Obama, Bernanke and Yellen Rigged the Bond Market. Now it’s Trump Turn to Dance or be their Dunce

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Published : March 20th, 2017
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Category : Crisis Watch

Government dysfunction is at its worst.  We voted them in.  We have no one to blame but ourselves. Granted, the choices were abysmal. But the Republican and Democratic parties, with no third party competition, can continue to run dysfunctional governments, whittling away our dominant global position until the cracks of our broken government becomes abundantly clear.  As a society, we play right into their subterfuge of keeping us so upset at the other party, we don’t see right in front of our own eyes the decay of policies created to reflect the success and desires of just one party.  Polarized politics that take the best and worst policies of one party instead of the best of both parties is destined to end in a deep, painful recession and possibly a global depression.  Pathetically, America is chained to a wall in Plato’s cave with half watching MSNBC and the other half Fox News since birth.  I fear changing the channel would be like Zhuangzi’s seventh hole in Wonton instead of enlightenment.  We are stuck with the landscape in front of us for now.

Since the dawn of politics, politicians have tried to balance keeping themselves in office and destroying the competing politicians while keeping the economy healthy and vibrant to ensure reelections.  Similar to strangling the golden goose to get every last golden egg without killing the goose, politicians play the same game with the economy.  Passing poor economic policies to reward constituents without derailing forward progress in an economy is a hard task and often leads to disastrous results.  In the US, when politicians pursue poor economic policies down party lines, the results from poor performance is swift and new politicians are elected.

The financial crisis of 2008 proved that poor economic performance leads to significant political change. It also proved that when pressed with a disaster, politicians can come together – though at the last possible moment – and craft policies to remedy the situation.  But that harmonious bipartisan relationship only lasted for moments.  Once the systemic downward spiral stabilized, their cooperation ended.  The task to get the economy away from the brink of a stabilized disaster and grow again fell in the lap of the Central Bank and Fed President Ben Bernanke.

Central banks are supposed to be void of political influence.  However, Alan Greenspan, Bernanke’s predecessor, had just retired and most would argue let the economy run too hot for too long with an extremely easy monetary policy.  Was Greenspan less of a monetary hawk, ignoring growing excesses to avoid shallow downturns that are part of a normal business cycle because he was about to retire?  A younger Greenspan surely wouldn’t have been so timid on the monetary policy front.  Did he care about his legacy and didn’t want to see a downturn until he left office?  Or was it less ego driven and more political influence?

Central banks are typically independent, and therefore, not viewed as a governmental puppet funding doomed policies regardless of merit.  If not independent, attracting foreign capital becomes difficult since the track record shows a cohabiting relationship fails in the long run.  But political influence can be hard to avoid, especially when hounded by politicians daily, not to mention handpicked by the political party in power.  Greenspan was blamed for having too restrictive of a policy on George Bush Sr.’s watch and used as a scapegoat when not reelected.  When George Bush Jr. was running for reelection, it seemed this point registered and Greenspan remained accommodative keeping rates too low for too long.

Following right along with this influential creep over the Central Bank, a visit by the Fed to the White House used to be rare and is now commonplace with a direct line of communication.  As Bernanke took office, it was obvious that the divisive political landscape could not produce solid economic policies and the Fed would be left to do the heavy lifting.  In order for Obama to fund his partisan economic policies, while attacking his political opponents (finance, healthcare and traditional energy sectors), he needed the Fed’s help.  Bernanke accommodated, bringing rates to zero, deprive savers and instead encourage borrowing and bringing future growth forward to offset Obamas policies. Sure, Bernanke could have maintained a rational higher rate monetary policy.  We would have suffered a shallow economic recession and politicians would have been forced to work together on good economic policy for all to escape another downward spiral.  But Bernanke was not a self-thinking maverick.  No, he was an academic that loved to be loved and took the easy way out.  This ensured the status quo would continue on his watch leaving destructive problems bubbling under the surface.  Next came Fed Chairman Yellen. After years under Bernanke as the Vice Chairman of the Fed, she knew the cost of low interest rates and trying to accomplish more than rational monetary policy can produce.  She decided not to have these issues unwind on her watch and continued funding poor economic policies to ensure continuation of what is now the longest expansion, albeit a slow expansion, in the US.

It’s easy to show Yellen knows the costs to a prolonged low interest rate policy.  When Yellen was the President of the San Francisco Federal Reserve, they created a web based game “Chair the Federal Reserve”.  In it, you as the Chair of the Fed can set monetary policy. In all instances, setting low interest rates for a prolonged period leads to high inflation. (Give it a go at http://www.frbsf.org/education/teacher-resour...al-reserve-e...).

The problem with funding poor economic policies with low interest rates – or outright monetization of almost 5 trillion dollars of debt - is eventually you run out of reasons to keep rates artificially low.  The Feds purchases amount to approximately the total debt we had in 2003.  Without the Fed’s purchases, the US would not have been able triple its debt since then!  We now have decades of poor partisan economic policy and a pile of debt that we will not be able to fund if interest rates ever reverted to the historic mean.

There are many obvious reasons higher interest rates will be destructive.  Public and private balance sheets are bloated and cannot service higher levels of rates.  Certain multi-billion dollar hedge funds which attracted capital holding hundreds of billions in fixed-income investments, leveraged and riding the bond rally down to historic low yields – with a nod and a wink from the Fed’s crony capitalism - have the potential to create systemic dislocations when investors’ redemptions due to poor performance force an unwind of these positions.  Some of these largest hedge funds are already seeing evacuations taking place from the stewards of these funds’ helms.  And when the international community, which holds half the US debt, realizes the next crisis will result in more debt issued and monetized by the central bank, not only will they avoid our debt market, they will run for the hills.  This will result in a parabolic move higher in yields, the dollar weakening and inflation limiting the response by the Fed. Sound like the 1980’s all over again. It should.  History, after all, rhymes, if it doesn’t repeat.

Now it’s Trump’s turn.  His grandiose plans of make America great again with expansionary economic policies that are badly needed are a catch-22.  The Fed has managed and manipulated interest rates significantly below market levels for so long, the cost of this expansive policy will prove to be catastrophic if rates adjust higher.  The US can only bluff investors to keep investing in these below market rates if they believe the next crisis is on the horizon or they believe growth will continue to be slow keeping inflation running around this 2% level.  Trump faces two scenarios: continue down the path of slow and steady growth assisted by Fed manipulated interest rates or pursue faster growth and suffer a recession or worse from markets setting higher rates.  Will he dance and play the game that is set before him, or pursue his agenda and end up being the dunce?

Yes, if Trump pursues a pro-growth agenda, sadly, it will end with higher rates and an economic crisis.  Ironically, this sounds like a tried and tested process to bring our politicians together and work in a bipartisan way.  Too bad it takes a crisis to make government functional.  I hope our luck of working together at the last moment only in times of crisis has not run out.

Investment veteran and published author, Michael Carino, prophetically called the timing and amplitude of the recent move in global bond markets publishing “Global Bond Markets – Skydiving Without a Parachute.”  Michael has spent the last 25 years managing fixed-income hedge funds and trading of over a trillion dollars of investments.  He is the CEO of Greenwich Endeavors, a financial service firm.  He feels compelled to get his unique and under-reported views on the markets out to the public.  He hopes to assist your readers’ creation of wealth and limit your readers’ destruction of wealth.  It's time a voice contrarian to other self-interested, behemoth Investment Managers’ voices are heard.

 

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Graham Summers is Chief Market Strategist for Phoenix Capital Investment Research, an independent financial research firm based in Charlottesville VA with clients in 56 countries around the world.
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