Trump’s Election Win Shows That The Bank Bailouts And Quantitative Easing Have Failed

The bigger picture of the early 21st century follows: Western nations experienced a massive blowout bubble of leverage, irrational exuberance, and Hayekian pseudo-money creation.

Yet this money was not going to overwhelmingly productive causes. The real output of the Western world did not follow anything close to the ebullience of the financial markets. Without the growth and jobs needed to service the debt load, many of the debtors—including most famously subprime mortgage borrowers—defaulted.  And thus the securitized debt bubble burst when—in the midst of two large and expensive American wars—the animal spirits of the market turned to panic over debt defaults.

What followed was not, it turns out, enough to right the ship. In theory, when markets are frightened of the future and productive human and financial capital lies idle, government borrowing can re-employ these resources until the animal spirits of the market emerge from their slump. In my view, there are two key measures of this: unemployment, and interest rates on government borrowing. High unemployment rates signify idle human capital. Low interest rates signify idle financial capital.

But this balancing did not occur. Even as the Brown and Obama governments engaged in a degree of fiscal stimulus, voters were not won over by the logic of this, and austerian conservatives came to parliamentary power in both the United States and United Kingdom. Government purse strings tightened. Instead, stimulus came down to central banks, who kept interest rates super low, and used quantitative easing as a form of simulated rate cut to cut interest rates beyond the lower bound of zero.

In my view, the political collapse we have seen since in the last year in both the United Kingdom and United States illustrates that this was not enough. Moreover—and more importantly— the continuation of the low interest rate environment illustrates that this was not enough. If quantitative easing had been worked as intended, interest rates would surely have bounced back by now, rather than remaining depressed? Certainly you can make an argument that we are now in an era of depressed interest rates as a result of our ageing society, where rising numbers of retirees mean that demand for savings is outpacing demand for productive investment opportunities. There is certainly some truth in that view. But ultimately, that is just one of many facts that governments and central banks had to weigh in getting the economy back to normal after 2008.

And maybe more quantitative easing would have allowed the market to bounce back and renormalize faster. Somehow, I doubt it. Why? Because quantitative easing is a Rube Goldbergian form of stimulus. It is a matter of pushing on a string. It is leading the horse to water. But there is no guarantee that the horse will drink. And the horse—in this case, the market—has not drunk. Demand for productive investment has not recovered, in spite the fact that that the central banks have made it super cheap. So the banks that got access to the cheap financing just sat on the money, instead of using it productively.

There is a bigger picture here, and it is something that I referred to in 2011 as Japanization. To wit:

Essentially, in both the United States and Japan, credit bubbles fuelling a bubble in the housing market collapsed, leading to a stock market crash, and asset price slides, triggering deflation throughout the respective economies—much like after the 1929 crash. Policy makers in both countries—at the Bank of Japan, and Federal Reserve — set about reflating the bubble by helicopter dropping yen and dollars. Fundamental structural problems in the banking system that contributed to the initial credit bubbles—in both Japan and the United States—have not really ever been addressed. Bad businesses were never liquidated, which is why there has not been aggressive new growth. So Japan’s zombie banks, and America’s too big to fail monoliths blunder on.

They have now blundered on into full on systemic contagion. Unhappy voters have lashed out and thrown out incumbents—the European Union and David Cameron in Britain, and the Bush-Clinton dynasties in America.

Unhappiness with the economy is at the very core of this. There has already been a quite voluminous debate about whether or not Trumpism and Brexitism were fuelled by economic anxiety or whether they are a traditionalist cultural backlash against minorities. Such debates present a false dichotomy. If Trumpism and Brexitism were not about the state of the economy, why did they not occur when the economy was strong? Why did they suddenly start rising after a financial crisis in the presence of a depressed economy—just as they did in the 1930s during the Great Depression? Hitler did not come to power when Germany was economically strong. Mussolini did not come to power when Italy was economically strong. The reality is that economic weakness and economic anxiety open the door to cultural backlash, to anti-immigrant sentiments, and ultimately to white supremacy. People who feel that the economy is bad are primed to listen to scapegoating. Immigrants, rising foreign powers, and establishment politicians like David Cameron and Hillary Clinton provide easy targets.

However, even within the false dichotomy of anxiety vs backlash, there is substantial evidence that the Trumpist communities that were falling behind. A Gallup analysis in August of this year found that: “communities with worse health outcomes, lower social mobility, less social capital, greater reliance on social security income, and less reliance on capital income, predicts higher levels of Trump support”. Indeed, as Max Ehrenfreund and Jeff Guo of The Washington Post—who took the “it’s not economic anxiety” position—noted, “there does seem to be a relationship between economic anxiety and Trump’s appeal”, even if that relationship is not as simple as unemployed and poor people diving into Trump’s camp.

