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.
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