Nihilo ex nihilo fit
Nihilo ex nihilo fit. Out of nothing, nothing comes. First put forward by ancient Greek philosopher Parmenides in the 5th century BC, Thomas Aquinas and St. Augustine later used this axiom to prove that the universe needed a “first mover,” to get things going.
Even if the whole thing began with some kind of “Big Bang” moment, it still needed a banger to bang it. Who? God, of course.
We don’t know. But our jaw dropped when we saw how the bangers over at the Federal Reserve have helped add $20 trillion in US household wealth since 2009 – setting yet another new record. The Wall Street Journal reports:
American’s wealth hit the highest level ever last year, according to data releasedThursday, reflecting a surge in the value of stocks and homes that has boosted the most affluent US households.
Ex nihilo? Who cares. It’s there. It’s spendable.
And yet… what kind of wealth comes from nothing? Is it solid and real, like the earth, the moon and the stars? Or is it something else? It is clearly something else. But what?
Milken's Legacy and Concerns
Michael Milken was writing in the Wall Street Journal this week. The "Junk Bond King" passed on an important lesson for investors: Beware a market heavily distorted by government intervention. Things may not be as they first seem …
Milken popularized the junk-bond market in the late 1970s and early 1980s. Then he went to jail for securities and tax fraud. He "understated the risks" associated with high-yield (junk) bonds, said the newspapers.
Thirty years later, the junk bond market is 10 to 20 times bigger … and the risks greater than ever. But now, it's not Milken understating the risks to investors; it's central bank policy. The Fed sets the price of credit. A certain class of speculators now believe that, as long as the Fed keeps borrowing costs on the floor, they don't have to worry about losing money.
But Milken never mentioned junk bonds yesterday. Instead, he was concerned with another grotesquerie perpetrated by the feds – this time in the US housing market.
The 'Deflation Danger' Should Abate …
What is it with this perennial fear the chief money printers have of falling prices? Not that we are likely to see it happen, but if it does, what of it? Bloomberg reports on the recent ECB decision with the following headline: “Draghi Says Deflation Danger Should Abate as Economy Revives”
The headline alone is a hodge-podge of arrant nonsense. First of all, 'deflation' (this is to say, falling prices), is not a 'danger'. Speaking for ourselves and billions of earth's consumers: we love it when prices fall! It means our incomes go further and our savings will buy more as well. What's not to love?
The problem is of course that when prices decline, the 'wrong' sectors of society actually benefit, while those whose bread is buttered by the inflation tax would no longer benefit at the expense of everybody else. But they never say that, do they? Has Draghi ever explained why he believes deflation to be a danger? No, we are just supposed to know/accept that it is.
Secondly, the 'as economy revives' part makes no sense whatsoever. Why and how should a genuinely reviving economy produce inflation? Economic growth occurs when more goods and services are produced. Their prices should, ceteris paribus, fall (of course, we are not supposed to inquire too deeply into which ceteris likely won't remain paribus if Draghi gets his wish).
Record Junk Bond Issuance
Dow down 35 on Wednesday. Gold up slightly. A dull day on Wall Street, with investors holding onto most of Tuesday's gains. Here's another record that was broken recently …
In the late 1970s, Michael Milken persuaded his boss at Drexel Burnham to let him start a high-yield bond trading department. (High-yield bonds are non-investment grade bonds that carry high default risk. Hence their nickname: "junk bonds.") Soon, Milken's trading department started earning a 100% return on investment.
The junk-bond market was tiny – with total issuance only rising to about $30 billion in the mid-1980s. Milken was right about junk bonds being hugely profitable. But that didn't stop the feds from putting him in jail in 1990 on six counts of securities and tax fraud. (Milken didn't just stop at legitimate means of making money in the high-risk world of junk bonds.)
Nevertheless, the junk-bond market continued to grow. At the end of the 1990s, issuance was hitting new records – at about $150 billion. Then junk-bond issuance collapsed with the tech bubble.
But unlike tech stocks, junk bonds were soon flying higher than ever. In the middle of the 2000-07 period, annual junk-bond issuance rose above the $150 billion mark. But in 2013, the junk really topped the charts – with about $330 billion of new bonds issued.