The same is true for the Brexiteers. As Ben Chu of The Independent notes: ” new research by the labour market economists Brian Bell and Stephen Machin… suggests the Leave vote tended to be bigger in areas of the country where wage growth has been weakest since 1997″.

The financial crisis of 2008 provided politicians with an opportunity to re-engineer the economic system to prevent these groups from falling behind so dramatically. The system failed, completely and utterly. Policy makers were in a position to re-design it. The financial system could have at very least been re-engineered to provide financing, training, and education to people in areas which lost out on manufacturing jobs thanks to automation and globalization.

Instead politicians capitulated utterly to Wall Street, and bailed out a fragile zombie system, as Japan did in the 1990s. The machine keeps blundering on, sitting on vast quantities of productive capital instead of setting it to work. Later, they set in place reforms like Dodd-Frank to shore up some of the fragilities in the banking system. These—in combination with the ongoing quantitative easing—may have prevented a financial crisis since 2008 (and Trump repealing such things may make the system much more fragile again). But that did not address the underlying problems. The fragility in the financial system was absorbed by the political system, and thus transferred into the political system. And now we reap the whirlwind of those choices, in the shape of a new nationalist populism that blames globalization, trade policies, and migration for the failures of Western politicians.

Trump already is setting his stand out as a builder and an investor in infrastructure, just as Hitler did.

As Keynes wrote in his introduction to The General Theory:

The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.

The laissez-faire West failed to implement his ideas and avoid an economic depression (albeit a relatively mild one compared to the 1930s) following 2008. Now proto-totalitarians like Trump will get their chance, instead.

The taper is finally here: What the Fed’s move means for the economy


Ben Bernanke, in his final press conference as chairman of the Federal Reserve, announced today that the central bank would be tapering asset purchases to $75 billion a month, down from $85 billion, which has been widely seen as a modest first step toward reducing the Fed’s outsized role in financial markets and the economy.

The move caught many economists by surprise — USA Today survey found that most economists polled said the Fed would maintain its current levels of quantitative easing, as the policy is known, before trimming down in January.

After the financial crisis in 2008, spooked investors started piling into low-risk assets like Treasuries, driving prices dramatically higher. The Fed’s aim in buying these assets was to take safe investments like Treasuries off the market, in order to encourage investors to take more risk and invest in higher-yielding and more productive ventures like stocks, equipment, and new employees.

The ultimate objective was more jobs, and more economic activity.

Read More At TheWeek.com

Can The Fed Taper?

The Taper Tapir

Back in June, I correctly noted that it was severely unlikely that the Federal Reserve would taper its asset buying programs in September. I based this projection on the macroeconomic indicators on which the Federal Reserve bases its decisions — unemployment, and inflation. The Federal Reserve has a mandate from Congress to delivery a monetary policy that results in full employment, and low and stable inflation. With consumer price inflation significantly below the Fed’s self-imposed 2% goal, and with the rate of unemployment relatively high — currently well over 7% — I saw very little chance of the Fed effectively tightening by reducing his asset purchases.

There exists another school of thought that also correctly noted that the Fed would not taper. This other school, however, believes that the Fed cannot ever taper and that the Fed will destroy the dollar before it ceases its monetary activism. This view is summarised by the Misesian economist Pater Tanebrarum:

While it is true that the liquidation of malinvested capital would resume if the monetary heroin doses were to be reduced, the only alternative is to try to engender an ‘eternal boom’ by printing ever more money. This can only lead to an even worse ultimate outcome, in the very worst case a crack-up boom that destroys the entire monetary system.

So the Misesian view appears to be that the Fed won’t stop buying because doing so would result in a mass liquidation, and so the Fed will print all the way to hyperinflation.

Since talk of a taper began, rates certainly spiked as the market began to price in a taper. How far would an actual taper have pushed rates up? Well, it’s hard to say. But given that banks now have massive capital buffers in the form of excess reserves — as well as a guaranteed lender-of-last-resort resource at the Fed — it is hard to believe that an end to quantitative easing now would push us back into the depths of post-Lehman liquidation. Certainly, in the year preceding the announcement of QE Infinity — when unemployment was higher, and bank balance sheets frailer — there was no such fall back into liquidation. What a taper certainly would have amounted to is a relative tightening in monetary policy at a time when inflation is relatively low (sorry Shadowstats) and when unemployment is still relatively and stickily high. Whether or not we believe that monetary policy is effective in bringing down unemployment or igniting inflation, it is very clear that doing such a thing would be completely inconsistent with the Federal Reserve’s mandate and stated goals.

