous about what it knows
(nothing of use) and doesn’t know (much more than it wants to admit),
particularly in times of economic stress.
It’s amusing the word “uncertainty” pops up multiple times every day.
The solution is not to hike rates to 3.25% in one fell swoop as Gilbert
suggested. One cannot possibly know what the interest rate should be after
the massive mess the central banks have created.
The solution is not what Krugman suggests either. There’s too much debt already.
Rather, the three-pronged solution that has not been tried is precisely
the thing that should be tried:
- Get rid of the Fed and let the free market set the
interest rates.
- End fractional reserve lending
- Let the free market decide what money is. Most likely
gold would be the answer.
Mike “Mish” Shedlock