Debt – the Name of the Game
Dow down a bit on Tuesday. Gold up a bit. The upward trend of US stocks – and now gold – has not yet been broken. Looking broadly at major trends of the last 50 years, debt was the name of the game from 1980 to 2007. Is it still the most important thing?
From about 160% of GDP in 1980, total debt in the US rose to about 360%. That was a big deal. Not the least because it meant that US businesses availed trillions of dollars in income with no offsetting labor charge.
Stocks, earnings, GDP, employment – with all this borrowed money flowing into the economy, the whole shebang looked good.
First, the market news: The Dow lost 89 points on Wednesday. Gold fell by four bucks an ounce. And now the good news: The Great Correction is over!
Hallelujah! People are going deeper into debt … and getting divorced again.
No kidding. Bloomberg reports:
“The number of Americans getting divorced rose for the third year in a row to about 2.4 million in 2012, after plunging in the 18-month recession ended June 2009, according to US Census Bureau data.
"As the economy normalizes, so too do family dynamics," said Mark Zandi, chief economist at Moody's Analytics Inc. in West Chester, Pennsylvania. "Birth rates and divorce rates are rising. We may even see them rise strongly in the next couple of years, as households who put off these life-changing events decide to act."
Divorces were at a 40-year low in 2009, according to Jessamyn Schaller, an economics professor at the University of Arizona in Tucson, citing data from the federal government's National Center for Health Statistics. The divorce rate more than doubled between 1940 and 1981 before falling a third by 2009, according to figures from NCHS, based in Hyattsville, Maryland.”
'We're on Track, We're on Track …' – Just Say it Often Enough
When Mr. Kuroda was appointed governor of the BoJ, there was great excitement in the markets. A committed inflationist! Practically a resurrected John Law, disguised as a bookish-looking Japanese functionary. Let's sell the yen, buy the Nikkei and get rid of our JGBs at once!
It seems though that the magic is gone now. After a string of rather disappointing economic data emanating from Japan lately (and keep in mind that the previous string of allegedly 'strong' data was largely the result of statistical tomfoolery), the Nikkei and the yen stalling out, and the JGB almost back at its previous record high, all that Japan has to show for the effort are somewhat poorer consumers, whose real income is now declining.
Apparently Kuroda is unperturbed though:
“The Bank of Japan maintained its expansionary monetary policy on Tuesday and extended special loan programs to help buoy economic growth, signaling its resolve to keep the positive mood generated by premier Shinzo Abe's reflationary policies from fading. The central bank reiterated its upbeat view on the economy, unfazed by recent signs of slowing growth and suggesting that any additional stimulus will be some time away.
BOJ Governor Haruhiko Kuroda said the expansion was aimed at enhancing the transmission mechanism of quantitative easing by encouraging banks to boost lending instead of sitting on piles of cash. "We have an engine with big horsepower, so it makes sense to have stronger tires," he told reporters after the decision.
While some investors viewed the loan program expansion as a policy signal the BOJ may take a more accommodative stance if necessary, Masashi Murata, senior currency strategist at Brown Brothers Harriman, cautioned that the reaction in the Japanese government bond market suggested this was not the case. "Bank shares drove the Nikkei, which drove the yen, but JGBs did not react much," he said.
As widely expected, the BOJ on Tuesday maintained its pledge of increasing base money, its key monetary policy gauge, at an annual pace of 60-70 trillion yen ($589-$687 billion). The central bank also stuck to its assessment that Japan is recovering moderately, a sign it remains confident the world's third-largest economy can weather the pain from a sales tax increase in April without additional stimulus. "The BOJ already expects the economy to contract immediately after the sales tax hike, so this cannot be the basis for additional easing," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management in Tokyo.
The BOJ has stood pat on policy since launching an intense burst of stimulus last April, when it pledged to accelerate inflation to 2 percent in roughly two years via aggressive asset purchases in a country mired in deflation for 15 years. Monday's weaker-than-expected fourth-quarter GDP has dashed hopes that a rush in household spending ahead of the April tax hike would cushion the pain from sluggish export growth. While the BOJ is in no mood to act immediately, market pressure for further stimulus may heighten in coming months if there is more evidence that personal consumption is losing momentum, some analysts say.