Generally, I find monetary policy as a means to control unemployment as rather Rube Goldberg-ish. Unemployment is much easier reduced through direct spending rather than trusting in the animal spirits of a depressed market to deliver such a thing, especially in the context of widespread deleveraging. But that does not mean that the Fed can never tighten again. While the depression ploughs on, the Fed will continue with or expand its current monetary policy measures. Whether or not these are effective, as Keynes noted, in the long run when the storm is over the ocean is flat. If by some luck — a technology shock, perhaps — there was an ignition of stronger growth, and unemployment began to fall significantly, the Fed would not just be able to tighten, it would have to to quell incipient inflationary pressure. Without luck and while the recovery remains feeble, it is true that it is hard to see the Fed tightening any time soon. Janet Yellen certainly believes that the Fed can do more to fight unemployment. This could certainly mean an increase in monetary activism. If she succeeds and the recovery strengthens and unemployment moves significantly downward, then Yellen will come under pressure to tighten sooner. 

In the current depressionary environment, the hyperinflation that the Misesians yearn for and see the Fed pushing toward is incredibly unlikely. The deflationary forces in the economy are stunningly huge. Huge quantities of pseudo-money were created in the shadow banking system before 2008, which are now being extinguished. The Fed would have had to double its monetary stimulus simply to push the money supply up to its long-term trend line. Wage growth throughout the economy is very stagnant, and the flow of cheap consumer goods from the East continues. So Yellen has the scope to expand without fearing inflationary pressure. The main concerns for inflation in my view are entirely non-monetary — geopolitical shocks, and energy shocks. Yet with ongoing deleveraging, any such inflationary shocks may actually prove helpful by decreasing the real burden of the nominal debt. Tightening or tapering in response to such shocks would be quite futile.

Sooner or later, the Fed will feel that the unemployment picture has significantly improved. That could be at 5% or even 6% so long as the job creation rate is strongly growing. At that point — perhaps by 2015  — tapering can begin. Tapering may slow the recovery to some extent not least through expectations. And that may be a good thing, guarding against the outgrowth of bubbles.

Yet if another shock pushes unemployment up much further, then tapering will be off the table for a long time. Although Yellen will surely try, with the Fed already highly extended under such circumstances, the only effective option left for job creation will be fiscal policy.

Minsky, the Lucas Critique, & the Great Moderation

Last week, I noted that the post-2008 world had provided an astonishingly good test for Milton Friedman’s notion that stabilising M2 growth was an effective antidote for economic depressions. Bernanke stabilised M2 growth, yet the depressive effects such as elevated unemployment, elevated long-term unemployment, and depressed growth still appeared, although not to such a great extent as was experienced in the 1930s. Friedman-style macro-stabilisation may have succeeded in reducing the damage, but in terms of preventing the onset of a depression Friedman’s ideas failed.

Of course, the onset of the post-2008 era was in many ways also a failure of the previous regime, and its so-called Great Moderation. Ben Bernanke in 2004 famously noted that “one of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility”.  Bernanke saw successful monetary policy as a significant reason for this stabilisation:

The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. As Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002). Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.

Bernanke’s presumptive successor, Janet Yellen explained in 2009 that from a Minskian perspective, this drop in visible volatility was itself symptomatic of underlying troubles beneath the surface:

One of the critical features of Minsky’s world view is that borrowers, lenders, and regulators are lulled into complacency as asset prices rise.It was not so long ago — though it seems like a lifetime — that many of us were trying to figure out why investors were demanding so little compensation for risk. For example, long-term interest rates were well below what appeared consistent with the expected future path of short-term rates. This phenomenon, which ended abruptly in mid-2007, was famously characterized by then-Chairman Greenspan as a “conundrum.” Credit spreads too were razor thin. But for Minsky, this behavior of interest rates and loan pricing might not have been so puzzling. He might have pointed out that such a sense of safety on the part of investors is characteristic of financial booms. The incaution that reigned by the middle of this decade had been fed by roughly twenty years of the so-called “great moderation,” when most industrialized economies experienced steady growth and low and stable inflation.

Minsky’s financial instability hypothesis can be thought of as an instance of the Lucas Critique applied to macro-stabilisation. Lucas’ contribution — earlier stated by Keynes — is that agents alter their behaviour and expectations in response to policy.  By enacting stabilisation policies, policy makers change the expectations and behaviour of economic agents. In the Minskian world, the promise and application of macro-stabilisation policies can lead to economic agents engaging in increasingly risky behaviour. A moderation is calm on the surface — strong growth, low inflation — but turbulent in the ocean deep where economic agents believing the hype of the moderation take risks they would otherwise not. In a Minskian world, these two things are not separate facts but deeply and intimately interconnected. Whichever way monetary policy swings, there will still be a business cycle. Only fiscal policy — direct spending on job creation that is not dependent on market mood swings — can bring down unemployment in such a context while the market recovers its lost panache.

The march of monetarists — following the lead of Scott Sumner — toward nominal GDP targeting, under which the central bank would target a level of nominal GDP, is a symptom of Friedman’s and the Great Moderation’s failure. If stabilising M2 growth had worked, nobody would be calling for stabilising other monetary aggregates like M4 growth, or stabilising the nominal level of economic activity in the economy. Sumner believes by definition, I think, that the policies enacted by Bernanke following 2008 were “too tight”, and that much more was needed.

Of course, what the NGDP targeters seem to believe is that they can have their Great Moderation after all if only they are targeting the right variable. This view is shared by other groups, with varying clinical pathways. Followers of von Mises’ business cycle theory believe that an uninhibited market will not exhibit a business cycle, as they believe that the business cycle is a product of government artificially suppressing interest rates. Minsky’s financial instability hypothesis and its notion that stability is destabilising is a slap in the face to all such moderation hypotheses. The more successful the moderation, the more economic agents will gradually change their behaviour to engage in increasingly risky activities, and the more bubbles will form, eventually destabilising the system once again. Markets are inherently tempestuous.

Or at least that is the theory. It would be nice to see empirical confirmation that the moderation produced by Sumnerian NGDP targeting is just as fragile and breakable as the Great Moderation. Which, of course, requires some monetary regimes somewhere to practice NGDP targeting.

Can Tightening Fight the Collateral Shortage?

Tyler Durden of Zero Hedge claims that any taper in QE will be a response to the collateral shortage — the fact that quantitative easing has stripped an important part of the market’s collateral base for rehypothecation out of the market. With less collateral in the market, there is less of a base for credit creation. The implication here is that quantitative easing is tightening rather than easing credit conditions. The evidence? Breakdown in the Treasuries market resulting in soaring fails-to-deliver and fails-to-receive:

20130621_fails_0

Tyler notes:

Simply put, the main reason the Fed is tapering has nothing to do with the economy and everything to do with the TBAC presentation (rehypothecation and collateral shortages) and that the US is now running smaller deficits!!!

I don’t disagree with this. The ultra-low rate environment (that is still an ultra-low rate environment in spite of the small spike in Treasuries since murmurs of the taper began) on everything from Treasuries to junk bonds is symptomatic of a collateral shortage. Quantitative easing may ease the base money supply (as an anti-deflationary response to the ongoing deflation of the shadow money supply since 2008), but it tightens the supply of collateral.

The evidence on this is clear — expanding government deficits post-2008 did not bridge the gap in securities issuance that the financial crisis and central bank interventions created:

assets

The obvious point, at least to me, is that it seems easier and certainly less Rube Goldberg-esque to fight the collateral shortage by running bigger Federal deficits until private market securities issuance can take its place. Unfortunately quantitative easing itself is something of a Rube Goldberg machine with an extremely convoluted transmission mechanism, and fiscal policy is not part of the Fed’s mandate.

But I am not sure that tightening can fight the collateral shortage at all. The money supply is still shrunken from the pre-crisis peak (much less the pre-crisis trend) even after all the quantitative easing. Yes, many have talked of the Federal Reserve inflating the money supply, but the broadest measures of the money supply are smaller than they were before the quantitative easing even started. This deflation is starting to show up in price trends, with core PCE falling below 1% — its lowest level in history. Simply, without the meagre inflation of the money supply that quantitative easing is providing, steep deflation seems highly likely. I don’t think the Fed can stop.

The Fed Shrugs

Since talk of the taper started, interest rates have been gradually rising. When Bernanke talked about the possibility of tapering QE in mid 2014 so long as growth and unemployment remain on track, rates leapt to their highest level since 2011:

10-year-treasury-1

A simple supply-demand analysis of Treasuries says that if the Fed buys less, ceteris paribus the price will fall and rates will rise. The Fed is implying it will buy less, and lo and behold markets are selling off on expectations that future demand will be lower. The analysis of those who say that quantitative easing is raising interest rates seems increasingly dubious to me.