Kuroda, however, remained sanguine, saying he saw no threat to the bank's rosy projections with overseas demand seen picking up and rising income underpinning consumption. "If risks materialize, we will not hesitate adjusting policy, but for now Japan's economy is on track and moving in line with our forecasts," he said.
As expected, the BOJ extended three special loan facilities by one year from their scheduled expiry in March. Of the three, it doubled funds available to banks under two facilities — one that encourages banks to funnel money to industries with growth potential and another that offers cheap funds to banks that boost lending. Both give banks access to funds for four years at a fixed rate of 0.1 percent.
But analysts doubt how much the expansion will do to boost lending, which has increased only moderately despite the BOJ's aggressive stimulus on sluggish corporate demand for funds. Of the combined 21.5 trillion yen that had already been set aside under the three facilities, less than 9 trillion yen has been tapped so far. Kuroda acknowledged that the BOJ was counting somewhat on the psychological effect by boosting the lending facilities. "We attempt to strengthen the incentive for banks to tap these facilities," he said. "We've included a strong message of support for these programs.”
Not a Woman, Just a Chair
In keeping with the political correctness befitting the first female Fed chairperson, Janet Yellen handed down her first decree last week, or as CNBC puts it, 'laid down the law':
“Federal Reserve chief Janet Yellen has instructed the central bank's staff to refer to her as "Fed chair" rather than "chairwoman," The Washington Post reported on Monday. The first woman to preside over the Fed in its history is striking a gender-neutral tone that belies her barrier-breaking history as an academic and a policymaker.
Out of two dozen economics doctorate students at Yale University in the early '70s, Yellen was the only woman to earn a Ph.D., the Post reported. Her early career was influenced by what the newspaper said was "skepticism of her abilities," based largely on her gender.
The 67-year-old economist takes over Monday amid growing fears over the Fed's ability to pull back on its massive monetary stimulus as investors worry about the effect of tapering on emerging markets.”
Making it up as She Goes Along
Tuesday was a good day for almost everyone on Wall Street. The Dow rose 198 points. Gold rose $15 an ounce. But long-dated Treasury bonds sold off. The bond market is worried its biggest buyer – the Janet Yellen Fed – will bow out.
The proximate cause of rising prices and falling ones was the news from Washington. First, Congress voted to raise the debt ceiling, without quibbles or conditions, until next year.
Second, Janet Yellen made her debut on Capitol Hill as Fed chairwoman with this question from Republican Congressman Jeb Hensarling, from the sovereign state of Texas:
"Are you a sensible central banker, and if not, when will you become one?"
It was a coded challenge, based on Yellen's 1995 statement that a sensible central bank follows formulae … and transparent rules … rather than making ad hoc decisions. Yellen replied that, yes, she was sensible and that, yes, a central bank should follow transparent rules …
… but that she would continue making it up as she goes along. Christian Science Monitor reports:
“For more than a year, the Fed's policy committee has said it wouldn't consider a hike in the short-term interest rate until unemployment dipped to 6.5%, as long as inflation didn't exceed 2%. Today, with the jobless rate already down to 6.6%, Fed officials including Yellen are saying the 6.5% rate is not a "trigger" for raising rates.
In practice, Yellen told lawmakers on Tuesday that she would be looking at a range of labor-market and inflation data to assess when to raise rates. It's likely the Fed will maintain ultra-low interest rates "well past the time that the unemployment rate declines below 6-6.5%," she said in the written testimony prepared for Tuesday's hearing.”
So, QE could go on …
Word from the Bank of Yellen
On Wednesday, the Bank of Janet Yellen said it would continue to "taper" QE. Instead of counterfeiting $75 billion every month, it will counterfeit only $65 billion. At this rate, it will be out of the counterfeiting business completely by the end of summer. On Thursday, the United State Department of Commerce said the US economy was growing at a 3.2% annual rate, which is satisfactory. Until you look at it more closely.
On Thursday, too, stocks went up – 109 points on the Dow. The Fed had little choice. It has to pretend to go straight at least for a month or two more. Otherwise, it won't have a shred of credibility left. And so far, so good. It looks like stocks will close the month of January down only 3%. Not catastrophic.
For what it is worth, our "Crash Alert" flag … the ol' black and blue … flies over our worldwide headquarters. We say "for what it is worth," because it hasn't been worth very much. Not the last three years.