The alternative analysis is that rates are rising on sentiment that the economy is improving. I wouldn’t rule that out, but the trouble is that the economy is still deeply depressed. GDP is still far below its pre-crisis trend. Broad monetary aggregates are still massively deflated. Lots and lots of working-age people who were working before 2008 still haven’t returned to the labour force:

062013krugman1-blog480

So while equities have returned to their pre-crisis heights — unsurprisingly, after all the financial sector is the Fed’s monetary transmission mechanism — the real economy, broadly speaking, hasn’t.

So it’s surprising to me that there is any talk of tapering. Headline unemployment is still 7.5%, and core inflation is just 1%, 1% below the Federal Reserve’s self-imposed target. Bernanke referred to disinflationary and deflationary forces in the economy as “transitory”, but any such diagnosis would seem to be the height of naïveté. The deflation of the shadow money supply and broad monetary aggregates is an ongoing structural transformation in the post-shadow-banking-bubble world. There is nothing “transitory” about it. If inflation was 3% or 4% and unemployment was below 6%, then talk of a taper would be expectable. Right now it just makes it seem like the Fed doesn’t have a clear framework. If QE3 was supposed to target unemployment, why is the Fed considering tapering when unemployment is still so high? Yes, the Fed’s internal DSGE models are saying that unemployment will continue to fall. Of course they do — these models have assumptions of clearing labour markets built into them! But right now inflation is below-mandate and unemployment is above mandate. Assuming away current conditions with the term “transitory” is basically saying that when the storm is long past the ocean is flat again.

Of course, at the zero-bound I think the Fed’s transmission mechanisms are relatively powerless in terms of any ability to stimulate employment or growth. It has taken the horse to water, but the horse hasn’t drunk. What the Fed can control with balance sheet monetary policy is interest rates on assets it buys. By shrugging, the Fed is signalling for a rise in government borrowing costs. That may be extremely premature.

Ben Bernanke Is Right About Interconnective Innovation

2013-05-18T152144Z_1_CBRE94H16OD00_RTROPTP_2_USA

I’d just like to double down on Ben Bernanke’s comments on why he is optimistic about the future of human economic progress in the long run:

Pessimists may be paying too little attention to the strength of the underlying economic and social forces that generate innovation in the modern world. Invention was once the province of the isolated scientist or tinkerer. The transmission of new ideas and the adaptation of the best new insights to commercial uses were slow and erratic. But all of that is changing radically. We live on a planet that is becoming richer and more populous, and in which not only the most advanced economies but also large emerging market nations like China and India increasingly see their economic futures as tied to technological innovation. In that context, the number of trained scientists and engineers is increasing rapidly, as are the resources for research being provided by universities, governments, and the private sector. Moreover, because of the Internet and other advances in communications, collaboration and the exchange of ideas take place at high speed and with little regard for geographic distance. For example, research papers are now disseminated and critiqued almost instantaneously rather than after publication in a journal several years after they are written. And, importantly, as trade and globalization increase the size of the potential market for new products, the possible economic rewards for being first with an innovative product or process are growing rapidly. In short, both humanity’s capacity to innovate and the incentives to innovate are greater today than at any other time in history.

My reasons for optimism for the long run are predominantly technological rather than social. I tend to see the potential for a huge organic growth in the long run resulting from falling energy and manufacturing costs from superabundant alternative energy sources like solar, synthetic petroleum, wind, and nuclear, as well as decentralised manufacturing through 3-D printing and ultimately molecular manufacturing.

But Bernanke’s reasons are pretty good too. I see it every day. Using Twitter, the blogosphere and various other online interfaces, I discuss and refine my views in the company a huge selection of people of various backgrounds. And we all have access to masses of data to backup or challenge our ideas. Intellectual discussions and disputes that might have taken years now take days or weeks — look at the collapse of Reinhart & Rogoff. Ideas, hypotheses, inventions and concepts can spread freely. One innovation shared can feed into ten or twenty new innovations. The internet has built a decentralised open-source platform for collaborative innovation and intellectual development like nothing the world has ever seen.

Of course, as the 2008 financial collapse as well as the more general Too Big To Fail problem shows greater interconnectivity isn’t always good news. Sometimes, greater interconnectivity allows for the transmission of the negative as well as the positive; in the case of 2008 the interconnective global financial system transmitted illiquidity in a default cascade.

But in this case, sharing ideas and information seems entirely beneficial both to the systemic state of human knowledge and innovation, and to individuals like myself who wish to hook into the human network.

So this is another great reason to be optimistic about the long run.