We brought it out on several occasions. The wind whipped it. The sun bleached it out. The rain soaked it. The markets didn't crash. Finally, we brought it in because we felt sorry for it. But it's back on the job today – even though we expect the crash will come later.
Jim Grant Is Calling a Spade a Spade
Jim Grant has always been a vocal critic of the Fed, and several recent comments of his in an interview he gave to CNBC are worth highlighting:
“The Federal Reserve's stimulus policies should have gone by a different, more controversial name, the founder and editor of Grant's Interest Rate Observer told CNBC on Wednesday.
Quantitative easing seems more like price control, said Jim Grant, who writes a twice-monthly journal that covers U.S. financial markets. And past attempts at artificially keeping prices low have ended badly, Grant told CNBC.
"It strikes me that the Fed in substance, if not in name, is engaged in a massive experiment in price control," Grant said. "They don't call it that. They fix the funds rate. They manipulate the yield curve. … I said 'experiment in,' but there is no really suspense about how price control turns out. It turns out invariably badly."
Bernanke's attempts to salvage the country's financial system in 2008 during the worst economic crisis since the Great Depression have been cast in a more favorable light after the U.S stock market saw record gains in 2013.
Grant doesn't share that view. Investors, he said, cannot trust market valuations in light of Bernanke's three rounds of quantitative easing. Also, despite record gains in 2013, the recent bull market in stocks was fueled by "excess dollars" from Fed policies, he said.
"They have their fingers, their thumbs, on the scales of finance," Grant said. "To change the metaphor, we all live to a degree in a valuation hall of mirrors. Who knows what value is when the Fed fixes the determining interest rate to zero."
Grant did not limit his criticism of the Fed to its policies. He described the institution as out of touch with market and technological forces that could help drive down prices and costs without intervention from "monetary mandarins."
"It seems to me that anyone who believes themselves or herself to be a capitalist ought to be in favor of the verdict of the marketplace," Grant said. The Fed is "a command and control regime that by the way is holy and anachronistic. The whole idea of social media, the great rush of technology in the 21st century, is collaboration.”
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.
The Copy Machine is Fixed!
Last month we were slightly perturbed by evidence that the Fed's copy machine seemed to be broken. After releasing FOMC statements throughout the year that looked like carbon copies of each other, the December statement boasted quite a few differences. We discussed the event in some detail at the time, so there is no need to go over the same ground again (as well-versed Kremlinologists, we offered what we believe was a reasonable explanation).
As the WSJ's trusty statement tracker reveals, the copy machine is back in working order – only, this time they have copied the December statement. There is really no point in parsing the de minimis semantic differences in a handful of sentences in which a single word or two were ever so slightly altered. The erroneous belief that these tiny changes hold clues to the thinking of the clueless really needs to be ditched. There are no secret messages hidden in there. If we know little, they are likely to know even less (their knowledge of the future state of the economy and how they will react to it policy-wise is usually strongly reminiscent of the CO2 concentration in the atmosphere if you get our drift…it's somewhere in the tiny region between nada and zilch).
The decisive point of the January meeting was contained in two sentences, namely the following:
“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month.”
Turkish Lira Saved? Maybe Not …
Turkey's central bank is making an effort to restore some credibility to its faltering currency after failing to defend it by means of forex interventions last week. In defiance of political pressure (probably making use of the currently weakened position of the government), it has raised rates at a special meeting that has been breathlessly awaited by market participants. And it didn't exactly announce baby step rate hikes either:
“Turkey’s lira strengthened the most in more than five years and bond yields declined after the central bank raised interest rates and signaled a return to a simpler monetary policy. Stocks fell.
The Turkish currency appreciated as much as 4 percent to 2.1626 per dollar, the biggest gain since November 2008. Yields on two-year benchmark notes fell 36 basis points to 10.70 percent and the Borsa Istanbul 100 Index of shares dropped 1.4 percent.
Governor Erdem Basci is fighting to halt a currency run that gained speed amid domestic upheaval and a global rout of emerging markets. Prime Minister Recep Tayyip Erdogan, who said yesterday he’s always opposed higher rates, is caught in a graft scandal that has ensnared several ministers and the chief executive officer of a state-owned bank. It spooked investors just as the reduction of monetary stimulus in the U.S. began sucking money out of riskier assets.
The central bank raised all its main interest rates at an emergency late-night meeting in an effort to shore up the lira, resisting government pressure and reversing years of policy aimed at stoking growth. The lira gained for a third day, adding 1 percent to 2.2313 per dollar at 1:06 p.m. in Ankara, paring losses that sent it to records lows against the dollar in eight of the previous 10 days. Interest rates had been on hold since August.
The Ankara-based bank increased the one-week repo rate to 10 percent from 4.5 percent, the overnight lending rate to 12 percent from 7.75 percent and the overnight borrowing rate to 8 percent from 3.5 percent. The central bank said the one-week repo rate, now at 10 percent, should be treated as the benchmark policy tool.”
The Truth About Bernanke's Legacy
Historians will look back on this period with awe and wonder. Somehow, three generations of economists and policy-makers have convinced themselves of things that can't be true.
"Not enough demand," they say, in penetrating analysis of today's lackluster economic growth rates. "We need to provide demand," they add, as though demand were like oranges. You just pack up the truck in Florida and deliver them to New York. Easy Peasy.
But it almost seems as though the world were created just so its creator could have a good laugh at simpleminded economists.
"Look at them now," we thought we heard a stentorian voice proclaim from the heavens. "They're adding demand that doesn't exist so that people will make products for people who can't pay for them. Hardy har har!"
There is Nothing Central Planners Cannot Do …
As Robert Murphy pointed out last week, yet another example of 'mission creep' at the Fed has recently surfaced. As readers are probably aware, the Fed is one of the bureaucracies that are constantly rewarded for failure. In fact, it is a general rule of thumb that the greater the failure, the greater the subsequent expansion of power that is granted to the bureaucracy concerned. Examples for this principle of statism abound – see e.g. the vast expansion of the budget and power of the national security bureaucracy after it failed so abjectly to avert the 9/11 attack.
It is similar with the Fed, the regulatory powers of which have been expanded greatly right after it presided over the biggest financial crash since 1929-1930. However, for some people this doesn't go far enough. The Fed should not only manipulate interest rates and the money supply and act as a kind of fox guarding the financial hen-house. As Bob Murphy relates, it is now argued that the Fed under Ms. Yellen's leadership should add credit dirigisme designed to 'save the planet' to its menu:
“I have referred to Ben Bernanke as the “FDR of central banking.” What I mean is that Bernanke not only instituted horrible economic policies, but he used the financial crisis to fundamentally transform the way Americans (and Earthlings more generally) view the role of the Federal Reserve. A recent Huffington Post article on Janet Yellen illustrates my case beautifully. The bio describes the writer, Mike Sandler, as a “climate change professional” (among other things). That should warm us up for his recommendations for incoming Fed chair Janet Yellen:
“On January 6, Janet Yellen will likely be confirmed as the next Chair of the Federal Reserve System. Her to-do list will be full of things like the interest rate, the bank bailouts, the unemployment rate, and in general, running the economy. Climate change would be an unexpected addition to that list, but the Fed Chair is in an important and rarely recognized position to to take action on the climate crisis.”
Sandler lists several ways that Yellen can tackle the “climate crisis,” but I don’t want to overwhelm you. Let’s look at just one of his suggestions:
“She can make a carbon cap a part of the Fed’s operations by tracking and requiring carbon reductions in the footprint of loans originated by Fed member banks. This could take the form of a declining number of annual allowances to banks that provide loans to the energy and oil industry. By connecting economic activity to greenhouse gas emissions, the Federal Reserve could create levers to allow for additional economic growth in low-carbon activities, while reining in high-carbon industries.”
Does everyone see the significance of this statement? Sandler wants the Fed chief to oversee commercial bank loans in order to micromanage specific industries. We have moved well beyond the idea of a Fed that promotes economic growth while trying to minimize the volatility of price inflation. Now we have “climate change professionals” telling the Fed chief to crack down on banks that make loans to industries that the writer thinks are emitting too much carbon dioxide. Finally, just to make sure that we throw out marginal cost/benefit analysis and view the issue in emotional terms, here is how Sandler ends his HuffPo piece:
“Janet Yellen will have unique powers over economic policy, and she can use her new powers to save the planet. To do so, she will need to add one more item to her 2014 to-do list.”